** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**Washington, DC 20549

 

**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
|           |
| **ý**     |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **For  the quarterly period ended August 31, 2003.** |
|           |   |   |
| **o**          |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **For the transition period from to** |

 

**Commission File Number:  000-24413**

 

| **TROY  GROUP, INC.**                                            |
|------------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)          |
|                                                             |
| **Delaware**                                                     | **33-0807798** |
| (State or other  jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |
|                                                             |   |
| **2331 South Pullman Street  Santa Ana, California**             | **92705** |
| (Address of  principal executive offices)                        | (Zip code) |
|                                                             |   |
| **(949) 250-3280**                                               |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.       Yes    ý     No   o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes  o     No   ý

 

As of September 30, 2003, 10,653,605 shares of theRegistrant’s Common Stock were outstanding. The aggregate market value of the Registrant’s outstanding common stockas of that date (based upon the last sale price of a share of common stock onthat date reported by the Nasdaq National Market), excluding outstanding sharesbeneficially owned by directors and executive officers, was $11,291,952.

 

 

----

 

**TROY GROUP, INC.**

**Quarterly Report on Form 10-Q for the**

**Quarterly Period Ended August 31,2003**

 

**INDEX**

 
| **PART I:   FINANCIAL INFORMATION** |
|------------------------------------------|
|                                     |
| Item 1.                                  | Financial Statements |
|                                     |   |
|                                     | Consolidated Balance Sheets  August 31, 2003 and November 30, 2002 |
|                                     |   |
|                                     | Consolidated Statements  of Operations for the  Three and Nine Months ended August 31, 2003 and 2002 |
|                                     |   |
|                                     | Consolidated Statements of Cash Flows for  the  Nine Months ended August 31, 2003 and 2002 |
|                                     |   |
|                                     | Notes  to Consolidated Financial Statements |
|                                     |   |
| Item 2.                                  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                     |   |
| Item  3.                                 | Quantitative  and Qualitative Disclosures About Market Risk |
|                                     |   |
| Item 4.                                  | Controls and Procedures |
|                                     |   |
| **PART II:  OTHER INFORMATION**     |
|                                     |
| Item  1.                                 | Legal  Proceedings |
|                                     |   |
| Item  2.                                 | Changes  in Securities and Use of Proceeds |
|                                     |   |
| Item 3.                                  | Defaults Upon  Senior Securities |
|                                     |   |
| Item  4.                                 | Submission  of Matters to a Vote of Security Holders |
|                                     |   |
| Item  5.                                 | Other  Information |
|                                     |   |
| Item 6.                                  | Exhibits and  Reports on Form 8-K |

 

2

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**PARTI:****  FINANCIALINFORMATION**

 

ITEM1 – FINANCIAL STATEMENTS

 

**TROY GROUP, INC.CONSOLIDATED BALANCE SHEETS**

 

**(inthousands, except per share amounts)**

 
|                                                                                                                                         |   | **August 31,  2003** |       | **November  30,  2002** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|------------|-------------------------|------------|
|                                                                                                                                         |   | **(Unaudited)**      |       |                    |       |
| **Assets**                                                                                                                                   |   |                 |       |                    |       |
| Current assets:                                                                                                                              |   |                 |       |                    |       |
| Cash and cash equivalents                                                                                                                    |   | $                    | 8,894      |                    | $          | 6,615 |   |
| Investment in available-for-sale securities                                                                                                  |   | —               |       | 497                     |       |
| Accounts receivable, less allowance for doubtful  accounts of $640 and $884                                                                  |   | 7,781                |       | 9,227                   |       |
| Income tax refund receivable                                                                                                                 |   | —               |       | 1,076                   |       |
| Inventories                                                                                                                                  |   | 5,331                |       | 5,540                   |       |
| Prepaid expenses and other                                                                                                                   |   | 724                  |       | 440                     |       |
| Deferred tax assets                                                                                                                          |   | 3,715                |       | 3,715                   |       |
| Total current assets                                                                                                                         |   | 26,445               |       | 27,110                  |       |
| Equipment and leasehold improvements, net                                                                                                    |   | 2,228                |       | 2,039                   |       |
| Other assets, including notes receivable from  stockholders $2,071 and $2,123                                                                |   | 4,130                |       | 4,390                   |       |
| Total assets                                                                                                                                 |   | $                    | 32,803     |                    | $          | 33,539 |   |
|                                                                                                                                         |   |                 |       |                    |       |
| **Liabilities  and Stockholders’ Equity**                                                                                               |   |                 | ** ** |                    | ** ** |
| Current liabilities:                                                                                                                         |   |                 |       |                    |       |
| Current portion of long-term debt                                                                                                            |   | $                    | 76         |                    | $          | 73 |   |
| Accounts payable                                                                                                                             |   | 2,296                |       | 4,138                   |       |
| Accrued expenses                                                                                                                             |   | 2,894                |       | 2,218                   |       |
| Deferred revenue                                                                                                                             |   | 1,124                |       | 1,364                   |       |
| Total current liabilities                                                                                                                    |   | 6,390                |       | 7,793                   |       |
| Long-term debt, net of current portion                                                                                                       |   | 64                   |       | 120                     |       |
| Stockholders’ equity:                                                                                                                   |   |                 |       |                    |       |
| Preferred stock, par value $.01 per share,  authorized 5,000,000 shares, issued none                                                         |   | —               |       | —                  |       |
| Common stock, par value $.01 per share; authorized  50,000,000 shares,issued  10,974,170  shares in 2003, and 10,969,657 shares in 2002 |   | 110                  |       | 110                     |       |
| Additional paid-in capital                                                                                                                   |   | 21,122               |       | 21,113                  |       |
| Retained earnings, including accumulated other  comprehensive income of$134 and none                                                         |   | 6,292                |       | 5,578                   |       |
|                                                                                                                                         |   | 27,524               |       | 26,801                  |       |
| Less cost of treasury stock – 320,565 common shares  in 2003 and 2002                                                              |   | 1,175                |       | 1,175                   |       |
| Total stockholders’ equity                                                                                                              |   | 26,349               |       | 25,626                  |       |
| Total liabilities and stockholders’ equity                                                                                              |   | $                    | 32,803     |                    | $          | 33,539 |   |

 

See Notes toConsolidated Financial Statements.

 

3

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**TROY GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

**(in thousands, except per shareamounts)**

 

 
|                                   |   | **Three  Months Ended August 31,** |       | **Nine  Months Ended August 31,** |       |
|----------------------------------------|--------|------------------------------------|------------|-----------------------------------|------------|
|                                   |   | **2003**                           |       | **2002**                          |       | **2003** |   | **2002** |   |
|                                   |   |                               | ** ** |                              | ** ** |   | ** ** |   | ** ** |
| Net sales                              |   | $                                  | 14,671     |                              | $          | 13,649 |   | $ | 42,474 |   | $ | 41,245 |   |
| Cost of goods sold                     |   | 9,636                              |       | 10,314                            |       | 26,267 |   | 26,958 |   |
| Gross profit                           |   | 5,035                              |       | 3,335                             |       | 16,207 |   | 14,287 |   |
|                                   |   |                               |       |                              |       |   |   |   |   |
| Operating expenses:                    |   |                               |       |                              |       |   |   |   |   |
| Selling, general and administrative    |   | 3,590                              |       | 3,415                             |       | 11,302 |   | 11,282 |   |
| Research and development               |   | 1,265                              |       | 1,696                             |       | 3,957 |   | 5,221 |   |
| Amortization of intangible assets      |   | 11                                 |       | 30                                |       | 33 |   | 90 |   |
| Operating income (loss)                |   | 169                                |       | (1,806                            | )          | 915 |   | (2,306 | ) |
|                                   |   |                               |       |                              |       |   |   |   |   |
| Interest income                        |   | 13                                 |       | 17                                |       | 39 |   | 96 |   |
| Interest expense                       |   | (1                                 | )          | (3                                | )          | (9 | ) | (33 | ) |
| Income (loss) before income taxes      |   | 181                                |       | (1,792                            | )          | 945 |   | (2,243 | ) |
| Provision for income taxes (credits)   |   | 74                                 |       | (627                              | )          | 366 |   | (786 | ) |
| Net income (loss)                      |   | $                                  | 107        |                              | $          | (1,165 | ) | $ | 579 |   | $ | (1,457 | ) |
|                                   |   |                               |       |                              |       |   |   |   |   |
| Net income (loss) per share:           |   |                               |       |                              |       |   |   |   |   |
| Basic                                  |   | $                                  | .01        |                              | $          | (.11 | ) | $ | .05 |   | $ | (.14 | ) |
| Diluted                                |   | $                                  | .01        |                              | $          | (.11 | ) | $ | .05 |   | $ | (.14 | ) |
|                                   |   |                               |       |                              |       |   |   |   |   |
| Shares used in per share computations: |   |                               |       |                              |       |   |   |   |   |
| Basic                                  |   | 10,653                             |       | 10,649                            |       | 10,651 |   | 10,646 |   |
| Diluted                                |   | 10,653                             |       | 10,649                            |       | 10,651 |   | 10,646 |   |

 

See Notes toConsolidated Financial Statements.

 

4

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**TROY GROUP, INC.**

**CONSOLIDATEDSTATEMENTSOF CASH FLOWS**

**(Unaudited)**

**(inthousands)**

 
|                                                                                      |   | **Nine  Months Ended August 31,** |       |
|-------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                      |   | **2003**                          |       | **2002** |   |
|                                                                                      |   |                              | ** ** |   | ** ** |
| Cash flows from operating activities:                                                     |   |                              |       |   |   |
| Net income (loss)                                                                         |   | $                                 | 579        |   | $ | (1,457 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |   |                              |       |   |   |
| Depreciation and amortization                                                             |   | 889                               |       | 980 |   |
| Provision for (recovery of) doubtful accounts                                             |   | 130                               |       | (212 | ) |
| Loss on disposal of furniture                                                             |   | 99                                |       | — |   |
| Accrued interest on available for sale securities                                         |   | —                            |       | (85 | ) |
| Changes in working capital components: (Increase)  decrease in:                           |   |                              |       |   |   |
| Accounts receivable                                                                       |   | 1,316                             |       | 2,526 |   |
| Income tax refund receivable                                                              |   | 1,076                             |       | (314 | ) |
| Inventories                                                                               |   | 209                               |       | 2,116 |   |
| Prepaid expenses and other                                                                |   | (284                              | )          | (449 | ) |
| Increase (decrease) in:                                                                   |   |                              |       |   |   |
| Accounts payable                                                                          |   | (1,842                            | )          | (1,927 | ) |
| Accrued expenses                                                                          |   | 784                               |       | (103 | ) |
| Deferred revenue                                                                          |   | (240                              | )          | (167 | ) |
| Net cash provided by operating activities                                                 |   | 2,716                             |       | 908 |   |
| Cash flows from investing activities:                                                     |   |                              |       |   |   |
| Purchase of equipment and leasehold improvements                                          |   | (936                              | )          | (302 | ) |
| Purchase of available-for-sale securities                                                 |   | —                            |       | (1,449 | ) |
| Maturities of available-for-sale securities                                               |   | 497                               |       | 5,393 |   |
| Increase in other assets, net                                                             |   | 46                                |       | (319 | ) |
| Net cash provided by (used in) investing activities                                       |   | (393                              | )          | 3,323 |   |
| Cash flows from financing activities:                                                     |   |                              |       |   |   |
| Payments on notes payable                                                                 |   | (53                               | )          | (52 | ) |
| Proceeds from issuance of common stock                                                    |   | 9                                 |       | 149 |   |
| Purchase of treasury stock                                                                |   | —                            |       | (79 | ) |
| Net cash provided by (used in) financing activities                                       |   | (44                               | )          | 18 |   |
| Net increase in cash and cash equivalents                                                 |   | 2,279                             |       | 4,249 |   |
| Cash and cash equivalents, beginning of period                                            |   | 6,615                             |       | 1,210 |   |
| Cash and cash equivalents, end of period                                                  |   | $                                 | 8,894      |   | $ | 5,459 |   |

 

See Notes toConsolidated Financial Statements.

 

5

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**TROY GROUP, INC.**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

(unaudited)

 

**Note 1.  Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q and Article 10 of RegulationS-X.  Accordingly, they do not includeall of the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring accruals and adjustments) considered necessary for a fairpresentation have been included. Operating results for the three and nine months ended August 31, 2003are not necessarily indicative of the results that may be expected for the yearending November 30, 2003.  For furtherinformation, refer to the consolidated financial statements and footnotesthereto included in the Company’s Annual Report on Form 10-K for its fiscalyear ended November 30, 2002 (File No. 000-24413).

 

Statementof Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-BasedCompensation,” as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition and Disclosure,” prescribes accounting and reportingstandards for all stock-based compensation plans, including employee stockoption plans. As allowed by SFAS No. 123, the Company has elected to continueto account for its employee stock-based compensation plan using the intrinsicvalue method in accordance with Accounting Principles Board (APB) Opinion No.25, “Accounting for Stock Issued to Employees,” and related Interpretations,which does not require compensation to be recorded if the consideration to bereceived is at least equal to the fair value of the common stock to be receivedat the measurement date. Under the requirements of SFAS No. 123, non-employeestock-based transactions require compensation to be recorded based on the fairvalue of the securities issued or the services received, whichever is morereliably measurable.

 

Thefollowing table illustrates the effect on net income (loss) and net income(loss) per share had compensation costs for the stock-based compensation planbeen determined based on grant date fair values of awards under the provisionsof SFAS No. 123, for the three-month and nine-month periods ended August 31(unaudited; in thousands, except per share data):

 

6

----

 
|                                                                                                                                      |   | **Three  months ended August 31,**                  |   | **Nine  months ended August 31,**                   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------|--------|-----------------------------------------------------|--------|
|                                                                                                                                      |   | **(amounts  in thousands, except  per share data)** |   | **(amounts  in thousands, except  per share data)** |   |
|                                                                                                                                      |   | **2003**                                            |   | **2002**                                            |   | **2003** |   | **2002** |   |
|                                                                                                                                      |   |                                                |   |                                                |   |   |   |   |   |
| Net income (loss) applicable to common stockholders

As reported                                                                          |   | $                                                   | 107    |                                                | $      | (1,165 | ) | $ | 579 |   | $ | (1,457 | ) |
|                                                                                                                                      |   |                                                |   |                                                |   |   |   |   |   |
| Less total stock-based employee compensation expense  determined under fair value-based method for all awards, net of related tax effects |   | (99                                                 | )      | (178                                                | )      | (301 | ) | (609 | ) |
| Proforma                                                                                                                                  |   | $                                                   | 8      |                                                | $      | (1,343 | ) | $ | 278 |   | $ | (2,066 | ) |
|                                                                                                                                      |   |                                                |   |                                                |   |   |   |   |   |
| Net income (loss) per share applicable to common  stockholders, basic and diluted                                                         |   |                                                |   |                                                |   |   |   |   |   |
| As reported                                                                                                                               |   | $                                                   | .01    |                                                | $      | (.11 | ) | $ | .05 |   | $ | (.14 | ) |
| Proforma                                                                                                                                  |   | $                                                   | — |                                                | $      | (.13 | ) | $ | .03 |   | $ | (.19 | ) |

 

Certainreclassifications have been made to the income statement with no effect on netincome or stockholders equity.

** **

**Note 2.  Inventories**

 

Inthe third quarter of fiscal 2003, the Company adjusted the inventory reservefor the wireless and connectivity products from a projected one-year usage to aprojected six-month usage to more closely match the risk from changes in thetechnology of the product components. As a result, the inventory reserve was increased by $381,000, and netincome was reduced by $229,000.

 

Inventoriesconsisted of the following as of August 31, 2003 and November 30, 2002 (amountsin thousands):

 
|                                             |   | **August 31,  2003  unaudited** |   | **November  30, 2002** |   |
|--------------------------------------------------|--------|---------------------------------|--------|------------------------|--------|
| Raw materials                                    |   | $                               | 5,038  |                   | $      | 5,136 |   |
| Work-in-process                                  |   | 687                             |   | 205                    |   |
| Finished goods                                   |   | 2,902                           |   | 4,112                  |   |
| Reserve for slow moving and obsolete inventories |   | (3,296                          | )      | (3,913                 | )      |
| Total                                            |   | $                               | 5,331  |                   | $      | 5,540 |   |

 

**Note 3.  Goodwill and Intangible Assets**

 

The Company adopted SFAS No. 142 effective December 1, 2002and performed the initial transitional impairment test as of that date. Theprovisions of SFAS No. 142 require that the Company allocate its goodwillto its various reporting units, determine the carrying value of thosebusinesses, and estimate the fair value of the reporting units so that atwo-step goodwill impairment test can be performed. The Company’s reportingunits are consistent with its operating segments, which are the same as thereportable segments, identified in Note 6. In the first step of thegoodwill impairment test, the fair value of each reporting unit is compared toits carrying value. If the fair value exceeds the carrying value, goodwill isnot impaired and no further testing is performed. If the carrying value exceedsthe fair value,

 

7

----

 

thenthe second step must be performed, and the implied fair value of the reportingunit’s goodwill must be determined and compared to the carrying value of thegoodwill for the reporting unit. If the carrying value of a reporting unit’sgoodwill exceeds its implied fair value, then an impairment loss equal to thedifference is recorded.

 

Thefair value of the Company’s reporting units was determined using the incomeapproach under which the fair value of a reporting unit is calculated based onthe present value of estimated future cash flows. Based on the results of itstransitional impairment test, the Company has determined that no impairment ofgoodwill existed as of December 1, 2002. However, future goodwill impairmenttests could result in a charge to earnings. The Company will continue toevaluate goodwill on an annual basis as of the beginning of the fourth quarter,and whenever events and changes in circumstances indicate that there may be apotential impairment.

 

TheCompany’s intangible assets subject to amortization at August 31, 2003 andNovember 30, 2002 are composed of (amounts in thousands):

 
|                                 |   | **Weighted  Average  Remaining Life** |      | **August 31, 2003  unaudited** |                          | **November 30, 2002** |    |
|--------------------------------------|--------|---------------------------------------|-----------|--------------------------------|-------------------------------|-----------------------|---------|
|                                 |   |                                  | **Gross** |                           | **Accumulated  Amortization** |                  | **Net** |   | **Gross** |   | **Accumulated  Amortization** |   | **Net** |   |
| Customer Lists                       |   | 2  years                              |      | $                              | 25                            |                  | $       | (19 | ) | $ | 6 |   | $ | 25 |   | $ | (16 | ) | $ | 9 |   |
| Core Technology                      |   | 6  years                              |      | 392                            |                          | (162                  | )       | 230 |   | 392 |   | (132 | ) | 260 |   |
| Total amortizable intangible  assets |   |                                  |      | $                              | 417                           |                  | $       | (181 | ) | $ | 236 |   | $ | 417 |   | $ | (148 | ) | $ | 269 |   |

 

Amortizationexpense related to intangible assets was $11,000 and $30,000 for thethree-month periods and $33,000 and $90,000 for the nine-month periods endedAugust 31, 2003 and 2002, respectively.

 

Estimatedfuture amortization expense related to purchased intangible assets at August31, 2003 is as follows:

 
| **Fiscal  year:**         |   | **(In thousands)** |   |
|---------------------------|--------|--------------------|--------|
| 2003 (Remaining 3 months) |   | $                  | 11     |   |
| 2004                      |   | 44                 |   |
| 2005                      |   | 42                 |   |
| 2006                      |   | 40                 |   |
| 2007                      |   | 40                 |   |
| Thereafter                |   | 59                 |   |
| Total                     |   | $                  | 236    |   |

 

8

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On December 1, 2002 the Company completed theallocation of goodwill (including amounts previously classified as assembledworkforce) to its reportable segments as part of its transitional impairmenttest. Goodwill allocated to the Company’s reportable segments as of November30, 2002 and changes in the carrying amount of goodwill for the nine-monthperiod ended August 31, 2003 are as follows (amounts in thousands):

 
|                                                               |   | **Wireless &  Connectivity** |   | **Security Printing  Solutions** |   | **Total** |   |
|--------------------------------------------------------------------|--------|----------------------------------|--------|----------------------------------|--------|-----------|--------|
|                                                               |   |                             |   |                             |   |      |   |
| Balance at November 30,  2002                                      |   | $                                | — |                             | $      | 235       |   | $ | 235 |   |
|                                                               |   |                             |   |                             |   |      |   |
| Goodwill adjustment for  previously classified assembled workforce |   | —                           |   | 46                               |   | 46        |   |
| Balance at August 31,  2003                                        |   | $                                | — |                             | $      | 281       |   | $ | 281 |   |

 

If the provisions of SFAS No. 142 had beenin effect for all periods presented, the Company’s net income (loss) and netincome (loss) per share would have been as follows for the three- andnine-month periods ended August 31, 2003 and 2002: 

 
|                                                          |   | **Three months ended August 31,**                   |   | **Nine months ended August 31,**                       |   |
|---------------------------------------------------------------|--------|-----------------------------------------------------|--------|--------------------------------------------------------|--------|
|                                                          |   | **(amounts in thousands, except   per share data)** |   | **(amounts in thousands, except per share data)** |   |
|                                                          |   | **2003**                                            |   | **2002**                                               |   | **2003** |   | **2002** |   |
|                                                          |   |                                                |   |                                                   |   |   |   |   |   |
| Net income (loss):                                            |   |                                                |   |                                                   |   |   |   |   |   |
| As reported                                                   |   | $                                                   | 107    |                                                   | $      | (1,165 | ) | $ | 579 |   | $ | (1,457 | ) |
|                                                          |   |                                                |   |                                                   |   |   |   |   |   |
| Add back amortization  of goodwill, net of taxes              |   | —                                              |   | 13                                                     |   | —— |   | 34 |   |
| Net income (loss), as  adjusted                               |   | $                                                   | 107    |                                                   | $      | (1,152 | ) | $ | 579 |   | $ | (1,423 | ) |
|                                                          |   |                                                |   |                                                   |   |   |   |   |   |
| Net income (loss) per  share, basic and diluted               |   |                                                |   |                                                   |   |   |   |   |   |
| As reported                                                   |   | $                                                   | .01    |                                                   | $      | (.11 | ) | $ | .05 |   | $ | (.14 | ) |
| Add back amortization  of goodwill, net of taxes              |   | —                                              |   | —                                                 |   | — |   | — |   |
| Net income (loss) per  share, basic and diluted, net of taxes |   | $                                                   | .01    |                                                   | $      | (.11 | ) | $ | .05 |   | $ | (.14 | ) |

 

9

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**Note4.  Stock Option and Stock Warrant Plans**

 

During the nine months ended August 31, 2003, theCompany did not grant any options to employees. The following is a summary oftotal outstanding options and stock warrants at August 31, 2003:

 
|                          |   | **Options  and Warrants Outstanding** |   | **Options and Warrants Exercisable**   |   |
|-------------------------------|--------|---------------------------------------|--------|----------------------------------------|--------|
| **Range of  Exercise Prices** |   | **Number of  Shares**                 |   | **Weighted-  Average  Exercise Price** |   | **Weighted-  Average  Remaining   Contractual Life** |   | **Number of  Shares** |   | **Weighted-  Average  Exercise Price** |   |
| $2.85 – 4.51             |   | 662,666                               |   | $                                      | 3.93   |   | 6.8 years |   | 359,456 |   | $ | 3.78 |   |
| 6.31 – 8.75              |   | 486,000                               |   | 7.31                                   |   | 5.8 years |   | 394,821 |   | 7.30 |   |
| 13.16 – 14.25            |   | 15,000                                |   | 13.52                                  |   | 6.3 years |   | 4,999 |   | 13.52 |   |
|                          |   | 1,163,666                             |   |                                   |   |   |   | 759,276 |   |   |   |
|                               |        |                                       |        |                                        |        |  |  |  |  |  |  |  |  |

 

At August 31, 2003, there were 1,688,000 shares remaining available forgrant under the Company’s option plans.

 

**Note 5.  Net Income (Loss) Per Share**

 

The following table sets forth the computation ofbasic and diluted net loss per share:

 
|                                                                                          |   | **Three months ended August 31,**                   |   | **Nine months ended August 31,**                       |   |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------------------------------|--------|--------------------------------------------------------|--------|
|                                                                                          |   | **(amounts in thousands, except   per share data)** |   | **(amounts in thousands, except per share data)** |   |
|                                                                                          |   | **2003**                                            |   | **2002**                                               |   | **2003** |   | **2002** |   |
| Numerator for basic and  diluted net income (loss) per share:                                 |   |                                                |   |                                                   |   |   |   |   |   |
|                                                                                          |   |                                                |   |                                                   |   |   |   |   |   |
| Net income (loss)                                                                             |   | $                                                   | 107    |                                                   | $      | (1,165 | ) | $ | 579 |   | $ | (1,457 | ) |
|                                                                                          |   |                                                |   |                                                   |   |   |   |   |   |
| Denominator for basic  net income (loss) per share – weighted-average shares outstanding |   | 10,653                                              |   | 10,649                                                 |   | 10,651 |   | 10,646 |   |
| Effect of employee  stock options and warrants                                                |   | —                                              |   | —                                                 |   | — |   | — |   |
| Denominator for diluted  net income (loss)  per share                                    |   | 10,653                                              |   | 10,649                                                 |   | 10,651 |   | 10,646 |   |
|                                                                                          |   |                                                |   |                                                   |   |   |   |   |   |
| Net income (loss) per  share:                                                                 |   |                                                |   |                                                   |   |   |   |   |   |
|                                                                                          |   |                                                |   |                                                   |   |   |   |   |   |
| Basic                                                                                         |   | $                                                   | .01    |                                                   | $      | (.11 | ) | $ | .05 |   | $ | (.14 | ) |
| Diluted                                                                                       |   | $                                                   | .01    |                                                   | $      | (.11 | ) | $ | .05 |   | $ | (.14 | ) |

 

**Note6.  Segment Information**

 

The following tables summarize net sales and netincome (loss) by the Company’s operating segments, Security Printing Solutionsand Wireless and Connectivity, and unallocated corporate for the three and ninemonths ended August 31, 2003 and 2002:

 

10

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|                         |   | **Three months ended August 31,** |   | **Nine months ended August 31,** |   |
|------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
|                         |   | **(amounts in thousands)**        |   | **(amounts in thousands)**       |   |
|                         |   | **2003**                          |   | **2002**                         |   | **2003** |   | **2002** |   |
| Net sales:                   |   |                              |   |                             |   |   |   |   |   |
|                         |   |                              |   |                             |   |   |   |   |   |
| Security Printing  Solutions |   | $                                 | 10,819 |                             | $      | 10,547 |   | $ | 31,257 |   | $ | 32,134 |   |
| Wireless and  Connectivity   |   | 3,852                             |   | 3,157                            |   | 11,217 |   | 9,314 |   |
| Less intersegment  revenue   |   | —                            |   | (55                              | )      | — |   | (203 | ) |
|                         |   | $                                 | 14,671 |                             | $      | 13,649 |   | $ | 42,474 |   | $ | 41,245 |   |
|                         |   |                              |   |                             |   |   |   |   |   |
| Net income (loss):           |   |                              |   |                             |   |   |   |   |   |
|                         |   |                              |   |                             |   |   |   |   |   |
| Security Printing  Solutions |   | $                                 | 1,292  |                             | $      | 379 |   | $ | 4,028 |   | $ | 2,914 |   |
| Wireless and Connectivity    |   | (460                              | )      | (813                             | )      | (157 | ) | (2,068 | ) |
| Unallocated Corporate        |   | (725                              | )      | (731                             | )      | (3,292 | ) | (2,303 | ) |
|                         |   | $                                 | 107    |                             | $      | (1,165 | ) | $ | 579 |   | $ | (1,457 | ) |

 

Certain reclassifications have been made to the August31, 2002 segment information to conform to the August 31, 2003 presentation(amounts in thousands).

 
|                         |   | **August 31, 2003** |   | **November 30, 2002** |   |
|------------------------------|--------|---------------------|--------|-----------------------|--------|
| Segment Assets:              |   |                |   |                  |   |
|                         |   |                |   |                  |   |
| Security Printing  Solutions |   | $                   | 11,072 |                  | $      | 11,637 |   |
| Wireless and  Connectivity   |   | 10,875              |   | 10,339                |   |
| Unallocated Corporate        |   | 17,524              |   | 24,478                |   |
|                         |   | $                   | 39,471 |                  | $      | 46,454 |   |

 

The following schedule is presented to reconcileAugust 31, 2003 and November 30, 2002 segment assets to the amounts reported inthe Company’s consolidated financial statements (amounts in thousands).

 
|                                 |   | **August 31, 2003** |   | **November 30, 2002** |   |
|--------------------------------------|--------|---------------------|--------|-----------------------|--------|
| Total assets of  reportable segments |   | $                   | 39,471 |                  | $      | 46,454 |   |
| Intersegment  receivables            |   | (6,434              | )      | (12,681               | )      |
| Investment in  subsidiaries          |   | (234                | )      | (234                  | )      |
| Consolidated assets                  |   | $                   | 32,803 |                  | $      | 33,539 |   |

 

**Note7.  Cash Flow Information**

 

Supplemental disclosure of cash flowinformation

 

|                              |   | **Nine months ended**      |   |
|-----------------------------------|--------|----------------------------|--------|
|                              |   | **(amounts in thousands)** |   |
|                              |   | **August 31, 2003**        |   | **August 31, 2002** |   |
| Cash paid during the  period for: |   |                       |   |   |   |
| Interest                          |   | $                          | 8      |   | $ | 46 |   |
| Income taxes                      |   | $                          | 513    |   | $ | 13 |   |

 

11

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**ITEM 2.**

 

**MANAGEMENT’SDISCUSSION AND ANALYSIS OF**

**FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

The following discussion and analysis should be readin conjunction with our Consolidated Financial Statements and related Notesincluded in this report.  This reportcontains forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. The statements contained in this report that are not historical innature, particularly those that utilize terminology such as “may,” “will,”“should,” “expects,” “anticipates,” “estimates,” “believes” or “plans,” orcomparable terminology, are forward-looking statements based on currentexpectations and assumptions.

 

Various risks anduncertainties could cause actual results to differ materially from thoseexpressed in forward-looking statements. These risks and uncertainties include our ability to consolidateoperations and reduce costs; the continued demand for printed financialdocuments; our ability to offset the expected decline in sales of our wiredconnectivity products; the success of the measures we implemented to addressinventory accounting controls; the market acceptance of products incorporatingwireless printing technologies; our ability to hire and retain qualifiedmanagement, technology and other personnel; the impact of competition fromexisting and new technologies and companies; and the other factors set forth inour annual report on Form 10-K under the heading “Certain Important Factors”and in our other periodic reports and other documents that we file from time totime with the Securities and Exchange Commission.

 

We own or have rights to trademarks that we use inconnection with the sale of our products. TROY®, *e*Check SecureTM, PrintraNetTM, TROYmarkTM,  StarACHTM, EtherwindTM, WindconnectTM,WindportTM, EtherSyncTM, Exact MICR TechnologyTM (ExMTTM) and Exact PositioningTechnologyTM (ExPTTM) are among the trademarks that we own.  This report also makes reference totrademarks and trade names of other companies.

 

# **Recent Developments**

# ** **

On September 18, 2003,TROY Group, Inc. (“TROY”) announced that its stockholders had votedagainst approval of the merger agreement between TROY and Dirk Inc., a companycontrolled by Patrick J. Dirk, the founder of TROY, and his family members,pursuant to which Mr. Dirk and his family members would have acquired theoutstanding shares of TROY common stock that they do not already own at a priceof $2.76 per share in cash.

 

AlthoughMr. Dirk and his family members had sufficient share ownership to approve themerger agreement under applicable law, the merger agreement was alsoconditioned on the affirmative vote of the holders of a majority of the sharescast either “for” or “against” the merger agreement, excluding the shares heldby Mr. Dirk and his family members and the officers and directors of TROY.  At a special meeting of stockholders held onSeptember 18, 2003, these “unaffiliated stockholders” voted against approval ofthe merger agreement.  Following thisspecial meeting of stockholders, the Board of Directors of TROY terminated themerger agreement and dissolved the Special Committee.

 

12

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## **Background**

## ** **

TROY Group, Inc. is a worldwide provider of enterpriseoutput solutions, which include products and services for enterprises orbusinesses, that are used in producing an output in a process. For the pastthree years we have been expanding beyond our core business in digital checkprinting systems and related consumables by developing electronic paymentsystems and wired and wireless print servers and networking solutions.  Most of this new product expansion wasaccomplished through the acquisition and further investment in five smalltechnology companies.  Theseacquisitions have been organized under the two primary business segments:  Security Printing Solutions (previously TROYSystems) and Wireless and Connectivity Solutions (previously TROY Wireless).

 

Security Printing Solutions provides state-of-the-artpayment systems ranging from high security digital check printing systems toelectronic payment and funds transfer solutions.  Our systems are used to transfer funds between bank accountsusing paper checks or electronic ACH (Automated Clearing House) processes.  Our products provide our customers withpayment solutions that offer security, speed, flexibility and efficiency.  Chase Manhattan, Citigroup, Del Monte Foods,Deutsche Bank, Federal Express, The Federal Reserve, Fidelity Investments, GMACCommercial, Heinz USA, Hewlett Packard, IBM, Maersk Line Ltd., Marsh USA,Monsanto, NCR Corporation, Progressive Insurance, Safeway Stores, Unisys, VISAUSA, and Xerox are among the TROY customers that purchased payment productsduring the last 12 months.

 

Wireless and Connectivity Solutions provides hardwareand software solutions that enable enterprises to share intelligent deviceslike printers either wirelessly or using traditional networks.  We have been a supplier of hardwired networkprinting solutions since 1991.  Ourwireless products include several devices which exchange information via *Bluetooth*TMand 802.11b short-range radio connections. Brother Industries, Ltd., Seiko Epson Corporation and DaimlerChrysler AGare among the Wireless and Connectivity Solutions customers that have purchasedthese products during the last 12 months.

 

We serve a wide variety of industries, includingfinancial services, insurance, telecommunications, computer hardware,automotive, personnel, government and others. We distribute our solutions around the world and market our productsthrough a network of distributors and value-added resellers and a direct salesforce.  More than 5,000 customers havepurchased our products and services during the last 12 months.

 

In the first nine months of fiscal 2003, there were nocustomers who accounted for 10% of the Company’s net sales.

 

13

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**Resultsof Operations**

 

The following table sets forth, for the periodsindicated, certain information derived from our consolidated statements ofoperations expressed as a percentage of net sales:

 
|                                          |   | **Three Months Ended August 31,** |   | **Nine Months Ended August 31,** |   |
|-----------------------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
|                                          |   | **2003**                          |   | **2002**                         |   | **2003** |   | **2002** |   |
| Net sales                                     |   | 100.0                             | %      | 100.0                            | %      | 100.0 | % | 100.0 | % |
| Cost of goods sold                            |   | 65.7                              |   | 75.6                             |   | 61.8 |   | 65.4 |   |
| Gross profit                                  |   | 34.3                              |   | 24.4                             |   | 38.2 |   | 34.6 |   |
| Selling, general and  administrative expenses |   | 24.5                              |   | 25.0                             |   | 26.7 |   | 27.3 |   |
| Research and  development expenses            |   | 8.6                               |   | 12.4                             |   | 9.3 |   | 12.7 |   |
| Amortization of  intangible assets            |   | 0.1                               |   | 0.2                              |   | 0.1 |   | 0.2 |   |
| Operating income (loss)                       |   | 1.1                               |   | (13.2                            | )      | 2.1 |   | (5.6 | ) |
| Interest income                               |   | 0.1                               |   | 0.1                              |   | 0.1 |   | 0.2 |   |
| Interest expense                              |   | —                            |   | —                           |   | — |   | — |   |
| Income (loss) before  income taxes            |   | 1.2                               |   | (13.1                            | )      | 2.2 |   | (5.4 | ) |
| Provision for income  taxes (credits)         |   | 0.5                               |   | (4.6                             | )      | 0.9 |   | (1.8 | ) |
| Net income (loss)                             |   | 0.7                               | %      | (8.5                             | )%     | 1.3 | % | (3.6 | )% |

 

**ThreeMonths Ended August 31, 2003 Compared to Three Months Ended August 31, 2002**

 

*NetSales*.  Our net sales were $14.7 million for thethree months ended August 31, 2003, with $10.8 million attributable to SecurityPrinting Solutions and $3.9 million attributable to Wireless and ConnectivitySolutions.  Net sales in the threemonths ended August 31, 2003 increased by $1.0 million, or 7.5%, from $13.7million in the three months ended August 31, 2002.  The increase in sales was primarily due to a $0.7 millionincrease in sales of both wired and wireless and connectivity products and a$0.3 million increase in revenue from our StarACHTM software.  Although sales of our wired connectivityproducts increased in the third quarter of fiscal 2003, we anticipate thatsales of wired connectivity products, which constitute a significant portion ofour overall sales of Wireless and Connectivity Solutions, will decline as theseproducts are at or approaching end of life. Net sales were not significantly affected by price changes.

 

*Costof Goods Sold*.  Cost of goods sold decreased by $0.7million, or 6.6%, to $9.6 million in the three months ended August 31, 2003from $10.3 million in the three months ended August 31, 2002, primarily due tocost reductions from the consolidation of manufacturing facilities. Inventoryadjustments of $0.7 million and severance costs of $0.2 million in 2002 wereoffset by a $0.9 million increase in the inventory reserve in 2003.  Cost of goods sold as a percentage of netsales decreased to 65.7% in the three months ended August 31, 2003 from 75.6%in the three months ended August 31, 2002. Cost of goods sold as a percent of sales will fluctuate based on shiftsin the mix of products sold.

 

*GrossProfit*.  Gross profit increased by $1.7 million to$5.0 million in the three months ended August 31, 2003 from $3.3 million in thethree months ended August 31, 2002, primarily due to increased sales of wiredand wireless connectivity products ($0.3 million), increased software revenue ($0.2million), and cost reductions from the consolidation of manufacturingfacilities.   Gross profit as apercentage of net sales increased to 34.3% in the three months ended August 31,2003 from 24.4% in the three months ended August 31, 2002.

14

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*Selling,General and Administrative Expenses*.  Selling,general and administrative expenses increased by $0.2 million, or 5.1%, to $3.6million in the three months ended August 31, 2003  from $3.4 million in the three months ended August 31, 2002.  General and administrative expenses in thethird quarter of fiscal 2003 included $0.5 million in professional fees related to the proposed mergerdescribed above under Recent Developments, which were offset by cost savingsfrom reductions in staff.  Selling,general and administrative expenses as a percentage of net sales decreased to24.5% in the three months ended August 31, 2003 from 25.0% in the three monthsended August 31, 2002.

* *

*Researchand Development Expenses*.  Research and developmentexpenses decreased by $0.4 million, or 25.4%, to $1.3 million in the threemonths ended August 31, 2003 from $1.7 million in the three months ended August31, 2002, primarily due to reduced spending for Security Printing Solutionsproducts. The total research and development expenses for the third quarter offiscal 2003 included $0.8 million for Security Printing Solutions and $0.5million for Wireless and Connectivity Solutions. Research and developmentexpenses as a percentage of net sales was 8.6% in the three months ended August31, 2003 compared to 12.4% in the three months ended August 31, 2002. We expectresearch and development activities to focus primarily on our security printingsolutions products and to a lesser extent on enhancements to our wirelessnetworking products. However, we have the ability to redirect our research anddevelopment activities as needed based on our product strategies and marketopportunities.  We forecast and budgetresearch and development expenses by segment, but not by project.  The anticipated timing for thecommercialization of any of our development efforts is not currently known.

* *

*Amortizationof Intangible Assets. *Amortization of intangible assetsdecreased by $19,000 to $11,000 in the three months ended August 31, 2003 from$30,000 in the three months ended August 31, 2002.  This decrease resulted from no amortization of goodwill in fiscal2003 compared to amortization of $19,000 in fiscal 2002.

* *

*OperatingIncome (Loss)*.  Operating income increased by $2.0 millionto income of $0.2 million in the three months ended August 31, 2003 from a lossof $1.8 million in the three months ended August 31, 2002.  The operating income as a percentage of netsales was 1.1% in the three months ended August 31, 2003 compared to loss of(13.2)% in the three months ended August 31, 2002.

* *

*InterestIncome.*  Interest income decreased by $4,000 to$13,000 in the three months ended August 31, 2003 from $17,000 in the threemonths ended August 31, 2002.  This decreasewas the result of reductions in our investment in available-for-sale securitiesdue to working capital requirements and lower rates of interest on investedsecurities.

* *

*InterestExpense*.  Interest expense decreased by $2,000 to$1,000 in the three months ended August 31, 2003 from $3,000 in the threemonths ended August 31, 2002.

* *

*IncomeTaxes*.  Income taxes increased to a $74,000 taxexpense in the three months ended August 31, 2003 from a $627,000 tax credit inthe three months ended August 31, 2002. This increase is a result of increased income before income taxes.  Income tax expense (credit) as a percentageof pretax income (loss) was 40.9% in the three months ended August 31, 2003compared to (35.0)% in the three months ended August 31, 2002.

 

15

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**NineMonths Ended August 31, 2003 Compared to Nine Months Ended August 31, 2002**

* *

*NetSales*.  Our net sales were $42.5 million for thenine months ended August 31, 2003, with $31.3 million attributable to SecurityPrinting Solutions and $11.2 million attributable to Wireless and ConnectivitySolutions.  Net sales in the nine monthsended August 31, 2003 increased by $1.2 million, or 3.0%, from $41.2 million inthe nine months ended August 31, 2002, primarily due to increased sales of ourwired connectivity products, partially offset by decreased sales of SecurityPrinting Solutions products.  Thedecline in Security Printing Solutions sales was primarily due to a $0.7million reduction in sales to a major distributor that declared Chapter 11bankruptcy in May 2003.  Although salesof our wired connectivity products increased in the first nine months of fiscal2003, we anticipate that sales of wired connectivity products, which constitutea significant portion of our overall sales of Wireless and ConnectivitySolutions, will decline as these products are at or approaching end oflife.  Net sales were not significantlyaffected by price changes.

* *

*Costof Goods Sold*.  Cost of goods sold decreased by $0.7 million,or 2.6%, to $26.3 million in the nine months ended August 31, 2003 from $27.0million in the nine months ended August 31, 2002, primarily due to inventoryadjustments of $1.2 million and severance costs of $0.2 million in 2002, whichwere partially offset by a $1.0 million increase in the inventory reserve in2003, and cost reductions from the consolidation of manufacturingfacilities.  Cost of goods sold as apercentage of net sales decreased to 61.8% in the nine months ended August 31,2003 from 65.4% in the nine months ended May 31, 2002.

* *

*GrossProfit*.  Gross profit increased by $1.9 million to$16.2 million in the nine months ended August 31, 2003 from $14.3 million inthe nine months ended August 31, 2002. primarily due to increased sales of wiredconnectivity products ($0.6 million), the inventory adjustments describedabove, and cost reductions from the consolidation of manufacturingfacilities.  Gross profit as apercentage of net sales increased to 38.2% in the nine months ended August 31,2003 from 34.6% in the nine months ended August 31, 2002.

* *

*Selling,General and Administrative Expenses*.  Selling,general and administrative expenses were $11.3 million in the nine months endedAugust 31, 2003 and 2002. General and administrative expenses in the first ninemonths of fiscal 2003 included  $1.5million in professional fees related to the proposed merger described aboveunder Recent Developments, which were offset by cost savings from reductions instaff. Selling, general and administrative expenses as a percentage of netsales decreased to 26.7% in the nine months ended August 31, 2003 from 27.3% inthe nine months ended August 31, 2002.

* *

*Researchand Development Expenses*.  Research and developmentexpenses decreased by $1.3 million, or 24.2%, to $3.9 million in the ninemonths ended August 31, 2003 from $5.2 million in the nine months ended August31, 2002, due to reduced spending in both Wireless and Connectivity andSecurity Printing Solutions. The total research and development expenses for thefirst nine months of fiscal 2003 included $2.5 million for Security PrintingSolutions and $1.4 million for Wireless and Connectivity Solutions. Researchand development expenses as a percentage of net sales was 9.3% in the ninemonths ended August 31, 2003 and 12.7% in the nine months ended August 31,2002. We expect research and development activities to focus primarily on oursecurity printing solutions products and to a lesser extent on enhancements toour wireless networking products. However, we have the ability to redirect ourresearch and development activities as needed based on our product strategiesand market opportunities.  We forecastand budget research and development expenses by segment, but not byproject.  The anticipated timing for thecommercialization of any of our development efforts is not currently known.

 

16

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*Amortizationof Intangible Assets. *Amortization of intangible assetsdecreased by $57,000 to $33,000 in the nine months ended August 31, 2003 from$90,000 in the nine months ended August 31, 2002.  This decrease resulted from no amortization of goodwill in fiscal2003 compared to amortization of $57,000 in fiscal 2002.

* *

*OperatingIncome (Loss)*.  Operating income (loss) increased by $3.2million to income of $0.9 million in the nine months ended August 31, 2003 froma loss of $2.3 million in the nine months ended August 31, 2002.  The operating income as a percentage of netsales was 2.2% in the nine months ended August 31, 2003 compared to loss of(5.6)% in the nine months ended August 31, 2002.

*InterestIncome.*  Interest income decreased by $57,000 to$39,000 in the nine months ended August 31, 2003 from $96,000 in the ninemonths ended August 31, 2002.  Thisdecrease is the result of reductions in our investment in available-for-salesecurities due to working capital requirements and lower rates of interest oninvested securities.

* *

*InterestExpense*.  Interest expense decreased by $24,000 to$9,000 in the nine months ended August 31, 2003 from $33,000 in the nine monthsended Augsut 31, 2002.  This decreasewas due to reductions in the balance due on notes payable.

* *

*IncomeTaxes*.  Income taxes increased to a $0.4 million taxexpense in the nine months ended August 31, 2003 from a $0.8 million tax creditin the nine months ended August 31, 2002. This increase is a result of increased income before income taxes.  Income tax expense (credit) as a percentageof pretax income (loss) was 38.7% in the nine months ended August 31, 2003 comparedto (35.0)% in the nine months ended August 31, 2002.

 

 

**Liquidityand Capital Resources**

 

Cash flows provided by operating activities were $2.7million in the nine months ended August 31, 2003 compared to $0.9 million inthe nine months ended August 31, 2002. This increase in cash flows provided was primarily due to increased netincome, a refund of income taxes, and improved collections of accountsreceivable.

 

Cash flows used in investing activities were $0.4million in the nine months ended August 31, 2003 compared to cash flowsprovided by investing activities of $3.3 million in the nine months endedAugust 31, 2002.  Included in cash flowsprovided by investing activities in the nine months ended August 31, 2002 was$3.9 million in net maturities of available-for-sale securities.

 

Cash flows used in financing activities were $44,000in the nine months ended August 31, 2003 compared to cash flows provided byfinancing activities of $18,000 in the nine months ended August 31, 2002, dueto reduced proceeds from issuance of common stock.

 

We have a $5.0 million line-of-credit agreement withComerica Bank.  As of Augsut 31, 2003,there were no borrowings outstanding against the line of credit.  Borrowings under the line of credit bearinterest at the lesser of the bank’s reference rate (4.00 % at August 31, 2003)less 0.25% or the bank’s LIBOR rate (1.12 % at August 31, 2003) plus 2% and arelimited to 80% of eligible accounts receivable and 50% of eligible inventoriesif total liabilities to tangible effective net worth is greater than two toone.  No formula is required if totalliabilities to tangible effective net worth is less than two to one. Inconnection with the line-of-credit agreement, we have a $650,000 standbyletter-of-credit sub-limit, of 

 

17

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which approximately $80,000 was outstanding at August31, 2003.  This line of credit issecured by substantially all of our assets. Our borrowing arrangement requires us to comply with certain financialcovenants. As of August 31, 2003, we had approximately $4.9 million inavailability under the line of credit. The line-of-credit borrowings are due on demand.  The agreement may be terminated by eitherparty.

 

We believe that existing cash balances, cash generatedby operating activities, and funds available under our credit facility will besufficient to finance our operating activities for at least the next 12 months,which will include expenditures of approximately $1.9 million for tonercompounding equipment, and approximately $400,000 for a new ERP system.  To the extent that the funds generated fromthese sources are insufficient to finance our operating activities, we wouldneed to raise additional funds through public or private financing.  We cannot assure you that additionalfinancing, if required, will be available on terms favorable to us, or at all.

 

In March 2001, Troy established a stock repurchaseprogram under which Troy’s common stock, with an aggregate market value up to$4.0 million, may be acquired in the open market.  As of August 31, 2003, Troy had purchased approximately 320,565shares of common stock in the open market under this stock repurchase program,at an average price of $3.67 per share. Approximately $2.8 million remains available for future common stockrepurchases.

 

**Critical Accounting Policies andEstimates**

 

We reaffirm the critical accounting policies and ouruse of estimates as reported in our Annual Report on Form 10-K for our fiscalyear ended November 30, 2002.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risk is the risk of loss to future earnings, tofair values or to future cash flows that may result from changes in the priceof a financial instrument.  The value ofa financial instrument may change as a result of changes in interest rates,exchange rates, commodity prices, equity prices and other market changes.  Market risk is attributed to all marketsensitive financial instruments, including long-term debt.

 

We do not utilize derivative financialinstruments.  Accordingly, our exposureto market risk is through our foreign currency transactions and through ourbank debt which bears interest at variable rates.    We do not hedge our exposure to foreign currency fluctuations.Rather, we monitor our foreign currency exposure on a monthly basis.  Principal foreign currencies are the Euroand the Canadian Dollar.  The bank debtis a revolving line of credit. Borrowings under the line of credit bear interest at the lesser of thebank’s reference rate (4.00 % at August 31, 2003) less 0.25% or the bank’sLIBOR rate (1.12 % at August 31, 2003) plus 2% and are limited to 80% ofeligible accounts receivable and 50% of eligible inventories if totalliabilities to tangible effective net worth is greater than two to one.  At August 31, 2003, there were no amountsoutstanding under the line of credit agreement and, accordingly, a sustainedincrease in the reference rate of 1% would not cause our annual interestexpense to change.

 

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**ITEM 4. CONTROLS AND PROCEDURES**

** **

**(a)****Evaluation of disclosure controls and procedures.**We maintain “disclosure controls and procedures,” as such term is definedin Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”), that are designed to ensure that information required to be disclosed byus in reports that we file or submit under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified inSecurities and Exchange Commission rules and forms and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure. In designing and evaluating our disclosurecontrols and procedures, management recognized that disclosure controls andprocedures, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the disclosurecontrols and procedures are met. Additionally, in designing disclosure controlsand procedures, our management necessarily was required to apply its judgmentin evaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

 

Based on their evaluation asof the end of the period covered by this Quarterly Report on Form 10-Q, ourChief Executive Officer and Chief Financial Officer have concluded that,subject to the limitations noted above, our disclosure controls and procedureswere effective to ensure that material information relating to TROY is madeknown to them by others, particularly during the period in which this QuarterlyReport on Form 10-Q was being prepared.

** **

**(b)****Changes ininternal controls.**There was no change in our internal control overfinancial reporting (as defined in Rule 13a-15(f) under the Exchange Act)identified in connection with the evaluation described in Item 4(a) above thatoccurred during our last fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II:  OTHERINFORMATION**

 

ITEM 1 - LEGALPROCEEDINGS

 

On November 21, 2002, TomLloyd filed an action in the Superior Court of the State of California in andfor Orange County against TROY and its directors, alleging that the defendantsbreached their fiduciary duties by attempting to provide the Dirk family withpreferential treatment in connection with their efforts to complete a sale ofTROY (the “Lloyd Action”).  Thecomplaint in the Lloyd Action sought to enjoin an acquisition of TROY by theDirk family, as well as attorneys’ fees. On June 25, 2003, TROY announced that it had reached an agreement in principleto settle the Lloyd Action, subject to court approval and other conditions,including consummation of the proposed merger agreement between TROY and Dirk,Inc., a company controlled by Patrick J. Dirk and his family members.  On September 18, 2003, TROY announced thatits stockholders had voted against approval of the merger agreement betweenTROY and Dirk Inc.  As a result,defendants have asked plaintiff to dismiss the action as moot.  Plaintiff has not responded to thisrequest.  Discovery has commenced inthis action, but no trial date has been set.

 

ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS

 

Not applicable.

 

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

 

A Special Meeting of Stockholders was held onSeptember 18, 2003, to consider and vote upon a proposal to approve anAgreement and Plan of Merger pursuant to which Dirk, Inc., a newly formedDelaware corporation controlled by Patrick Dirk, the founder of TROY, and hisfamily members, would be merged with and into TROY. The Merger was subject to:

 

(1)          approval by the holdersof a majority of the outstanding shares of TROY’s common stock, and

 

(2)          approval by the holdersof a majority of the shares of TROY’s common stock cast either “for” or“against” the Agreement and Plan of Merger (excluding shares beneficially ownedby Dirk, Inc., the Dirk family members and any officers or directors of Dirk,Inc. or TROY).

 

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The voting results wereas follows:

 
|                                                                                                                                                                                                                                       |   | **For**   |   | **Against** |   | **Abstain** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|-------------|--------|-------------|--------|
|                                                                                                                                                                                                                                       |   |      |   |        |   |        |   |
| (1) Approval by holders  of a majority of the outstanding shares                                                                                                                                                                           |   | 7,761,962 |   | 1,488,727   |   | 23,425      |   |
| (2) Approval by holders  of a majority of the shares cast either “for” or “against,” excluding shares  beneficially owned by Dirk, Inc., the Dirk family members and any officers or  directors of Dirk, Inc. or TROY. |   | 702,112   |   | 1,438,727   |   | N/A         |   |

 

ITEM 5 - OTHERINFORMATION

 

None.

 

ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

 

(a)           Exhibits.

 
| **Exhibit Number** |   | **Description**                                                                                           |
|--------------------|--------|-----------------------------------------------------------------------------------------------------------|
| 31.1               |   | Rule 13a-14(a)  Certification of Chief Executive Officer.                                                 |
|               |   |                                                                                                      |
| 31.2               |   | Rule 13a-14(a)  Certification of Chief Financial Officer.                                                 |
|               |   |                                                                                                      |
| 32.1               |   | Certification of the  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |
|               |   |                                                                                                      |
| 32.2               |   | Certification of the  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |

 

(b)                           Reportson Form 8-K

 

On July 14, 2003, the Company filed a Current Reporton Form 8-K dated July 11, 2003 under Item 9. regarding a press release announcing its financialresults for the second quarter and six months ended May 31, 2003.

 

On September 19, 2003, the Company filed a CurrentReport on Form 8-K dated September 18, 2003 under Item 5. regarding a pressrelease announcing that its stockholders had voted against approvalof the merger agreement between the Company and Dirk Inc., a company controlledby Patrick J. Dirk, the founder of the Company, and his family members,pursuant to which Mr. Dirk and his family members would have acquired theoutstanding shares of the Company common stock that they do not already own ata price of $2.76 per share in cash.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, asamended, the registrant has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 

 
|             | TROY GROUP, INC.                                                |
|------------------|-----------------------------------------------------------------|
|             |                                                            |
|             |                                                            |
| October 10, 2003 | /S/ Patrick J. Dirk                                             |
|             | Patrick J. Dirk                                                 |
|             | Chairman, President and Chief Executive Officer                 |
|             |                                                            |
|             | /S/ James W. Klingler                                           |
| October 10, 2003 | James W. Klingler                                               |
|             | Vice President-Finance, Treasurer and Chief   Financial Officer |

 

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