** **

**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 February 28, 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 FileNumber:  **000-24413**

**TROY GROUP, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**  (State or other jurisdiction  of incorporation or organization)                     |   | **33-0807798**  (I.R.S. Employer  Identification No.) |
|---------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------|
|                                                                                              |   |                                                  |
| **2331 South Pullman Street****Santa  Ana, California**  (Address of principal executive offices) |   | **92705**  (Zip code)                                 |

 

**(949) 250-3280**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.       Yes   ý    No    o

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

 

As of March 31,2003, 10,649,092 shares of the Registrant’s Common Stock were outstanding.  The aggregate market value of theRegistrant’s outstanding common stock as of that date (based upon the last saleprice of a share of common stock on that date reported in the over-the-countermarket), excluding outstanding shares beneficially owned by directors andexecutive officers, was $10,923,896.

 

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**TROY GROUP, INC.**

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

**Quarterly Period Ended February 28,2003**

**INDEX**
| **PART I:  FINANCIAL INFORMATION** |                                                                                                       |
|-----------------------------------------|------------------------------------------------------------------------------------------------------------|
|                                    |                                                                                                       |
| Item 1.                                 | Financial Statements                                                                                       |   |
|                                    |                                                                                                       |   |
|                                    | Consolidated Balance  Sheets  February 28, 2003 and November 30, 2002                                      |   |
|                                    |                                                                                                       |   |
|                                    | Consolidated  Statements of Operations for the  Three Months ended February 28, 2003 and February 28, 2002 |   |
|                                    |                                                                                                       |   |
|                                    | Consolidated  Statements of Cash Flows for the  Three Months ended February 28, 2003 and February 28, 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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**PART I:  FINANCIAL INFORMATION**

** **

**ITEM 1.— FINANCIAL STATEMENTS**

 

**TROYGROUP, INC.CONSOLIDATED BALANCE SHEETS**

**(in thousands, except share amounts)**

 

** **
| **Assets**                                                                                                              |   | **February  28,  2003**

(Unaudited) |   | **November  30, 2002** |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|------------------------|--------|
| Current assets:                                                                                                         |   |                                 |   |                   |   |
| Cash and cash equivalents                                                                                               |   | $                                    | 5,762  |                   | $      | 6,615 |   |
| Investment in available-for-sale securities                                                                             |   | —                               |   | 497                    |   |
| Accounts receivable, less allowance for doubtful  accounts of  $911 and $884,  respectively                        |   | 10,237                               |   | 9,227                  |   |
| Income tax refund receivable                                                                                            |   | 1,016                                |   | 1,076                  |   |
| Inventories                                                                                                             |   | 6,169                                |   | 5,540                  |   |
| Prepaid expenses and other                                                                                              |   | 157                                  |   | 440                    |   |
| Deferred tax assets                                                                                                     |   | 3,715                                |   | 3,715                  |   |
| Total current assets                                                                                                    |   | 27,056                               |   | 27,110                 |   |
| Equipment and leasehold improvements, net                                                                               |   | 1,844                                |   | 2,039                  |   |
| Other assets, including receivable from stockholders  2003, $2,071; 2002, $2,123                                        |   | 4,885                                |   | 4,390                  |   |
| Total assets                                                                                                            |   | $                                    | 33,785 |                   | $      | 33,539 |   |
|                                                                                                                    |   |                                 |   |                   |   |
| **Liabilities and Stockholders’  Equity**                                                                          |   |                                 |   |                   |   |
| Current liabilities:                                                                                                    |   |                                 |   |                   |   |
| Current portion of long-term debt                                                                                       |   | $                                    | 73     |                   | $      | 73 |   |
| Accounts payable                                                                                                        |   | 3,905                                |   | 4,138                  |   |
| Accrued expenses                                                                                                        |   | 2,514                                |   | 2,218                  |   |
| Deferred revenue                                                                                                        |   | 1,283                                |   | 1,364                  |   |
| Total current liabilities                                                                                               |   | 7,775                                |   | 7,793                  |   |
| Long-term debt, net of current portion                                                                                  |   | 102                                  |   | 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 10,969,657 shares   in 2003 and 2002 |   | 110                                  |   | 110                    |   |
| Additional paid-in capital                                                                                              |   | 21,113                               |   | 21,113                 |   |
| Retained earnings                                                                                                       |   | 5,860                                |   | 5,578                  |   |
|                                                                                                                    |   | 27,083                               |   | 26,801                 |   |
| Less cost of treasury stock — 320,565 common shares  in 2003 and 2002                                              |   | 1,175                                |   | 1,175                  |   |
| Total stockholders’ equity                                                                                         |   | 25,908                               |   | 25,626                 |   |
| Total liabilities and stockholders’ equity                                                                         |   | $                                    | 33,785 |                   | $      | 33,539 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

3

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**TROY GROUP, INC.**

**CONSOLIDATED STATEMENTS****OFOPERATIONS**

**(Unaudited)**

**(in thousands, except per share amounts)**

 

 
|                                      |   | **Three  Months Ended** |   |
|-------------------------------------------|--------|-------------------------|--------|
|                                      |   | **February  28,  2003** |   | **February  28,  2002  As Restated** |   |
| Net sales                                 |   | $                       | 14,408 |   | $ | 13,571 |   |
| Cost of goods sold                        |   | 8,438                   |   | 8,157 |   |
| Gross profit                              |   | 5,970                   |   | 5,414 |   |
|                                      |   |                    |   |   |   |
| Operating expenses:                       |   |                    |   |   |   |
| Selling, general and administrative       |   | 4,007                   |   | 4,006 |   |
| Research and development                  |   | 1,462                   |   | 1,676 |   |
| Amortization of intangible assets         |   | 33                      |   | 30 |   |
| Operating income (loss)                   |   | 468                     |   | (298 | ) |
|                                      |   |                    |   |   |   |
| Interest income                           |   | 3                       |   | 44 |   |
| Interest expense                          |   | (2                      | )      | (29 | ) |
| Income (loss) before income taxes         |   | 469                     |   | (283 | ) |
| Provision for (benefit from) income taxes |   | 187                     |   | (103 | ) |
| Net income (loss)                         |   | $                       | 282    |   | $ | (180 | ) |
|                                      |   |                    |   |   |   |
| Net income (loss) per share:              |   |                    |   |   |   |
| Basic                                     |   | $                       | .03    |   | $ | (.02 | ) |
| Diluted                                   |   | $                       | .03    |   | $ | (.02 | ) |
|                                      |   |                    |   |   |   |
| Weighted-average shares outstanding:      |   |                    |   |   |   |
| Basic                                     |   | 10,649                  |   | 10,646 |   |
| Diluted                                   |   | 10,649                  |   | 10,646 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

4

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**TROY GROUP, INC.**

**CONSOLIDATED STATEMENTS****OF CASHFLOWS**

**(Unaudited)**

**(in thousands)**
|                                                                                  |   | **Three  Months Ended** |   |
|---------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                  |   | **February  28,  2003** |   | **February  28,  2002  As Restated** |   |
| Cash flows from operating activities:                                                 |   |                    |   |   |   |
| Net income (loss)                                                                     |   | $                       | 282    |   | $ | (180 | ) |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |   |                    |   |   |   |
| Depreciation and amortization                                                         |   | 316                     |   | 321 |   |
| Recovery of doubtful accounts                                                         |   | 27                      |   | (5 | ) |
| Accretion of investment discounts, net                                                |   | —                  |   | (30 | ) |
| Changes in working capital components:                                                |   |                    |   |   |   |
| (Increase) decrease in:                                                               |   |                    |   |   |   |
| Accounts receivable                                                                   |   | (1,037                  | )      | 563 |   |
| Income tax refund receivable                                                          |   | 60                      |   | (181 | ) |
| Inventories                                                                           |   | (629                    | )      | 223 |   |
| Prepaid expenses and other                                                            |   | 284                     |   | (21 | ) |
| Increase (decrease) in:                                                               |   |                    |   |   |   |
| Accounts payable                                                                      |   | (233                    | )      | (1,667 | ) |
| Accrued expenses                                                                      |   | 296                     |   | 75 |   |
| Deferred revenue                                                                      |   | (82                     | )      | 132 |   |
| Net cash used in operating activities                                                 |   | (716                    | )      | (770 | ) |
| Cash flows from investing activities:                                                 |   |                    |   |   |   |
| Purchase of equipment and leasehold improvements                                      |   | (18                     | )      | (89 | ) |
| Purchase of available-for-sale securities                                             |   | —                  |   | (1,449 | ) |
| Maturities of available-for-sale securities                                           |   | 497                     |   | 3,172 |   |
| Increase in other assets, net                                                         |   | (598                    | )      | (123 | ) |
| Net cash provided by  investing activities                                       |   | (119                    | )      | 1,511 |   |
| Cash flows from financing activities:                                                 |   |                    |   |   |   |
| Payments on notes payable                                                             |   | (18                     | )      | (17 | ) |
| Proceeds from issuance of common stock                                                |   | —                  |   | 118 |   |
| Purchase of treasury stock                                                            |   | —                  |   | (79 | ) |
| Net cash provided by (used in) financing activities                                   |   | (18                     | )      | 22 |   |
| Net increase (decrease) in cash and cash equivalents                                  |   | (853                    | )      | 763 |   |
| Cash and cash equivalents, beginning of period                                        |   | 6,615                   |   | 1,210 |   |
| Cash and cash equivalents, end of period                                              |   | $                       | 5,762  |   | $ | 1,973 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

5

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**TROY GROUP, INC.NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS(UNAUDITED)**

**Note1.  Basis of Presentation**

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals andadjustments) considered necessary for a fair presentation have beenincluded.  Operating results for thethree months ended February 28, 2003 are not necessarily indicative of theresults that may be expected for the year ended November 30, 2003.  For further information, refer to thefinancial statements and footnotes thereto included in the Company’s AnnualReport on Form 10-K for its fiscal year ended November 30, 2002 (File No.000-24413).

The quarterly resultsfor the first and second quarter of fiscal 2002 have been restated to reflectthe recording of certain inventory and inventory related accounts payableadjustments discovered in the third quarter of fiscal 2002 to the relevantperiods.  During the third quarter physical inventory counts wereconducted and certain inventory adjustments were discovered.  The Companycompleted a comprehensive review of its inventory related internal controls todetermine the cause of the identified inventory differences.  The Companyhas determined that certain differences arising from inventory and inventoryrelated accounts payable were attributable to the first and second quarters offiscal 2002.  The Company restated the results of those quarters andassociated year-to-date amounts in those periods and filed amended Forms 10-Q.

 

The effect of therestatements on the Company’s unaudited interim consolidated quarterlyfinancial statements is as follows:

 

**Summary Balance Sheet Data:**

**(inthousands)**
| **At February 28, 2002:**    |   | **As  previously  reported** |   | **As  restated** |   |
|------------------------------|--------|------------------------------|--------|------------------|--------|
| Inventory                    |   | $                            | 9,445  |             | $      | 9,028 |   |
| Income tax refund receivable |   | 1,133                        |   | 1,240            |   |
| Working capital              |   | 21,331                       |   | 21,133           |   |
| Total assets                 |   | 37,407                       |   | 37,097           |   |
| Accounts payable             |   | 2,863                        |   | 2,751            |   |
| Total liabilities            |   | 8,617                        |   | 8,505            |   |
| Retained earnings            |   | 8,771                        |   | 8,573            |   |
| Stockholders’equity     |   | 28,790                       |   | 28,592           |   |
|                              |        |                              |        |                  |        |  |  |

 

 

6

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**Summary Statements of OperationsData:**

**(in thousands, except per share data)**

** **
| **For the three months ended February 28, 2002:** |   | **As  previously  reported** |   | **As  restated** |   |
|---------------------------------------------------|--------|------------------------------|--------|------------------|--------|
| Net sales                                         |   | $                            | 13,571 |             | $      | 13,571 |   |
| Gross profit                                      |   | 5,797                        |   | 5,414            |   |
| Operating expenses                                |   | 5,790                        |   | 5,712            |   |
| Income (loss) before income taxes (credits)       |   | 22                           |   | (283             | )      |
| Provision for income taxes (credits)              |   | 4                            |   | (103             | )      |
| Net income (loss)                                 |   | $                            | 18     |             | $      | (180 | ) |
| Basic net income (loss) per share                 |   | $                            | — |             | $      | (.02 | ) |
| Diluted net income (loss) per share               |   | $                            | — |             | $      | (.02 | ) |
| Weighted average basic shares outstanding         |   | 10,646                       |   | 10,646           |   |
| Weighted average diluted shares outstanding       |   | 10,705                       |   | 10,646           |   |

 

Certain reclassifications have been made to the 2002financial statements to conform to the 2003 presentation with no effect on netincome or stockholders equity.

**Note2.  Inventories**

 

Inventories consisted of the following as of February28, 2003 and November 30, 2002 (amounts in thousands):
|                                             |   | **February  28, 2003** |   | **November  30, 2002** |   |
|--------------------------------------------------|--------|------------------------|--------|------------------------|--------|
| Raw materials                                    |   | $                      | 6,599  |                   | $      | 5,136 |   |
| Work-in-process                                  |   | 365                    |   | 205                    |   |
| Finished goods                                   |   | 3,217                  |   | 4,112                  |   |
| Reserve for slow moving and obsolete inventories |   | (4,012                 | )      | (3,913                 | )      |
| Total                                            |   | $                      | 6,169  |                   | $      | 5,540 |   |

 

**Note 3.  Stock Optionand Stock Warrant Plans**

During the three months ended February 28, 2003, theCompany did not grant any options to employees. The following is a summary oftotal outstanding options and stock warrants at February 28, 2003:
|                         |   | **Options  and Warrants Outstanding** |   | **Options  and Warrants Exercisable** |   |
|------------------------------|--------|---------------------------------------|--------|---------------------------------------|--------|
| **Range of Exercise Prices** |   | **Number of  Options**                |   | **Weighted-Average  Exercise Price**  |   | **Weighted-Average  Remaining Contractual Life** |   | **Number of  Options** |   | **Weighted-Average  Exercise Price** |   |
| $2.85 — 4.51            |   | 708,666                               |   | $                                     | 3.92   |   | 7.4 years |   | 278,206 |   | $ | 3.69 |   |
| $6.31 — 8.75            |   | 597,000                               |   | $                                     | 7.50   |   | 6.5 years |   | 377,328 |   | $ | 7.43 |   |
| $13.16 — 14.25          |   | 25,000                                |   | $                                     | 13.38  |   | 6.8 years |   | 8,332 |   | $ | 13.38 |   |
|                         |   | 1,330,666                             |   |                                  |   |   |   | 663,866 |   |   |   |

 

At February 28,2003 there were 1,501,000 shares remaining available for grant under theCompany’s option plans.

 

 

7

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**Note4.  Net Income (Loss) Per Share**

 

The following table sets forth the computation ofbasic and diluted net income (loss) per share:
|                                                                                          |   | **Three  months ended**                             |   |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------------------------------|--------|
|                                                                                          |   | **(amounts  in thousands,  except per share data)** |   |
|                                                                                          |   | **February  28,  2003**                             |   | **February  28,  2002  As Restated** |   |
| Numerator for basic and diluted net income (loss)  per share:                                 |   |                                                |   |   |   |
| Net income (loss)                                                                             |   | $                                                   | 282    |   | $ | (180 | ) |
|                                                                                          |   |                                                |   |   |   |
| Denominator for basic net income (loss) per share —  weighted-average shares outstanding |   | 10,649                                              |   | 10,646 |   |
| Effect of employee stock options and warrants                                                 |   | —                                              |   | — |   |
| Denominator for diluted net income (loss) per share                                           |   | 10,649                                              |   | 10,646 |   |
|                                                                                          |   |                                                |   |   |   |
| Net income (loss) per share:                                                                  |   |                                                |   |   |   |
| Basic                                                                                         |   | $                                                   | .03    |   | $ | (.02 | ) |
| Diluted                                                                                       |   | $                                                   | .03    |   | $ | (.02 | ) |

 

**Note5.  Segment Information**

 

The followingtables summarize revenues and net income (loss) by operating segment andunallocated corporate for the three months ended February 28, 2003 and February28, 2002:

 
|                        |   | **Three  months ended**     |   |
|-----------------------------|--------|-----------------------------|--------|
|                        |   | **(amounts  in thousands)** |   |
|                        |   | **February  28,  2003**     |   | **February  28,  2002  As Restated** |   |
| Revenues:                   |   |                        |   |   |   |
|                        |   |                        |   |   |   |
| Security Printing Solutions |   | $                           | 10,339 |   | $ | 10,391 |   |
| Wireless and Connectivity   |   | 4,069                       |   | 3,256 |   |
| Less intersegment revenue   |   | —                      |   | (76 | ) |
|                        |   | $                           | 14,408 |   | $ | 13,571 |   |
|                        |   |                        |   |   |   |
| Net income (loss):          |   |                        |   |   |   |
|                        |   |                        |   |   |   |
| Security Printing Solutions |   | $                           | 1,296  |   | $ | 1,237 |   |
| Wireless and Connectivity   |   | 209                         |   | (700 | ) |
| Unallocated Corporate       |   | (1,223                      | )      | (717 | ) |
|                        |   | $                           | 282    |   | $ | (180 | ) |

 

 

8

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Certain reclassifications have been made to theFebruary 28, 2002 segment information to conform to the February 28, 2003presentation.
|                        |   | **February  28,  2003** |   | **November  30,  2002** |   |
|-----------------------------|--------|-------------------------|--------|-------------------------|--------|
| Segment Assets:             |   |                    |   |                    |   |
|                        |   |                    |   |                    |   |
| Security Printing Solutions |   | $                       | 12,729 |                    | $      | 11,637 |   |
| Wireless and Connectivity   |   | 10,861                  |   | 10,339                  |   |
| Unallocated Corporate       |   | 18,724                  |   | 24,478                  |   |
|                        |   | $                       | 42,314 |                    | $      | 46,454 |   |

 

The following schedule is presented to reconcileFebruary 28, 2003 and November 30, 2002 segment assets to the amounts reportedin the Company’s consolidated financial statements (amounts in thousands). 
|                                |   | **February  28,  2003** |   | **November  30,  2002** |   |
|-------------------------------------|--------|-------------------------|--------|-------------------------|--------|
| Total Assets of Reportable Segments |   | $                       | 42,314 |                    | $      | 46,454 |   |
| Intersegment Receivables            |   | (8,295                  | )      | (12,681                 | )      |
| Investment in Subsidiaries          |   | (234                    | )      | (234                    | )      |
| Consolidated assets                 |   | $                       | 33,785 |                    | $      | 33,539 |   |

 

**Note 6.  Cash FlowInformation**

Supplementaldisclosure of cash flow information
|                             |   | **Nine  months ended**      |   |
|----------------------------------|--------|-----------------------------|--------|
|                             |   | **(amounts  in thousands)** |   |
|                             |   | **February  28,  2003**     |   | **February  28,  2002  As Restated** |   |
| Cash paid during the period for: |   |                        |   |   |   |
| Interest                         |   | $                           | 2      |   | $ | 29 |   |
| Income taxes                     |   | $                           | 127    |   | $ | 3 |   |

 

 

9

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**ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS 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 Private SecuritiesLitigation Reform Act of 1995.  Thestatements contained in this report that are not historical in nature,particularly those that utilize terminology such as “may,” “will,” “should,”“expects,” “anticipates,” “estimates,” “believes” or “plans,” or comparableterminology, are forward-looking statements based on current expectations andassumptions.

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 declining sales of our wired connectivityproducts; the success of the measures we implemented to address inventoryaccounting controls; the market acceptance of products incorporating wirelessprinting technologies; the impact of the delisting of our common stock from theNasdaq National Market; our ability to hire and retain qualified management,technology and other personnel; the impact of competition from existing and newtechnologies and companies; and the other factors set forth in our annualreport on Form 10-K under the heading “Certain Important Factors” and in ourother periodic reports and other documents that we file from time to time withthe 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 March 21, 2003 TROY Group, Inc. announced that it had entered intoan Agreement and Plan of Merger which sets forth the terms and conditions ofthe proposed acquisition of the Company by Dirk, Inc., a Delaware corporationcontrolled by Patrick Dirk, the founder of the Company, and his family members.

Under the terms ofthe Merger Agreement, stockholders of the Company (other than Dirk, Inc. andthe Dirk family members) will receive $2.70 per share, in cash, for eachoutstanding share of Company common stock owned by such stockholders.  The transaction is structured as a forwardmerger in which Dirk, Inc. will merge with and into the Company, with theCompany continuing as the surviving corporation.  The board of directors of both the Company and Dirk, Inc. haveunanimously approved the Merger Agreement and the Merger.  In the case of the Company’s Board, theapproval follows the unanimous recommendation of a special committee of outsidedirectors of the Company that was formed to evaluate and respond to the Dirks’original proposal.

 

The Companyexpects the merger to close in June or July 2003.  The Merger is subject to (i) approval by the holders of amajority of the outstanding shares of the Company’s common stock which areoutstanding as of the record date for the special meeting of the Company’sstockholders to be called to consider the Merger (the “Special Meeting”), (ii)approval by the holders of a majority of the shares of the Company’s commonstock voting on the Merger at the Special Meeting (excluding sharesbeneficially owned by Dirk, Inc., the Dirk family members and any officers ordirectors of Dirk, Inc. or the 

 

 

10

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Company), (iii) thecompletion of the financing arrangements necessary to consummate the Merger,and (iv) certain other closing conditions.

 

## **Background**

## ** **

TROY Group, Inc.is a worldwide provider of enterprise output solutions.  For the past three years we have beenexpanding beyond our core business in digital check printing systems andrelated consumables by developing electronic payment systems and wired andwireless networking solutions.  Most ofthis new product expansion was accomplished through the acquisition and furtherinvestment in five small technology companies. These acquisitions have been organized under the two primary businesssegments:  Security Printing Solutions(previously TROY Systems) and Wireless and Connectivity Solutions (previouslyTROY Wireless).

 

Security PrintingSolutions provides state-of-the-art payment systems ranging from high securitydigital check printing systems to electronic payment and funds transfersolutions.  Our systems are used totransfer funds between bank accounts using paper checks or electronic ACH(Automated Clearing House) processes. Our products provide our customers with payment solutions that offersecurity, speed, flexibility and efficiency. Chase Manhattan, Citigroup, Del Monte Foods, Deutsche Bank, FederalExpress, Federal Reserve, Fidelity Investments, GMAC Commercial, Heinz USA,Hewlett Packard, IBM, Maersk Line Ltd., Marsh USA, Monsanto, NCR Corporation,Progressive Insurance, Safeway Stores, Unisys, VISA USA, and Xerox are amongthe TROY customers that purchased payment products during the last 12 months.

 

Wireless andConnectivity Solutions provides hardware and software solutions that enableenterprises to share intelligent devices like printers either wirelessly orusing traditional networks.  We havebeen a supplier of hardwired network printing solutions since 1991.  Our wireless products include severaldevices which exchange information via *Bluetooth*TM and 802.11b short-range radioconnections.  Brother Industries, Ltd.,Seiko Epson Corporation and DaimlerChrysler AG are among the Wireless andConnectivity Solutions customers that have purchased these products during thelast 12 months.

 

We serve a widevariety of industries including financial services, insurance,telecommunications, computer hardware, automotive, personnel, government andothers.  We distribute our solutionsaround the world and market our products through a network of distributors andvalue-added resellers and a direct sales force.  More than 5,000 customers have purchased our products andservices during the last 12 months.

 

In the firstquarter of fiscal 2003, there were no customers who accounted for 10% of theCompany’s net sales.

 

**Resultsof Operations**

 

The followingtable sets forth, for the periods indicated, certain information derived fromour consolidated statements of operations expressed as a percentage of netsales:

 

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|                                         |   | **Three  Months Ended** |   |
|----------------------------------------------|--------|-------------------------|--------|
|                                         |   | **February  28,  2003** |   | **February  28,  2002  As Restated** |   |
| Net sales                                    |   | 100.0                   | %      | 100.0 | % |
| Cost of goods sold                           |   | 58.6                    |   | 60.1 |   |
| Gross Profit                                 |   | 41.4                    |   | 39.9 |   |
| Selling, general and administrative expenses |   | 27.9                    |   | 29.6 |   |
| Research and development expenses            |   | 10.1                    |   | 12.3 |   |
| Amortization of intangible assets            |   | 0.2                     |   | 0.2 |   |
| Operating income (loss)                      |   | 3.2                     |   | (2.2 | ) |
| Interest income                              |   | 0.1                     |   | 0.3 |   |
| Interest expense                             |   | —                  |   | (0.2 | ) |
| Income (loss) before income taxes (credits)  |   | 3.3                     |   | (2.1 | ) |
| Provision for income taxes (credits)         |   | 1.3                     |   | (0.8 | ) |
| Net income (loss)                            |   | 2.0                     | %      | (1.3 | )% |

 

**ThreeMonths Ended February 28, 2003 Compared to Three Months Ended February 28, 2002**

 

*Net Sales*. Our net sales were $14.4 million for the three months ended February 28,2003, with $10.3 million attributable to Security Printing Solutions and $4.1million attributable to Wireless and Connectivity Solutions.  Net sales in the three months ended February28, 2003 increased by $0.8 million, or 6.2%, from $13.6 million in the threemonths ended February 28, 2002, primarily due to increased sales of our wiredconnectivity products versus a decline in sales of those products in the firstquarter of last year.  Although sales ofwired connectivity products increased in the first quarter of fiscal 2003, weanticipate that sales of wired connectivity products, which constitute asignificant 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.

 

*Cost of Goods Sold*. Cost of goods sold increased by $0.3 million, or 3.4%, to $8.4 millionin the three months ended February 28, 2003 from $8.1 million in the threemonths ended February 28, 2002, primarily due to increased sales. Cost of goods sold as a percentage of net sales decreased to 58.6% inthe three months ended February 28, 2003 from 60.1% in the three months endedFebruary 28, 2002, primarily due to cost reductions from the consolidation ofmanufacturing facilities in fiscal 2002.

 

*Gross Profit*. Gross profit increased by $0.6 million to $6.0 million in the threemonths ended February 28, 2003 from $5.4 million in the three months endedFebruary 28, 2002.  Gross profit as apercentage of net sales increased to 41.4% in the three months ended February28, 2003 from 39.9% in the three months ended February 28, 2002, primarily dueto cost reductions from the consolidation of manufacturing facilities in fiscal2002.

 

*Selling, General and AdministrativeExpenses*.  Selling, general and administrativeexpenses  were $4.0 million in the threemonths ended February 28, 2003  andFebruary 28, 2002.  General andadministrative expenses in the first quarter of fiscal 2003 included  $0.7 million in professional fees related tothe year-end audit and the proposed merger described above under RecentDevelopments, which were offset by savings from reductions in staff. Selling,general and administrative expenses as a percentage of net sales decreased to27.9% in the three months ended February 28, 2003 from 29.6% in the threemonths ended February 28, 2002.

 

 

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*Research and Development Expenses*. Research and development expenses decreased by $0.2 million, or 12.8%,to $1.5 million in the three months ended February 28, 2003 from $1.7 millionin the three months ended February 28, 2002, primarily due to reduced spendingfor wireless and connectivity products. The total research and developmentexpenses for the first quarter of fiscal 2003 included $1.0 million forSecurity Printing Solutions and $0.5 million for Wireless and ConnectivitySolutions. Research and development expenses as a percentage of net sales was10.1% in the three months ended February 28, 2003 and 12.3% in the three monthsended February 28, 2002. We expect research and development activities to focusprimarily on our security printing solutions products and to a lesser extent onenhancements to our wireless networking products. However, we have the abilityto redirect our research and development activities as needed based on ourproduct strategies and market opportunities. We forecast and budget research and development expenses by segment, butnot by project.  The anticipated timingfor the commercialization of any of our development efforts is not currentlyknown.

 

*Amortization of IntangibleAssets. *Amortization of intangible assets increased by $3,000to $33,000 in the three months ended February 28, 2003 from $30,000 in thethree months ended February 28, 2002. This increase was the result of revised estimates of the lives ofintangible assets at the end of fiscal year 2002.

 

*Operating Income (Loss)*. Operating income (loss) increased by $0.8 million to income of $0.5million in the three months ended February 28, 2003 from a loss of $0.3 millionin the three months ended February 28, 2002. The operating income as a percentage of net sales was 3.2% in the threemonths ended February 28, 2003 compared to loss of (2.2)% in the three monthsended February 28, 2002.

 

*Interest Income.* Interest income decreased by $41,000 to $3,000 in the three months endedFebruary 28, 2003 from $44,000 in the three months ended February 28,2002.  This decrease is the result ofreductions in our investment in available-for-sale securities due to workingcapital requirements and lower rates of interest on invested securities.

 

*Interest Expense*. Interest expense decreased by $27,000 to $2,000 in the three monthsended February 28, 2003 from $29,000 in the three months ended February 28,2002.  This decrease was due toreductions in the balance due on notes payable.

 

*Income Taxes*. Income taxes increased to a $0.2 million tax expense in the three monthsended February 28, 2003 from a $0.1 million tax benefit in the three monthsended February 28, 2002.  This increaseis a result of increased income before income taxes.  Income tax expense (benefit) as a percentage of pretax income(loss) was 39.9% in the three months ended February 28, 2003 compared to 36.4%in the three months ended February 28, 2002.

 

**Liquidity and Capital Resources**

 

Cash flows used inoperating activities were $0.7 million in the three months ended February 28,2003 compared to $0.8 million in the three months ended February 28, 2002.  This decrease in cash flows used was dueprimarily to net income of $0.3 million in the three months ended February 28,2003 compared to a net loss of $0.2 million in the three months ended February28, 2002 and lower payments to vendors, partially offset by.an increase ininventories and accounts receivable. The accounts receivable increase resulted primarily from delayedpayments from customers who subsequently have brought their accounts current.

 

 

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Cash flows used ininvesting activities were $0.1 million in the three months ended February 28,2003 compared to cash flows provided by investing activities of $1.5 million inthe three months ended February 28, 2002. Included in cash flows provided by investing activities in the threemonths ended February 28, 2002 was $1.7 million in net maturities ofavailable-for-sale securities.

 

Cash flows used infinancing activities were $18,000 in the three months ended February 28, 2003compared to cash flows provided by financing activities of $22,000 in the threemonths ended February 28, 2002.

 

We have a $5.0million line-of-credit agreement with Comerica Bank.  As of February 28, 2003, there were no borrowings outstandingagainst the line of credit.  Borrowingsunder the line of credit bear interest at the lesser of the bank’s referencerate (4.25 % at February 28, 2003) less 0.25% or the bank’s LIBOR rate (1.34 %at February 28, 2003) plus 2% and are limited to 80% of eligible accountsreceivable and 50% of eligible inventories if total liabilities to tangibleeffective net worth is greater than two to one.  In connection with the line-of-credit agreement, we have a $650,000standby letter-of-credit sublimit agreement of which approximately $80,000 wasoutstanding at February 28, 2003.  Thisline of credit is secured by substantially all of our assets.  Our borrowing arrangement requires us tocomply with certain financial covenants. As of February 28, 2003, we hadapproximately $4.9 million in availability under the line of credit.  The line-of-credit borrowings are due ondemand.  The agreement may be terminatedby either party.

 

We have completeda commitment letter with Comerica Bank in connection with the merger describedabove under Recent Developments.  Theterms of the commitment letter include increasing the line of credit to $7.0million and adding term loan of $1.5 million. As of February 28, 2003 no definitive documents have been executed.

 

We believe thatexisting cash balances, cash generated by operating activities, and fundsavailable under our credit facility will be sufficient to finance our operatingactivities for at least the next 12 months, which will include expenditures ofapproximately $1.9 million for toner compounding equipment, and approximately$400,000 for a new ERP system.  To theextent that the funds generated from these sources are insufficient to financeour operating activities, we would need to raise additional funds throughpublic or private financing.  We cannotassure you that additional financing will be available on terms favorable tous, or at all.

 

In March 2001,Troy established a stock repurchase program under which Troy’s common stock,with an aggregate market value up to $4.0 million, may be acquired in the openmarket.  As of February 28, 2003, Troyhas purchased approximately 320,565 shares of common stock in the open market,at an average price of $3.67 per share, under the stock repurchaseprogram.  Approximately $2.8 millionremains available for future common stock repurchases.

 

**Accounting Standards Pending Adoption**

 

In December 2002, the FAS issued SFAS No. 148, *Accounting for Stock-Based Compensation*.  This standard amends SFAS 123, *Accounting for Stock-Based Compensation*,to provide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  In addition, this Statement amends thedisclosure requirements of SFAS 123 to require prominent disclosures in bothannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  SFAS 148 is effective forfiscal years and interim periods beginning after December 15, 2002.  SFAS 148 is not expected to have a materialimpact on the Company’s results of operations or financial position.

 

 

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**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Marketrisk is the risk of loss to future earnings, to fair values or to future cashflows that may result from changes in the price of a financial instrument.  The value of a financial instrument may changeas a result of changes in interest rates, exchange rates, commodity prices,equity prices and other market changes. Market risk is attributed to all market sensitive financial instruments,including long-term debt.

 

We do not utilizederivative financial instruments. Accordingly, our exposure to market risk is through our bank debt whichbears interest at variable rates.    Thebank debt is a revolving line of credit. Borrowings under the line of credit bear interest at the lesser of thebank’s reference rate (4.25 % at February 28, 2003) less 0.25% or the bank’sLIBOR rate (1.34 % at February 28, 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 February 28, 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.

 

**ITEM4. CONTROLS AND PROCEDURES**

 

Within the 90 days prior tothe date of this report, we carried out an evaluation, under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and our Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures pursuant to Rules 13a-14and 13a-15 under the Securities Exchange Act of 1934, as amended.  Based upon that evaluation, our ChiefExecutive Officer and our Chief Financial Officer concluded that our disclosurecontrols and procedures are effective.

 

On October 15,2002, we issued a press release announcing that the filing of our Form 10-Q forthe fiscal quarter ended August 31, 2002 would be delayed. We had conductedphysical inventory counts and discovered certain inventory shortfalls and otheradjustments. We delayed the filing of our Form 10-Q for the fiscal quarterended August 31, 2002 in order to give us sufficient time to review the causesof such inventory adjustments and to determine if any of the financialstatements for prior periods would need to be restated.  We also reviewed our inventory accountingcontrols and determined that there were certain material weaknesses.  As a result, we have taken a number ofcorrective measures to address these weaknesses.  Our Irvine and Boise facilities have now been closed andconsolidated into our Wheeling facility, where the employees have moreexperience in using our materials management system.  In addition, we have implemented additional training proceduresto ensure that this continues to be the case, have hired personnel with moreexperience in managing the accounting function in a manufacturing environment,and currently expect to install a new ERP system by the end of fiscal year2003.  The Company also intends toconduct quarterly physical inventory counts until it is satisfied that itssystems are operating properly.  Therewere no other significant changes in our internal controls or in other factorsthat could significantly affect these controls subsequent to the date of ourevaluation.

 

 

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**PARTII:  OTHER INFORMATION**

 

ITEM 1 - LEGALPROCEEDINGS

 

Not applicable.

 

ITEM 2 - CHANGES INSECURITIES AND USE OF PROCEEDS

 

Not applicable.

 

ITEM 3 - DEFAULTS UPONSENIOR SECURITIES

 

Not applicable.

 

ITEM 4 - SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

 

Not applicable.

 

ITEM 5 - OTHERINFORMATION

 

None.

 

ITEM 6 - EXHIBITS ANDREPORTS ON FORM 8-K

 

(a)                            Exhibits.

 
| **Exhibit Number** |   | **Description**                                                                                          |
|--------------------|--------|----------------------------------------------------------------------------------------------------------|
| 99.1               |   | Certification of the Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 99.2               |   | Certification of the Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

(b)         Reports on Form 8-K

On January 21,2003, the Company filed a Current Report on Form 8-K under Item 4 regarding thedecision by its Board of Directors to dismiss KPMG LLP as its independentpublic accountants.

 

On February 7,2003, the Company filed a Current Report on Form 8-K under Item 4 regarding itsengagement of McGladrey & Pullen LLP as its independent public accountants.

 

On March 21, 2003, theCompany filed a Current Report on Form 8-K dated March 20, 2003 under Item 5.announcing that it has entered into an Agreement and Plan of Merger which setsforth the terms and conditions of the proposed acquisition of the Company byDirk, Inc., a Delaware corporation controlled by Patrick Dirk, the founder ofthe Company, and his family members.

 

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**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|           | TROY GROUP, INC.                                                                 |
|----------------|----------------------------------------------------------------------------------|
|           |                                                                             |
| April 14, 2003 | /s/ Patrick J. Dirk                                                              |
|           | Patrick J. Dirk  Chairman, President and Chief Executive Officer                 |
|           |                                                                             |
|           | /s/James W. Klingler                                                             |
|           | James W. Klingler  Vice President-Finance, Treasurer and Chief Financial Officer |
|           |                                                                             |

 

 

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**CERTIFICATIONS**

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I, Patrick J.Dirk, certify that:

 

1.             I have reviewed this quarterlyreport on Form 10-Q of Troy Group, Inc.;

 

2.             Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report; and

 

3.             Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report.

 

4.             The registrant’s other certifyingofficer and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

 

(a)           designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

(b)           evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

(c)           presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifyingofficer and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

(a)           all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(b)           any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.             The registrant’s other certifyingofficer and I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  April 14, 2003 | /s/Patrick J.  Dirk                    |
|----------------------------|----------------------------------------|
|                       | Patrick J. Dirk                        |
|                       | President and  Chief Executive Officer |

 

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**CERTIFICATIONS**

 

I, James W. Klingler certify that:

 

1.             I have reviewed this quarterlyreport on Form 10-Q of Troy Group, Inc.;

 

2.             Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report; and

 

3.             Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report.

 

4.             The registrant’s other certifyingofficer and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

 

(a)           designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

(b)           evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

(c)           presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifyingofficer and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

(a)           all significantdeficiencies in the design or operation of internal controls which could adverselyaffect the registrant’s ability to record, process, summarize and reportfinancial data and have identified for the registrant’s auditors any materialweaknesses in internal controls; and

 

(b)           any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.             The registrant’s other certifyingofficer and I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  April 14, 2003 | /s/James W.  Klingler                  |
|----------------------------|----------------------------------------|
|                       | James W.  Klingler                     |
|                       | Vice President-Finance,  Treasurer and |
|                       | Chief Financial  Officer               |

 

 

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*The written statements  required pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,accompanied the filing of this report by correspondence to the Securities andExchange Commission.*

 

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