**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 May  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 registrantas 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 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 90days.    Yes   ý    No    o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of1934).   Yes  o    No   ý

 

As of June 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 $12,059,805.

 

 

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**TROY GROUP, INC.**

**Quarterly Report on Form 10-Q for theQuarterly Period Ended May 31, 2003**

 

**INDEX**

 
| **PART I:   FINANCIAL INFORMATION** |
|------------------------------------------|
|                                     |
| Item  1.                                 | Financial  Statements |
|                                     |   |
|                                     | Consolidated Balance Sheets  May 31, 2003 and November 30, 2002 |
|                                     |   |
|                                     | Consolidated  Statements of Operations for the  Three and Six Months ended May 31, 2003 and 2002 |
|                                     |   |
|                                     | Consolidated  Statements of Cash Flows for the  Six Months ended May 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 |
|                                     |   |
| **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

 

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

 

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

 
|                                                                                                                                    |   | **May 31,  2003** |       | **November  30,  2002** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|-------------------------|------------|
|                                                                                                                                    |   | **(Unaudited)**   |       |                    |       |
| **Assets**                                                                                                                              |   |              |       |                    |       |
| Current assets:                                                                                                                         |   |              |       |                    |       |
| Cash and cash  equivalents                                                                                                              |   | $                 | 6,474      |                    | $          | 6,615 |   |
| Investment in  available-for-sale securities                                                                                            |   | —            |       | 497                     |       |
| Accounts  receivable, less allowance for doubtful accounts of $1,074 and $884                                                           |   | 8,268             |       | 9,227                   |       |
| Income tax  refund receivable                                                                                                           |   | 1,027             |       | 1,076                   |       |
| Inventories                                                                                                                             |   | 6,675             |       | 5,540                   |       |
| Prepaid expenses  and other                                                                                                             |   | 289               |       | 440                     |       |
| Deferred tax  assets                                                                                                                    |   | 3,715             |       | 3,715                   |       |
| Total current assets                                                                                                                    |   | 26,448            |       | 27,110                  |       |
| Equipment and  leasehold improvements, net                                                                                              |   | 2,263             |       | 2,039                   |       |
| Other assets,  including notes receivable from stockholders $2,071 and $2,123                                                           |   | 4,186             |       | 4,390                   |       |
| Total assets                                                                                                                            |   | $                 | 32,897     |                    | $          | 33,539 |   |
|                                                                                                                                    |   |              |       |                    |       |
| **Liabilities and Stockholders’  Equity**                                                                                          |   |              | ** ** |                    | ** ** |
| Current  liabilities:                                                                                                                   |   |              |       |                    |       |
| Current portion  of long-term debt                                                                                                      |   | $                 | 76         |                    | $          | 73 |   |
| Accounts payable                                                                                                                        |   | 2,575             |       | 4,138                   |       |
| Accrued expenses                                                                                                                        |   | 2,732             |       | 2,218                   |       |
| Deferred revenue                                                                                                                        |   | 1,245             |       | 1,364                   |       |
| Total current  liabilities                                                                                                              |   | 6,628             |       | 7,793                   |       |
| Long-term debt,  net of current portion                                                                                                 |   | 82                |       | 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 $80 and none                                                    |   | 6,130             |       | 5,578                   |       |
|                                                                                                                                    |   | 27,362            |       | 26,801                  |       |
| Less cost of  treasury stock – 320,565 common shares in 2003 and 2002                                                              |   | 1,175             |       | 1,175                   |       |
| Total  stockholders’ equity                                                                                                        |   | 26,187            |       | 25,626                  |       |
| Total  liabilities and stockholders’ equity                                                                                        |   | $                 | 32,897     |                    | $          | 33,539 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

3

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**TROY GROUP, INC.CONSOLIDATED STATEMENTSOF OPERATIONS**

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

 
|                                    |   | **Three  Months Ended May 31,** |       | **Six Months  Ended May 31,** |       |
|-----------------------------------------|--------|---------------------------------|------------|-------------------------------|------------|
|                                    |   | **2003**                        |       | **2002**                      |       | **2003** |   | **2002** |   |
|                                    |   |                            | ** ** | **Restated**                  | ** ** |   | ** ** | **Restated** | ** ** |
| Net sales                               |   | $                               | 13,395     |                          | $          | 14,025 |   | $ | 27,803 |   | $ | 27,596 |   |
| Cost of goods  sold                     |   | 8,193                           |       | 8,487                         |       | 16,631 |   | 16,644 |   |
| Gross profit                            |   | 5,202                           |       | 5,538                         |       | 11,172 |   | 10,952 |   |
|                                    |   |                            |       |                          |       |   |   |   |   |
| Operating  expenses:                    |   |                            |       |                          |       |   |   |   |   |
| Selling, general  and administrative    |   | 3,683                           |       | 4,088                         |       | 7,712 |   | 7,867 |   |
| Research and  development               |   | 1,230                           |       | 1,622                         |       | 2,692 |   | 3,525 |   |
| Amortization of  intangible assets      |   | 11                              |       | 30                            |       | 22 |   | 60 |   |
| Operating income  (loss)                |   | 278                             |       | (202                          | )          | 746 |   | (500 | ) |
|                                    |   |                            |       |                          |       |   |   |   |   |
| Interest income                         |   | 23                              |       | 35                            |       | 26 |   | 79 |   |
| Interest expense                        |   | (6                              | )          | (1                            | )          | (8 | ) | (30 | ) |
| Income (loss)  before income taxes      |   | 295                             |       | (168                          | )          | 764 |   | (451 | ) |
| Provision for  income taxes (credits)   |   | 105                             |       | (56                           | )          | 292 |   | (159 | ) |
| Net income  (loss)                      |   | $                               | 190        |                          | $          | (112 | ) | $ | 472 |   | $ | (292 | ) |
|                                    |   |                            |       |                          |       |   |   |   |   |
| Net income  (loss) per share:           |   |                            |       |                          |       |   |   |   |   |
| Basic                                   |   | $                               | .02        |                          | $          | (.01 | ) | $ | .04 |   | $ | (.03 | ) |
| Diluted                                 |   | $                               | .02        |                          | $          | (.01 | ) | $ | .04 |   | $ | (.03 | ) |
|                                    |   |                            |       |                          |       |   |   |   |   |
| Shares used in  per share computations: |   |                            |       |                          |       |   |   |   |   |
| Basic                                   |   | 10,651                          |       | 10,643                        |       | 10,650 |   | 10,645 |   |
| Diluted                                 |   | 10,651                          |       | 10,643                        |       | 10,650 |   | 10,645 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

4

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**TROY GROUP, INC.CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(Unaudited)(in thousands)**

 
|                                                                                      |   | **Six Months  Ended May 31,** |       |
|-------------------------------------------------------------------------------------------|--------|-------------------------------|------------|
|                                                                                      |   | **2003**                      |       | **2002** |   |
|                                                                                      |   |                          | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                                    |   |                          |       |   |   |
| Net income  (loss)                                                                        |   | $                             | 472        |   | $ | (292 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |   |                          |       |   |   |
| Depreciation and  amortization                                                            |   | 591                           |       | 685 |   |
| Provision for  (recovery of) doubtful accounts                                            |   | 200                           |       | (337 | ) |
| Accretion of  investment discounts, net                                                   |   | —                        |       | (72 | ) |
| Changes in  working capital components:                                                   |   |                          |       |   |   |
|  (Increase) decrease in:                                                             |   |                          |       |   |   |
| Accounts  receivable                                                                      |   | 759                           |       | 1,363 |   |
| Income tax  refund receivable                                                             |   | 49                            |       | (183 | ) |
| Inventories                                                                               |   | (1,135                        | )          | 1,006 |   |
| Prepaid expenses  and other                                                               |   | 151                           |       | (9 | ) |
| Increase (decrease)  in:                                                                  |   |                          |       |   |   |
| Accounts payable                                                                          |   | (1,563                        | )          | (2,058 | ) |
| Accrued expenses                                                                          |   | 643                           |       | 324 |   |
| Deferred revenue                                                                          |   | (119                          | )          | 95 |   |
| Net cash  provided by operating activities                                                |   | 48                            |       | 522 |   |
| Cash flows from  investing activities:                                                    |   |                          |       |   |   |
| Purchase of  equipment and leasehold improvements                                         |   | (621                          | )          | (244 | ) |
| Purchase of  available-for-sale securities                                                |   | —                        |       | (1,449 | ) |
| Maturities of  available-for-sale securities                                              |   | 497                           |       | 3,959 |   |
| Increase in  other assets, net                                                            |   | (39                           | )          | (355 | ) |
| Net cash  provided by (used in) investing activities                                      |   | (163                          | )          | 1,911 |   |
| Cash flows from  financing activities:                                                    |   |                          |       |   |   |
| Payments on  notes payable                                                                |   | (35                           | )          | (34 | ) |
| Proceeds from  issuance of common stock                                                   |   | 9                             |       | 148 |   |
| Purchase of  treasury stock                                                               |   | —                        |       | (79 | ) |
| Net cash  provided by (used in) financing activities                                      |   | (26                           | )          | 35 |   |
| Net increase  (decrease) in cash and cash equivalents                                     |   | (141                          | )          | 2,468 |   |
| Cash and cash  equivalents, beginning of period                                           |   | 6,615                         |       | 1,210 |   |
| Cash and cash  equivalents, end of period                                                 |   | $                             | 6,474      |   | $ | 3,678 |   |

 

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 financial statements have beenprepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions to Form 10-Q andArticle 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 been included.  Operating results for the three and sixmonths ended May 31, 2003 are not necessarily indicative of the results thatmay be expected for the year ending November 30, 2003.  For further information, refer to theconsolidated financial statements and footnotes thereto included in theCompany’s Annual Report on Form 10-K for its fiscal year ended November 30,2002 (File No. 000-24413).

 

The quarterly results for the first and second quarter of fiscal 2002have been restated to reflect the recording of certain inventory and inventoryrelated accounts payable adjustments discovered in the third quarter of fiscal2002 to the relevant periods.  Duringthe third quarter, physical inventory counts were conducted and certaininventory adjustments were discovered. The Company completed a comprehensive review of its inventory relatedinternal controls to determine the cause of the identified inventorydifferences.  The Company has determinedthat certain differences arising from inventory and inventory related accountspayable were attributable to the first and second quarters of fiscal 2002.  The Company has restated the results ofthose quarters and associated year-to-date amounts in those periods and filedamended Forms 10-Q.

 

The effect of the restatements on the Company’s unaudited interimconsolidated quarterly financial statements is as follows:

 

**Summary Balance Sheet Data:(in thousands)**

 
| **At May 31, 2002:**          |   | **As  previously  reported** |   | **As  restated** |   |
|-------------------------------|--------|------------------------------|--------|------------------|--------|
| Inventory                     |   | $                            | 8,825  |             | $      | 8,245 |   |
| Income tax  refund receivable |   | 1,059                        |   | 1,242            |   |
| Working capital               |   | 21,339                       |   | 20,998           |   |
| Total assets                  |   | 35,507                       |   | 35,110           |   |
| Accounts payable              |   | 2,416                        |   | 2,360            |   |
| Total  liabilities            |   | 6,658                        |   | 6,602            |   |
| Retained  earnings            |   | 8,801                        |   | 8,460            |   |
| Stockholders’  equity    |   | 28,849                       |   | 28,508           |   |
|                               |        |                              |        |                  |        |  |  |

 

6

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**Summary Statements of Operations Data:(in thousands, except per share data)**

 
|                                         |   | **Three  months ended May 31, 2002** |   | **Six months  ended May 31, 2002** |   |
|----------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                         |   | **As  previously  reported**         |   | **As  restated**                   |   | **As  previously  reported** |   | **As  restated** |   |
| Net sales                                    |   | $                                    | 14,025 |                               | $      | 14,025 |   | $ | 27,596 |   | $ | 27,596 |   |
| Gross profit                                 |   | 5,850                                |   | 5,538                              |   | 11,647 |   | 10,952 |   |
| Operating  expenses                          |   | 5,833                                |   | 5,740                              |   | 11,623 |   | 11,452 |   |
| Income (loss)  before income taxes (credits) |   | 51                                   |   | (168                               | )      | 73 |   | (451 | ) |
| Provision for  income taxes (credits)        |   | 21                                   |   | (56                                | )      | 25 |   | (159 | ) |
| Net income  (loss)                           |   | $                                    | 30     |                               | $      | (112 | ) | $ | 48 |   | $ | (292 | ) |
| Basic net income  (loss) per share           |   | $                                    | — |                               | $      | (.01 | ) | $ | — |   | $ | (.03 | ) |
| Diluted net  income (loss) per share         |   | $                                    | — |                               | $      | (.01 | ) | $ | — |   | $ | (.03 | ) |
| Weighted average  basic shares outstanding   |   | 10,643                               |   | 10,643                             |   | 10,645 |   | 10,645 |   |
| Weighted average  diluted shares outstanding |   | 10,758                               |   | 10,643                             |   | 10,731 |   | 10,645 |   |

 

Statement of Financial Accounting Standards (SFAS) No. 123, “Accountingfor Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure,” prescribes accountingand reporting standards for all stock-based compensation plans, includingemployee stock option plans. As allowed by SFAS No. 123, the Company haselected to continue to account for its employee stock-based compensation plan usingthe intrinsic value method in accordance with Accounting Principles Board (APB)Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedInterpretations, which does not require compensation to be recorded if theconsideration to be received is at least equal to the fair value of the commonstock to be received at the measurement date. Under the requirements of SFASNo. 123, non-employee stock-based transactions require compensation to berecorded based on the fair value of the securities issued or the servicesreceived, whichever is more reliably measurable.

 

The following table illustrates the effect on net income (loss) and netincome (loss) per share had compensation costs for the stock-based compensationplan been determined based on grant date fair values of awards under theprovisions of SFAS No. 123, for the three-month and six-month periods ended May31 (unaudited; in thousands, except per share data):

 

7

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|                                                                                                                                       |                                                | **Three  months ended May 31,** |                                                | **Six months  ended May 31,** |     |
|--------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------|---------------------------------|-----------------------------------------------------|-------------------------------|----------|
|                                                                                                                                       | **(amounts  in thousands, except  per share data)** |                            | **(amounts  in thousands, except  per share data)** |                          |
|                                                                                                                                       | **2003**                                            |                            | **2002**                                            |                          | **2003** |   | **2002** |   |
|                                                                                                                                       |                                                |                            |                                                | **Restated**                  |     |   |   | **Restated** |   |
| Net income (loss) applicable to common stockholders                                                                                        |                                                |                            |                                                |                          |     |   |   |   |   |
| As reported                                                                                                                                |                                                | $                               | 190                                                 |                          | $        | (112 | ) | $ | 472 |   | $ | (292 | ) |
|                                                                                                                                       |                                                |                            |                                                |                          |     |   |   |   |   |
| Less total  stock-based employee compensation expense determined under fair value-based  method for all awards, net of related tax effects |                                                | (100                            | )                                                   | (184                          | )        | (202 | ) | (431 | ) |
| Proforma                                                                                                                                   |                                                | $                               | 90                                                  |                          | $        | (296 | ) | $ | 270 |   | $ | (723 | ) |
|                                                                                                                                       |                                                |                            |                                                |                          |     |   |   |   |   |
| Net income  (loss) per share applicable to common stockholders, basic and diluted                                                          |                                                |                            |                                                |                          |     |   |   |   |   |
| As reported                                                                                                                                |                                                | $                               | .02                                                 |                          | $        | (.01 | ) | $ | .04 |   | $ | (.03 | ) |
| Proforma                                                                                                                                   |                                                | $                               | .01                                                 |                          | $        | (.03 | ) | $ | .03 |   | $ | (.07 | ) |

 

Certain reclassifications have been made to the income statement withno effect on net income or stockholders equity.

 

**Note2.  Inventories**

 

Inventories consisted of the following as of May 31, 2003 and November30, 2002 (amounts in thousands):

 
|                                              |   | **May 31,  2003** |   | **November  30, 2002** |   |
|---------------------------------------------------|--------|-------------------|--------|------------------------|--------|
| Raw materials                                     |   | $                 | 6,138  |                   | $      | 5,136 |   |
| Work-in-process                                   |   | 667               |   | 205                    |   |
| Finished goods                                    |   | 3,310             |   | 4,112                  |   |
| Reserve for slow  moving and obsolete inventories |   | (3,440            | )      | (3,913                 | )      |
| Total                                             |   | $                 | 6,675  |                   | $      | 5,540 |   |

 

**Note3.  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, then the second step must be performed, and the implied fairvalue of the reporting unit’s goodwill must be determined and compared to thecarrying value of the goodwill for the reporting unit. If the carrying value ofa reporting unit’s goodwill exceeds its implied fair value, then an impairmentloss equal to the difference is recorded.

 

8

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The fair value of the Company’s reporting units was determined usingthe income approach under which the fair value of a reporting unit iscalculated based on the present value of estimated future cash flows. Based onthe results of its transitional impairment test, the Company has determinedthat no impairment of goodwill existed as of December 1, 2002. However,future goodwill impairment tests could result in a charge to earnings. TheCompany will continue to evaluate goodwill on an annual basis as of thebeginning of the fourth quarter, and whenever events and changes incircumstances indicate that there may be a potential impairment.

 

The Company’s purchased intangible assets associated with completedacquisitions at May 31, 2003 and November 30, 2002 are composed of(amounts in thousands):

 
|                                           |   | **Weighted**  |   |              |   |                   |   |    |   |      |   |             |   |    |   |
|------------------------------------------------|--------|---------------|--------|-------------------|--------|------------------------|--------|---------|--------|-----------|--------|------------------|--------|---------|--------|
|                                           |   | **Average**   |   | **May 31,  2003** |   | **November  30, 2002** |   |
|                                           |   | **Remaining** |   |              |   | **Accumulated**        |   |    |   |      |   | **Accumulated**  |   |    |   |
|                                           |   | **Life**      |   | **Gross**         |   | **Amortization**       |   | **Net** |   | **Gross** |   | **Amortization** |   | **Net** |   |
| Customer lists                                 |   | 2 yrs.        |   | $                 | 25     |                   | $      | (18     | )      | $         | 7      |             | $      | 25      |   | $ | (16 | ) | $ | 9 |   |
|                                           |   |          |   |              |   |                   |   |    |   |      |   |             |   |    |   |
| Core technology                                |   | 6 yrs.        |   | 392               |   | (152                   | )      | 240     |   | 392       |   | (132             | )      | 260     |   |
| Total  amortizable purchased intangible assets |   |          |   | $                 | 417    |                   | $      | (170    | )      | $         | 247    |             | $      | 417     |   | $ | (148 | ) | $ | 269 |   |

 

Amortization expense related to purchased intangible assets was $11,000and $30,000 for the three-month periods and $22,000 and $60,000 for thesix-month periods ended May 31, 2003 and 2002, respectively.

 

Estimated future amortization expense related to purchased intangibleassets at May 31, 2003 is as follows:

 
| **Fiscal year:**           |   | **(In  thousands)** |   |
|----------------------------|--------|---------------------|--------|
| 2003 (Remaining  6 months) |   | $                   | 22     |   |
| 2004                       |   | 44                  |   |
| 2005                       |   | 42                  |   |
| 2006                       |   | 40                  |   |
| 2007                       |   | 40                  |   |
| Thereafter                 |   | 59                  |   |
|                       |   |                |   |
| Total                      |   | $                   | 247    |   |

 

On December 1, 2002 the Company completed the allocation of goodwill(including amounts previously classified as assembled workforce) to itsreportable segments as part of its transitional impairment test. Goodwillallocated to the Company’s reportable segments as of November 30, 2002 andchanges in the carrying amount of goodwill for the six-month period ended May31, 2003 are as follows (amounts in thousands):

 

9

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

 

If the provisions of SFAS No. 142 had been in effect for allperiods presented, the Company’s net income (loss) and net income (loss) pershare would have been as follows for the three- and six-month periods ended May31, 2003 and 2002: 

 
|                                                          |                                                | **Three  months ended May 31,** |                                                | **Six months  ended May 31,** |     |
|---------------------------------------------------------------|-----------------------------------------------------|---------------------------------|-----------------------------------------------------|-------------------------------|----------|
|                                                          | **(amounts  in thousands,  except per share data)** |                            | **(amounts  in thousands,  except per share data)** |                          |
|                                                          | **2003**                                            |                            | **2002**                                            |                          | **2003** |   | **2002** |   |
|                                                          |                                                |                            |                                                | **Restated**                  |     |   |   | **Restated** |   |
| Net income  (loss)                                            |                                                |                            |                                                |                          |     |   |   |   |   |   |   |   |   |
| As reported                                                   |                                                | $                               | 190                                                 |                          | $        | (112 | ) | $ | 472 |   | $ | (292 | ) |
|                                                          |                                                |                            |                                                |                          |     |   |   |   |   |
| Add back  amortization of goodwill, net of taxes              |                                                | —                          |                                                | 13                            |     | — |   | 25 |   |
| Net income  (loss), as adjusted                               |                                                | $                               | 190                                                 |                          | $        | (99 | ) | $ | 472 |   | $ | (267 | ) |
|                                                          |                                                |                            |                                                |                          |     |   |   |   |   |
| Net income  (loss) per share, basic and diluted               |                                                |                            |                                                |                          |     |   |   |   |   |
| As reported                                                   |                                                | $                               | .02                                                 |                          | $        | (.01 | ) | $ | .04 |   | $ | (.03 | ) |
| Add back  amortization of goodwill, net of taxes              |                                                | —                          |                                                | —                        |     | — |   | — |   |
| Net income  (loss) per share, basic and diluted, net of taxes |                                                | $                               | .02                                                 |                          | $        | (.01 | ) | $ | .04 |   | $ | (.03 | ) |

 

10

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

 

During the six months ended May 31, 2003, the Company did not grant anyoptions to employees. The following is a summary of total outstanding optionsand stock warrants at May 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             |   | 708,666                               |   | $                                      | 3.92   |   | 7.1 years |   | 350,955 |   | $ | 3.76 |   |
| 6.31 – 8.75              |   | 558,000                               |   | 7.45                                   |   | 6.2 years |   | 385,159 |   | 7.46 |   |
| 13.16 – 14.25            |   | 25,000                                |   | 13.38                                  |   | 6.5 years |   | 8,332 |   | 13.38 |   |
|                          |   | 1,291,666                             |   |                                   |   |   |   | 744,446 |   |   |   |
|                               |        |                                       |        |                                        |        |  |  |  |  |  |  |  |  |

 

At May 31, 2003, there were 1,540,000 shares remaining available forgrant under the Company’s option plans.

 

**Note5.  Net Income (Loss) Per Share**

 

The following table sets forth the computation of basic and diluted netloss per share:

 
|                                                                                          |   | **Three  months ended May 31,**                     |   | **Six months  ended May 31,**                       |   |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------------------------------|--------|-----------------------------------------------------|--------|
|                                                                                          |   | **(amounts  in thousands, except  per share data)** |   | **(amounts  in thousands, except  per share data)** |   |
|                                                                                          |   | **2003**                                            |   | **2002**                                            |   | **2003** |   | **2002** |   |
|                                                                                          |   |                                                |   | **Restated**                                        |   |   |   | **Restated** |   |
| Numerator for  basic and diluted net income (loss) per share:                                 |   |                                                |   |                                                |   |   |   |   |   |
|                                                                                          |   |                                                |   |                                                |   |   |   |   |   |
| Net income  (loss)                                                                            |   | $                                                   | 190    |                                                | $      | (112 | ) | $ | 472 |   | $ | (292 | ) |
|                                                                                          |   |                                                |   |                                                |   |   |   |   |   |
| Denominator for  basic net income (loss) per share – weighted-average shares outstanding |   | 10,651                                              |   | 10,643                                              |   | 10,650 |   | 10,645 |   |
| Effect of  employee stock options and warrants                                                |   | —                                              |   | —                                              |   | — |   | — |   |
| Denominator for  diluted net income (loss) per share                                          |   | 10,651                                              |   | 10,643                                              |   | 10,650 |   | 10,645 |   |
|                                                                                          |   |                                                |   |                                                |   |   |   |   |   |
| Net income  (loss) per share:                                                                 |   |                                                |   |                                                |   |   |   |   |   |
|                                                                                          |   |                                                |   |                                                |   |   |   |   |   |
| Basic                                                                                         |   | $                                                   | .02    |                                                | $      | (.01 | ) | $ | .04 |   | $ | (.03 | ) |
| Diluted                                                                                       |   | $                                                   | .02    |                                                | $      | (.01 | ) | $ | .04 |   | $ | (.03 | ) |

 

**Note6.  Segment Information**

 

The following tables summarize net sales and net income (loss) by theCompany’s operating segments, Security Printing Solutions and  Wireless and Connectivity, and unallocatedcorporate for the three and six months ended May 31, 2003 and 2002:

 

11

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|                             |                        | **Three  months ended May 31,** |                        | **Six months  ended May 31,** |     |
|----------------------------------|-----------------------------|---------------------------------|-----------------------------|-------------------------------|----------|
|                             | **(amounts  in thousands)** |                            | **(amounts  in thousands)** |                          |
|                             | **2003**                    |                            | **2002**                    |                          | **2003** |   | **2002** |   |
|                             |                        |                            |                        | **Restated**                  |     |   |   | **Restated** |   |
| Net sales:                       |                        |                            |                        |                          |     |   |   |   |   |
|                             |                        |                            |                        |                          |     |   |   |   |   |
| Security  Printing Solutions     |                        | $                               | 10,099                      |                          | $        | 11,196 |   | $ | 20,438 |   | $ | 21,587 |   |
| Wireless  and  Connectivity |                        | 3,296                           |                        | 2,901                         |     | 7,365 |   | 6,157 |   |
| Less  intersegment revenue       |                        | —                          |                        | (72                           | )        | — |   | (148 | ) |
|                             |                        | $                               | 13,395                      |                          | $        | 14,025 |   | $ | 27,803 |   | $ | 27,596 |   |
|                             |                        |                            |                        |                          |     |   |   |   |   |
| Net income  (loss):              |                        |                            |                        |                          |     |   |   |   |   |
|                             |                        |                            |                        |                          |     |   |   |   |   |
| Security  Printing Solutions     |                        | $                               | 1,440                       |                          | $        | 1,298 |   | $ | 2,736 |   | $ | 2,535 |   |
| Wireless  and  Connectivity |                        | 94                              |                        | (555                          | )        | 303 |   | (1,255 | ) |
| Unallocated  Corporate           |                        | (1,344                          | )                           | (855                          | )        | (2,567 | ) | (1,572 | ) |
|                             |                        | $                               | 190                         |                          | $        | (112 | ) | $ | 472 |   | $ | (292 | ) |

 

Certain reclassifications have been made to the May 31, 2002 segmentinformation to conform to the May 31, 2003 presentation (amounts in thousands).

 
|                             |   | **May 31,  2003** |   | **November  30, 2002** |   |
|----------------------------------|--------|-------------------|--------|------------------------|--------|
|                             |   |              |   |                   |   |
| Segment Assets:                  |   |              |   |                   |   |
|                             |   |              |   |                   |   |
| Security  Printing Solutions     |   | $                 | 11,628 |                   | $      | 11,637 |   |
| Wireless  and  Connectivity |   | 11,627            |   | 10,339                 |   |
| Unallocated  Corporate           |   | 18,307            |   | 24,478                 |   |
|                             |   | $                 | 41,562 |                   | $      | 46,454 |   |

 

The following schedule is presented to reconcile May 31, 2003 andNovember 30, 2002 segment assets to the amounts reported in the Company’sconsolidated financial statements (amounts in thousands).

 
|                                 |   | **May 31,  2003** |   | **November  30, 2002** |   |
|--------------------------------------|--------|-------------------|--------|------------------------|--------|
|                                 |   |              |   |                   |   |
| Total assets of  reportable segments |   | $                 | 41,562 |                   | $      | 46,454 |   |
| Intersegment  receivables            |   | (8,431            | )      | (12,681                | )      |
| Investment in  subsidiaries          |   | (234              | )      | (234                   | )      |
| Consolidated assets                  |   | $                 | 32,897 |                   | $      | 33,539 |   |

 

**Note7.  Cash Flow Information**

 

Supplemental disclosure of cash flow information

 
|                                                                  |   | **Six months  ended**       |   |
|-----------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                  |   | **(amounts  in thousands)** |   |
|                                                                  |   | **May 31,  2003**           |   | **May 31,  2002** |   |
|                                                                  |   |                        |   | **Restated** |   |
| Cash paid during  the period for:                                     |   |                        |   |   |   |
| Interest                                                              |   | $                           | 8      |   | $ | 36 |   |
| Income taxes                                                          |   | $                           | 271    |   | $ | 5 |   |
| Supplemental  schedule of non-cash investing and financing activities |   |                        |   |   |   |
| Change in  foreign currency translation adjustments                   |   | $                           | 80     |   | $ | — |   |

 

12

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**ITEM 2****.**

 

**MANAGEMENT’SDISCUSSION****AND ANALYSIS OFFINANCIAL CONDITION 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.

 

# **RecentDevelopments**

 

On March 21, 2003 TROY Group, Inc. announced that ithad entered into an Agreement and Plan of Merger which sets forth the terms andconditions of the proposed acquisition of the Company by Dirk, Inc., a Delawarecorporation controlled by Patrick Dirk, the founder of the Company, and hisfamily members.

 

Under the terms of the Merger Agreement, stockholdersof the Company (other than Dirk, Inc. and the Dirk family members) will receive$2.70 per share, in cash, for each outstanding share of Company common stockowned by such stockholders.  Thetransaction is structured as a forward merger in which Dirk, Inc. will mergewith and into the Company, with the Company continuing as the survivingcorporation.  The board of directors ofboth the Company and Dirk, Inc. have unanimously approved the Merger Agreementand the Merger.  In the case of theCompany’s Board, the approval follows the unanimous recommendation of a specialcommittee of outside directors of the Company that was formed to evaluate andrespond to the Dirks’ original proposal.

 

On June 25, 2003 the Company announced that it hadentered into an Amended Merger Agreement with Dirk, Inc. pursuant to whichDirk, Inc. has agreed to increase its offer to purchase all of the outstandingshares of TROY common stock (other than shares owned by Dirk, Inc. and the Dirkfamily members) from a price of $2.70 per share in cash to a price of $2.76 pershare in cash.

 

13

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The Company expects the merger to close in August2003.  The Merger is subject to (i)approval by the holders of a majority of the outstanding shares of theCompany’s common stock which are outstanding as of the record date for thespecial meeting of the Company’s stockholders to be called to consider the Merger(the “Special Meeting”), (ii) approval by the holders of a majority of theshares of the Company’s common stock voting on the Merger at the SpecialMeeting (excluding shares beneficially owned by Dirk, Inc., the Dirk familymembers and any officers or directors of Dirk, Inc. or the 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 enterpriseoutput solutions, which include products and services sold to enterprises orbusinesses, that are used in producing an output in a process.  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 print servers and networking solutions.  Most of this new product expansion was accomplished through theacquisition and further investment in five small technology companies.  These acquisitions have been organized underthe two primary business segments: Security Printing Solutions (previously TROY Systems) and Wireless andConnectivity 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, 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 six months of fiscal 2003, there were nocustomers who accounted for 10% of the Company’s net sales.

 

**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:

 

14

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|                                          |   | **Three  Months Ended May 31,** |   | **Six Months  Ended May 31,** |   |
|-----------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                          |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
|                                          |   |                            |   | **Restated**                  |   |   |   | **Restated** |   |
| Net sales                                     |   | 100.0                           | %      | 100.0                         | %      | 100.0 | % | 100.0 | % |
| Cost of goods  sold                           |   | 61.2                            |   | 60.5                          |   | 59.8 |   | 60.3 |   |
| Gross profit                                  |   | 38.8                            |   | 39.5                          |   | 40.2 |   | 39.7 |   |
| Selling, general  and administrative expenses |   | 27.5                            |   | 29.1                          |   | 27.7 |   | 28.5 |   |
| Research and  development expenses            |   | 9.2                             |   | 11.6                          |   | 9.7 |   | 12.8 |   |
| Amortization of  intangible assets            |   | —                          |   | 0.2                           |   | 0.1 |   | 0.2 |   |
| Operating income  (loss)                      |   | 2.1                             |   | (1.4                          | )      | 2.7 |   | (1.8 | ) |
| Interest income                               |   | 0.1                             |   | 0.2                           |   | 0.1 |   | 0.3 |   |
| Interest expense                              |   | —                          |   | —                        |   | — |   | (0.1 | ) |
| Income (loss)  before income taxes            |   | 2.2                             |   | (1.2                          | )      | 2.8 |   | (1.6 | ) |
| Provision for  income taxes (credits)         |   | 0.8                             |   | (0.4                          | )      | 1.1 |   | (0.5 | ) |
| Net income  (loss)                            |   | 1.4                             | %      | (0.8                          | )%     | 1.7 | % | (1.1 | )% |

 

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

 

*NetSales*.  Our net saleswere $13.4 million for the three months ended May 31, 2003, with $10.1 millionattributable to Security Printing Solutions and $3.3 million attributable toWireless and Connectivity Solutions. Net sales in the three months ended May 31, 2003 decreased by $0.6million, or 4.5%, from $14.0 million in the three months ended May 31,2002.  The decline in sales wasprimarily due to a $0.5 million reduction in sales to a major Security PrintingSolutions distributor that declared Chapter 11 bankruptcy in May 2003.  Although sales of wired connectivityproducts increased in the second 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*.  Costof goods sold decreased by $0.3 million, or 3.5%, to $8.2 million in the threemonths ended May 31, 2003 from $8.5 million in the three months ended May 31,2002, primarily due to decreased sales. Cost of goods sold as a percentage of net sales increased to 61.2% inthe three months ended May 31, 2003 from 60.5% in the three months ended May31, 2002, primarily due to a shift in mix to lower margin Wireless andConnectivity products.  Cost of goods soldas a percent of sales will fluctuate based on shifts in the mix of productssold.

 

*GrossProfit*.  Gross profitdecreased by $0.3 million to $5.2 million in the three months ended May 31,2003 from $5.5 million in the three months ended May 31, 2002.  Gross profit as a percentage of net salesdecreased to 38.8% in the three months ended May 31, 2003 from 39.5% in thethree months ended May 31, 2002, primarily due to a shift in mix to lowermargin Wireless and Connectivity products

 

*Selling,General and Administrative Expenses*.  Selling, general and administrativeexpenses  decreased by $0.4 million, or9.9%, to $3.7 million in the three months ended May 31, 2003  from $4.1 million in the three months endedMay 31, 2002.  General andadministrative expenses in the second quarter of fiscal 2003 included  $0.4 million in professional fees related tothe year-end audit and the proposed merger described above under RecentDevelopments, which were offset by cost savings from reductions in staff.  Selling, general and administrative expensesas a percentage of net sales decreased to 27.5% in the three months ended May31, 2003 from 29.1% in the three months ended May 31, 2002.

 

15

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*Researchand Development Expenses*. Research and development expenses decreased by $0.4 million, or 24.2%,to $1.2 million in the three months ended May 31, 2003 from $1.6 million in thethree months ended May 31, 2002, primarily due to reduced spending for SecurityPrinting Solutions products. The total research and development expenses forthe second quarter of fiscal 2003 included $0.7 million for Security PrintingSolutions and $0.5 million for Wireless and Connectivity Solutions. Researchand development expenses as a percentage of net sales was 9.2% in the threemonths ended May 31, 2003 and 11.6% in the three months ended May 31, 2002. Weexpect research and development activities to focus primarily on our securityprinting solutions products and to a lesser extent on enhancements to ourwireless 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.

 

*Amortizationof Intangible Assets. *Amortizationof intangible assets decreased by $19,000 to $11,000 in the three months endedMay 31, 2003 from $30,000 in the three months ended May 31, 2002.  This decrease resulted from no amortizationof goodwill in fiscal 2003 compared to amortization of $19,000 in fiscal 2002.

 

*OperatingIncome (Loss)*. Operating income (loss) increased by $0.5 million to income of $0.3million in the three months ended May 31, 2003 from a loss of $0.2 million inthe three months ended May 31, 2002. The operating income as a percentage of net sales was 2.1% in the three monthsended May 31, 2003 compared to loss of (1.4)% in the three months ended May 31,2002.

 

*InterestIncome.*  Interestincome decreased by $12,000 to $23,000 in the three months ended May 31, 2003from $35,000 in the three months ended May 31, 2002.  This decrease is the result of reductions in our investment inavailable-for-sale securities due to working capital requirements and lowerrates of interest on invested securities.

 

*InterestExpense*.  Interestexpense increased by $5,000 to $6,000 in the three months ended May 31, 2003from $1,000 in the three months ended May 31, 2002.

 

*IncomeTaxes*.  Income taxesincreased to a $105,000 tax expense in the three months ended May 31, 2003 froma $56,000 tax benefit in the three months ended May 31, 2002.  This increase is a result of increasedincome before income taxes.  Income taxexpense (benefit) as a percentage of pretax income (loss) was 35.6% in thethree months ended May 31, 2003 compared to 33.3% in the three months ended May31, 2002.

 

**SixMonths Ended May 31, 2003 Compared to Six Months Ended May 31, 2002**

 

*NetSales*.  Our net saleswere $27.8 million for the six months ended May 31, 2003, with $20.4 millionattributable to Security Printing Solutions and $7.4 million attributable toWireless and Connectivity Solutions. Net sales in the six months ended May 31, 2003 increased by $0.2million, or 0.8%, from $27.6 million in the six months ended May 31, 2002,primarily due to increased sales of our wired connectivity products, partiallyoffset by decreased sales of Security Printing Solutions products.  The decline in Security Printing Solutionssales was primarily due to a $0.7 million reduction in sales to a majordistributor that declared Chapter 11 bankruptcy in May 2003.  Although sales of wired connectivityproducts increased in the first six months 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.

 

16

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*Costof Goods Sold*.  Costof goods sold were $16.6 million in the six months ended May 31, 2003 and2002.  Cost of goods sold as apercentage of net sales decreased to 59.8% in the six months ended May 31, 2003from 60.3% in the six months ended May 31, 2002, primarily due to costreductions from the consolidation of manufacturing facilities in fiscal 2002.

 

*GrossProfit*.  Gross profitincreased by $0.2 million to $11.2 million in the six months ended May 31, 2003from $11.0 million in the six months ended May 31, 2002.  Gross profit as a percentage of net salesincreased to 40.2% in the six months ended May 31, 2003 from 39.7% in the sixmonths ended May 31, 2002, primarily due to cost reductions from theconsolidation of manufacturing facilities in fiscal 2002.

 

*Selling,General and Administrative Expenses*.  Selling, general and administrativeexpenses  decreased by $0.2 million, or2.0%, to $7.7 million in the six months ended May 31, 2003  from $7.9 million in the six months endedMay 31, 2002.  General andadministrative expenses in the first six months of fiscal 2003 included  $1.1 million in professional fees related tothe year-end audit and the proposed merger described above under RecentDevelopments, which were offset by cost savings from reductions in staff.Selling, general and administrative expenses as a percentage of net salesdecreased to 27.7% in the six months ended May 31, 2003 from 28.5% in the sixmonths ended May 31, 2002.

 

*Researchand Development Expenses*. Research and development expenses decreased by $0.8 million, or 23.6%,to $2.7 million in the six months ended May 31, 2003 from $3.5 million in thesix months ended May 31, 2002, due to reduced spending in both Wireless andConnectivity and Security Printing Solutions. The total research anddevelopment expenses for the first six months of fiscal 2003 included $1.7million for Security Printing Solutions and $1.0 million for Wireless andConnectivity Solutions. Research and development expenses as a percentage ofnet sales was 9.7% in the six months ended May 31, 2003 and 12.8% in the sixmonths ended May 31, 2002. We expect research and development activities tofocus primarily on our security printing solutions products and to a lesserextent on enhancements to our wireless networking products. However, we havethe ability to redirect our research and development activities as needed basedon our product strategies and market opportunities.  We forecast and budget research and development expenses bysegment, but not by project.  Theanticipated timing for the commercialization of any of our development effortsis not currently known.

 

*Amortizationof Intangible Assets. *Amortizationof intangible assets decreased by $38,000 to $22,000 in the six months endedMay 31, 2003 from $60,000 in the six months ended May 31, 2002.  This decrease resulted from no amortizationof goodwill in fiscal 2003 compared to amortization of $38,000 in fiscal 2002.

 

*OperatingIncome (Loss)*. Operating income (loss) increased by $1.2 million to income of $0.7million in the six months ended May 31, 2003 from a loss of $0.5 million in thesix months ended May 31, 2002.  Theoperating income as a percentage of net sales was 2.7% in the six months endedMay 31, 2003 compared to loss of (1.8)% in the six months ended May 31, 2002.

 

*InterestIncome.*  Interestincome decreased by $53,000 to $26,000 in the six months ended May 31, 2003from $79,000 in the six months ended May 31, 2002.  This decrease is the result of reductions in our investment inavailable-for-sale securities due to working capital requirements and lowerrates of interest on invested securities.

 

17

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*InterestExpense*.  Interestexpense decreased by $22,000 to $8,000 in the six months ended May 31, 2003from $30,000 in the six months ended May 31, 2002.  This decrease was due to reductions in the balance due on notespayable.

 

*IncomeTaxes*.  Income taxesincreased to a $0.3 million tax expense in the six months ended May 31, 2003from a $0.2 million tax benefit in the six months ended May 31, 2002.  This increase is a result of increasedincome before income taxes.  Income taxexpense (benefit) as a percentage of pretax income (loss) was 38.2% in the sixmonths ended May 31, 2003 compared to 35.3% in the six months ended May 31,2002.

 

**Liquidityand Capital Resources**

 

Cash flows provided by operating activities were$48,000 in the six months ended May 31, 2003 compared to $0.5 million in thesix months ended May 31, 2002.  Thisdecrease in cash flows provided was primarily due to an increase in inventoriespartially offset by increased net income.

 

Cash flows used in investing activities were $0.2 millionin the six months ended May 31, 2003 compared to cash flows provided byinvesting activities of $1.9 million in the six months ended May 31, 2002.  Included in cash flows provided by investingactivities in the six months ended May 31, 2002 was $2.5 million in netmaturities of available-for-sale securities.

 

Cash flows used in financing activities were $26,000in the six months ended May 31, 2003 compared to cash flows provided byfinancing activities of $35,000 in the six months ended May 31, 2002.

 

We have a $5.0 million line-of-credit agreement withComerica Bank.  As of May 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 (4.25 % at May 31, 2003)less 0.25% or the bank’s LIBOR rate (1.32 % at May 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.  In connection with theline-of-credit agreement, we have a $650,000 standby letter-of-credit sublimitagreement of which approximately $80,000 was outstanding at May 31, 2003.  This line of credit is secured by substantiallyall of our assets.  Our borrowingarrangement requires us to comply with certain financial covenants. As of May31, 2003, we had approximately $4.9 million in availability under the line ofcredit.  The line-of-credit borrowingsare due on demand.  The agreement may beterminated by either party.

 

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 will be available on terms favorable to us, or at all.

 

We have completed a commitment letter with ComericaBank in connection with the merger described above under RecentDevelopments.  This commitment issubject to customary conditions, including the negotiation, execution anddelivery of definitive documentation. As of May 31, 2003 no definitivedocuments have been executed. Execution of the loan documents is anticipated ator around the effective time of the merger.

 

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The total amount of funds necessary to complete themerger and to pay the related fees and expenses is estimated to beapproximately $12.3 million, and the merger is conditioned, among other things,on the availability of sufficient funds to pay these amounts. We anticipatethat the merger consideration will be funded from two primary sources:

 

• Our existingcash, cash equivalents and working capital, net of amounts necessary for ourongoing needs.

 

• Financingfrom Comerica Bank in the form of (i) an expansion of our revolving lineof credit facility from $5.0 million to $7.0 million, and (ii) a term loanin the amount of $1.5 million.

 

As of May 31, 2003, our net working capital was $19.8million, which included cash and cash equivalents of $6.5 million. We currentlyanticipate that we will be able to generate sufficient cash to fund our ongoingoperations on an annual basis; however, we estimate that we will requireapproximately $3.0 million in cash to fund our monthly changes in workingcapital. The merger is subject to there being sufficient funds available to paythe merger consideration and related expenses, and there can be no assurance thatsuch funds will be available on the terms described in the commitment letter orat 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 May 31, 2003, Troy has purchased approximately 320,565shares of common stock in the open market, at an average price of $3.67 pershare, under the stock repurchase program. Approximately $2.8 million remains available for future common stockrepurchases.

 

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**ITEM 3****.  QUANTITATIVEAND 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 market sensitivefinancial 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 (4.25 % at May 31, 2003) less 0.25% or the bank’s LIBORrate (1.32 % at May 31, 2003) plus 2% and are limited to 80% of eligibleaccounts receivable and 50% of eligible inventories if total liabilities totangible effective net worth is greater than two to one.  At May 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.

 

**ITEM 4.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 releaseannouncing that the filing of our Form 10-Q for the fiscal quarter ended August31, 2002 would be delayed. We had conducted physical inventory counts anddiscovered certain inventory shortfalls and other adjustments. We delayed thefiling of our Form 10-Q for the fiscal quarter ended August 31, 2002 in orderto give us sufficient time to review the causes of such inventory adjustmentsand to determine if any of the financial statements for prior periods wouldneed to be restated.  We also reviewedour inventory accounting controls and determined that there were certain materialweaknesses.  As a result, we have takena number of corrective measures to address these weaknesses.  Our Irvine, California and Boise, Idahofacilities have now been closed and consolidated into our Wheeling, WestVirginia facility, where the employees have more experience in using ourmaterials management system.  Inaddition, we have implemented additional training procedures to ensure thatthis continues to be the case, have hired personnel with more experience inmanaging the accounting function in a manufacturing environment, and currentlyexpect to install a new ERP system by the end of fiscal year 2003.  The Company also intends to conductquarterly physical inventory counts until it is satisfied that its systems areoperating properly.  There were no othersignificant changes in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of our evaluation.

 

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**PART II****:  OTHER INFORMATION**

 

ITEM 1 - LEGAL PROCEEDINGS

 

On June 25, 2003 theCompany announced that it had reached an agreement in principle to settle theaction Lloyd v. TROY Group, Inc., et.al. filed on November 21, 2002 in theSuperior Court for the State of California in and for Orange County.  The settlement is subject to court approvaland other conditions.

 

ITEM 2 - CHANGES IN SECURITIES AND USE OFPROCEEDS

 

Not applicable.

 

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS

 

Not applicable.

 

ITEM 5 - OTHER INFORMATION

 

None.

 

ITEM 6 - EXHIBITS AND REPORTS 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. |

 

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(b)                           Reportson Form 8-K

 

On April 18, 2003, the Company filed a Current Reporton Form 8-K dated April 14, 2003 under Item 9. regarding a press releasereporting financial results for the first quarter ended February 28, 2003.

 

On June 27, 2003, the Company filed a Current Reporton Form 8-K dated June 25, 2003 under Item 5. regarding a press releaseannouncing it has entered into an amended merger agreement (the “Amendment”)with Dirk, Inc., a company controlled by Patrick J. Dirk, the founder ofthe Company, and his family members, pursuant to which Dirk, Inc. hasagreed to increase its offer to purchase all of the outstanding shares of theCompany’s common stock (other than shares owned by Dirk Inc. and the Dirkfamily members) from a price of $2.70 per share in cash to a price of $2.76 pershare in cash. The Company and Dirk, Inc. had originally approved a mergeragreement on March 20, 2003.

 

On July 3, 2003, the Company filed a Current Report onForm 8-K dated July 3, 2003 under Item 5. regarding a press release announcingthat the special committee of the Company’s Board of Directors has responded toa proposal from Westar Capital LLC to increase its offer to purchase all of theoutstanding equity of the Company, including the majority interest held by theDirk family, from $3.50 per share to $4.00 per share.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, as amended, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|          | TROY GROUP, INC.                                               |
|---------------|----------------------------------------------------------------|
|          |                                                           |
|          |                                                           |
| July 11, 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**

 

I, Patrick J. Dirk, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Troy Group, Inc.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport; and

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report.

 

4.             Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a)           designed such disclosure controls and procedures to ensurethat material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

(b)           evaluated the effectiveness of the registrant’s disclosurecontrols and procedures as of a date within 90 days prior to the filing date ofthis quarterly report (the “Evaluation Date”); and

 

(c)           presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.             Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)           all significant deficiencies in the design or operation ofinternal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

(b)           any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.             Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:   July 11, 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.                                       Ihave reviewed this quarterly report on Form 10-Q of Troy Group, Inc.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport; and

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report.

 

4.             Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a)           designed such disclosure controls and procedures to ensurethat material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

(b)           evaluated the effectiveness of the registrant’s disclosurecontrols and procedures as of a date within 90 days prior to the filing date ofthis quarterly report (the “Evaluation Date”); and

 

(c)           presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.             Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)           all significant deficiencies in the design or operation ofinternal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

(b)           any fraud, whether or not material, that involves managementor other employees who have a significant role in the registrant’s internalcontrols; and

 

6.             Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:   July 11, 2003 | /s/ James W.  Klingler                                         |   |
|--------------------------------------|----------------------------------------------------------------|--------|
|                                 | James W. Klingler                                              |
|                                 | Vice President-Finance, Treasurer and  Chief Financial Officer |

 

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