TransAct Technologies - 10-Q quarterly report FY

(Mark One)

Commission file number: 0-21121

 

______________________________________________________________________

(Exact name of registrant as specified in its charter)

(Former name, former address and former fiscal year, if changed since last report.)

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

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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   o   No   ý

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

(unaudited)

The accompanying unaudited financial statements of TransAct Technologies Incorporated have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America to be included in full year financial statements.  In the opinion of management, all adjustments considered necessary for a fair statement of the results for the periods presented have been included.  The December 31, 2009 condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of Ame rica.  These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2009 included in our Annual Report on Form 10-K.

The financial position and results of operations of our U.K. foreign subsidiary are measured using local currency as the functional currency.  Assets and liabilities of such subsidiary have been translated at the end of period exchange rates, and related revenues and expenses have been translated at the weighted average exchange rates with the resulting translation gain or loss recorded in accumulated other comprehensive income in the condensed consolidated balance sheets.  Transaction gains and losses are included in other income in the condensed consolidated statement of income.

The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results to be expected for the full year.  Certain prior period amounts in the Condensed Consolidated Financial Statements have been reclassified to conform with the current period presentation.

Transfers of Financial Assets:  The FASB improved the relevance and comparability of information that a reporting entity provides in its financial statements about transfers of financial assets.  The provisions became applicable on January 1, 2010 and are applied to transfers of financial assets completed after December 31, 2009.  Currently these provisions do not have an impact on our consolidated financial statements since we do not have transfers of financial assets and we do not anticipate these provisions will have a material impact on our consolidated financial statements.

Multiple-Deliverable Revenue Arrangements:  In October 2009, the FASB established the accounting and reporting guidance for arrangements including multiple revenue-generating activities. This guidance provides amendments to the criteria for separating deliverables, measuring and allocating arrangement consideration to one or more units of accounting. The amendments also establish a selling price hierarchy for determining the selling price of a deliverable. Significantly enhanced disclosures are also required to provide information about a vendor’s multiple-deliverable revenue arrangements, including information about the nature and terms, significant deliverables, and its performance within arrangements. The amendments also require providing inf ormation about the significant judgments made and changes to those judgments and about how the application of the relative selling-price method affects the timing or amount of revenue recognition. The amendments are effective prospectively for revenue arrangements entered into or materially modified in the fiscal years beginning on or after June 15, 2010. Early application is permitted. We are currently evaluating this new guidance.

Fair Value Measurements:  In January 2010, the FASB issued new guidance that both expanded and clarified the disclosure requirements related to fair value measurements.  Entities are required to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 of the fair value valuation hierarchy and describe the reasons for the transfers.  Additionally, entities are required to disclose and roll forward Level 3 activity on a gross basis rather than as one net number.  The new guidance also clarified that entities are required to provide fair value measurement disclosures for each class of assets and liabilities.  In addition, entities are required to provide disclosures about the valua tion techniques and inputs used to measure fair value of assets and liabilities that fall within Level 2 or Level 3 of the fair value valuation hierarchy.  We adopted the new disclosures on January 1, 2010.

The components of inventories are:

(unaudited)

We generally warrant our products for up to 24 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs.

The following table summarizes the activity recorded in the accrued product warranty liability during the nine months ended September 30, 2010:

The current portion of the accrued product warranty liability is included in accrued liabilities and the long-term portion of the accrued product warranty liability is included in other liabilities in the accompanying condensed consolidated balance sheets.

The following table summarizes the activity recorded in accrued restructuring expenses during the three and nine months ended September 30, 2010 and 2009 and is included in accrued liabilities in the accompanying condensed consolidated balance sheets.

(unaudited)

The following table sets forth the reconciliation of basic weighted average shares outstanding and diluted weighted average shares outstanding:

Unvested restricted stock is excluded from the calculation of weighted average common shares for basic EPS.  For diluted EPS, weighted average common shares include the impact of unvested restricted stock under the treasury stock method.

For the three months ended September 30, 2010 and 2009, there were 372,750 and 508,000, respectively, potentially dilutive shares consisting of stock options and nonvested restricted stock, that were excluded from the calculation of earnings per diluted share.  For the nine months ended September 30, 2010 and 2009, there were 372,750 and 531,100, respectively, potentially dilutive shares consisting of stock options and nonvested restricted stock, that were excluded from the calculation of earnings per diluted share.

The following table summarizes our comprehensive income:

We paid a portion of the 2009 incentive bonus for the chief executive officer and chief financial officer in the form of deferred stock units.  Such deferred stock units were granted in March 2010 and were fully vested at the time of grant.

(unaudited)

We recorded an income tax provision for the third quarter of 2010 of $544,000 at an effective tax rate of 34.1%, compared to an income tax provision during the third quarter of 2009 of $597,000 at an effective tax rate of 33.5%. For the nine months ended September 30, 2010, we recorded an income tax provision of $1,566,000 at an effective tax rate of 35.7%, compared to an income tax provision during the nine months ended September 30, 2009 of $985,000 at an effective tax rate of 33.5%.

We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions.  We have substantially concluded all U.S. federal income tax, state and local, and foreign tax audit matters through 2003.  During 2008, a limited scope examination of our 2005 and 2006 federal tax returns was completed.  However, our federal tax returns for the years 2004 through 2009 remain open to examination.  Various state and foreign tax jurisdiction tax years remain open to examination as well, though we believe that any additional assessment would be immaterial to the consolidated financial statements.  No federal, state or foreign tax jurisdictions are currently under examination.

TransAct Technologies Incorporated designs, develops, assembles, markets and services world-class transaction printers under the Epic and Ithaca(R) brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers generate top-quality transaction records such as receipts, tickets, coupons, register journals and other documents. We focus on the following core markets: banking and point-of-sale, casino and gaming, and lottery. We sell our products to original equipment manufacturers (“OEMs”), value-added resellers, selected distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australi a, the Caribbean Islands and the South Pacific. Beyond printers, TransAct is a leader in providing printing supplies to the full transaction printer market.  Through our TransAct Services Group we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the hospitality, banking, retail, gaming, and government markets.  Through our webstore, www.transactsupplies.com, and our direct selling team, we address the on-line demand for these products.  We operate in one reportable segment, the design, development, assembly and marketing of transaction printers and printer-related service, supplies and replacement parts.

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared by us in accordance with accounting principles generally accepted in the United States of America.  The presentation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities.  Our estimates include those related to revenue recognition, inventory obsolescence, the valuation of deferred tax assets and liabilities, depreciable lives of equipment, warranty obligations, and contingent liabilities.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances.

For a complete description of our accounting policies, see Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Critical Accounting Policies and Estimates,” included in our Form 10-K for the year ended December 31, 2009.  We have reviewed those policies and determined that they remain our critical accounting policies for the nine months ended September 30, 2010.

Net Sales. Net sales, which include printer sales and sales of replacement parts, consumables and repair services, by market for the three months ended September 30, 2010 and 2009 were as follows:

Net sales for the third quarter of 2010 decreased $1,613,000, or 9%, from the same period last year due primarily to lower printer sales into our lottery (a decrease of $1,017,000, or 31%) and banking and point-of-sale markets (a decrease of $776,000, or 13%) as well as lower sales from our TransAct Services Group (“TSG”) (a decrease of $142,000, or 3%), partially offset by a $322,000, or 7%, increase from our casino and gaming market.  Overall, international sales increased $495,000, or 15%, largely due to higher international shipments of our casino and gaming printers.  During the third quarter of 2010, our printer sales volume decreased 1% compared to the third quarter of 2009.  The average selling

price of our printers decreased 10% for two reasons: (1) we sold more banking printers, which have higher average selling prices than our other printers, in the third quarter of 2009 compared to the third quarter of 2010 and (2) we sold more thermal POS printers, which have lower average selling prices than our other printers, in the third quarter of 2010 compared to the third quarter of 2009.

Revenue from the banking and point-of-sale (“POS”) market includes sales of printers used by banks, credit unions, and other financial institutions to print and/or validate receipts at bank teller stations.  Revenue from this market also includes sales of thermal, inkjet and impact printers used primarily by retailers in the restaurant (including fine dining, casual dining and fast food), hospitality, and specialty retail industries to print receipts for consumers, validate checks, or print on linerless labels or other inserted media.  Sales of our banking and POS printers worldwide decreased $776,000, or 13%.

Domestic banking and POS printer revenue decreased to $4,914,000, representing a $676,000, or 12%, decrease from the third quarter of 2009 primarily driven by an 83% decrease in sales of banking printers in the third quarter of 2010 compared to the third quarter of 2009 due to the completion of a project by one of our large banking customers utilizing our BANKjet® 1500 bank teller printers in the fourth quarter of 2009. This decrease was partially offset by our third consecutive quarter of increased year-over-year sales of our BANKjet® 2500 printer.  Although we are currently pursuing several banking opportunities, due to the project-oriented nature of these sales, we cannot predict the level of future sales.  Domestic sales of our POS printers increased 113% in the third quarter of 2010 primarily due to a 306% increase in sales of our two printer products for McDonalds for its combined beverage initiative and its POS system upgrade and grill initiatives.  We expect sales for McDonalds in the fourth quarter of 2010 to remain consistent with those of the third quarter of 2010 as McDonalds continues the roll-out of its new POS system, which includes the grill initiative printer upgrades, to all of its U.S. stores.

International banking and POS printer revenue decreased $100,000, or 43%, to $132,000, due primarily to lower legacy impact printer sales to our international distributors in Latin America and Mexico in the third quarter of 2010.

Revenue from the casino and gaming market includes sales of printers used in slot machines, video lottery terminals (“VLTs”), and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos and racetracks (“racinos”) and other gaming venues worldwide.  Revenue from this market also includes sales of printers used in the international off-premise gaming market in gaming machines at non-casino gaming establishments such as Amusement with Prizes (“AWP”), Skills with Prizes (“SWP”), and Fixed Odds Betting Terminals (“FOBT”).  Sales of our casino and gaming printers increased $322,000, or 7%, from the third quarter of 2009.

Domestic sales of our casino and gaming printers decreased $226,000, or 11%.  We believe that our decreased casino printer sales during the third quarter of 2010 resulted from the overall replacement cycle of slot machines being lower in the third quarter of 2010 as compared to the third quarter of 2009.  We anticipate little to no improvement in the domestic slot machine replacement cycle during the remainder of 2010. We believe the current uncertain economic environment could continue to negatively impact the casino industry’s level of capital expenditures in 2010, and as a result, our future sales to the domestic casino and gaming market could be unpredictable and adversely affected.

International casino and gaming printer sales increased $548,000, or 21%, to $3,162,000 in the third quarter of 2010.  This increase was due primarily to sales of our off-premise gaming printer to a new customer for use in gaming machines in the U.K.

Revenue from the lottery market includes sales of lottery printers to Lottomatica’s GTECH Corporation (“GTECH”), the world’s largest provider of lottery terminals, for various lottery applications.  

Domestic and international printer sales to GTECH, which include thermal on-line and other lottery printers, decreased $1,017,000, or 31%, in the third quarter of 2010 compared to the third quarter of 2009, with domestic sales decreasing $1,031,000 and international sales increasing $14,000.  Our sales to GTECH are directly dependent on the timing and number of new and upgraded lottery terminal installations GTECH performs, and as a result, may fluctuate significantly quarter-to-quarter.  Our sales to GTECH are not indicative of GTECH’s overall business or revenue.  We expect total sales to GTECH to decrease in the fourth quarter of 2010 compared to the third quarter of 2010.  

Revenue from TSG includes sales of consumable products (inkjet cartridges, ribbons, receipt paper and other printing supplies), replacement parts, maintenance and repair services, testing services, refurbished printers, and shipping and handling charges.  Sales from TSG decreased $142,000, or 3%.

Domestic revenue from TSG decreased $175,000, or 5%, largely due to a decrease of 6% in sales of consumable products compared to the same period in 2009.  The decrease in consumable products sales was primarily due to lower sales of inkjet cartridges resulting from a significant stocking order from a large recurring customer in the third quarter of 2009 that did not repeat to the same extent in the third quarter of 2010, largely offset by higher sales of inkjet cartridges to newly acquired customers.

Internationally, TSG revenue increased $33,000, or 13%, to $292,000, due primarily to increased sales of consumables as well as higher service revenue.

Gross Profit.  Gross profit information is summarized below (in thousands, except percentages):

Gross profit is measured as revenue less cost of goods sold.  Cost of goods sold includes primarily the cost of all raw materials and component parts, direct labor and the associated manufacturing overhead expenses, and the cost of finished products purchased directly from contract manufacturers.  Gross profit increased $32,000, or less than 1%, to $5,557,000 and gross margin increased to 33.9% from 30.7%.  Both our gross profit and gross margin increased due to (1) an increase in sales of contract manufactured products with lower overall product costs, including lower labor costs, resulting from the move of production for the majority of our products to a low cost contract manufacturer in China and (2) a more favorable sales mix as we sold fewer lower margin banking and lottery printers in the third quart er of 2010 compared to the third quarter of 2009.  Our gross margin for the third quarter of 2009 was adversely impacted by higher material and labor costs as we depleted a substantial portion of our higher cost domestic inventory in preparation for the completion of our production transfer to China.

Engineering, Design and Product Development.  Engineering, design and product development information is summarized below (in thousands, except percentages):

Engineering, design and product development expenses primarily include salary and payroll related expenses for our engineering staff, depreciation and product design expenses (including prototype printer expenses, outside design and testing services, and supplies).  Such expenses for the third quarter of 2010 increased $34,000, or 5%, due primarily to an increase of $13,000 in employee compensation related

expenses resulting largely from annual salary increases and higher incentive compensation and an increase of $22,000 in outside testing and pre-production expenses related to new product development projects compared to the prior year period.  

Selling and Marketing. Selling and marketing information is summarized below (in thousands, except percentages):

Selling and marketing expenses primarily include salaries and payroll related expenses for our sales and marketing staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, e-commerce and other promotional marketing expenses.  Selling and marketing expenses for the third quarter of 2010 increased $106,000, or 7%, primarily due to $85,000 of increased travel related expenses and $27,000 of increased demonstration printer expenses compared to the prior year period. These increases were partially offset by a $28,000 decrease in employee compensation related expenses associated with the departure of our SVP, TSG in June 2010 as well as lower sales commissions resulting from lower sales volume.

General and Administrative. General and administrative information is summarized below (in thousands, except percentages):

General and administrative expenses primarily include salaries and payroll related expenses for our executive, accounting, human resource, business development and information technology staff, expenses for our corporate headquarters, professional and legal expenses, telecommunication expenses, and other expenses related to being a publicly-traded company.  General and administrative expenses increased $55,000, or 3%, due primarily to an increase of $64,000 in certain state and local taxes, $36,000 in recruitment expenses for replacement staff, and $26,000 in employee compensation related expenses due largely to annual salary increases and higher incentive compensation.  These increases were partially offset by decreases of $35,000 in professional expenses, $18,000 in legal expenses related to business development, and $16,000 in information technology hardware and software maintenance expenses during the third quarter of 2010 as compared to the third quarter of 2009.

Operating Income.  Operating income information is summarized below (in thousands, except percentages):

During the third quarter of 2010, we reported operating income of $1,631,000, or 10.0% of net sales, compared to operating income of $1,794,000, or 10.0% of net sales in the third quarter of 2009.  The decrease in our operating income was primarily due to higher operating expenses in the third quarter of 2010 compared to that of 2009.  However, despite a 9% decline in our sales, our operating margin remained consistent at 10.0% of net sales due to an increase in our gross margin in the third quarter of 2010 as compared to the third quarter of 2009.

Interest.  We recorded net interest expense of $21,000 in the third quarter of 2010 compared to net interest expense of $15,000 in the third quarter of 2009.  Interest expense for the third quarter of 2010 includes $24,000 of interest expense related to certain prior years’ state and local tax liabilities partially offset by higher interest income due to our cash balance being higher in the third quarter of 2010 compared to the third quarter of 2009.  Interest expense related to the unused revolving credit line fee and amortization of the deferred financing costs on our revolving credit facility with TD Bank remained consistent in the third quarter of 2010 compared to the third quarter of 2009.  See “Liquidity and Capital Resources” below for more information.

Other Income (Expense).  We recorded other expense of $14,000 in the third quarter of 2010 compared to other income of $2,000 in the third quarter of 2009.  The decrease was primarily due to foreign currency transaction exchange loss recorded by our U.K. subsidiary resulting from a 4% strengthening of the U.S. dollar against the British pound during the third quarter of 2009 compared to a 5% weakening of the U.S. dollar against the British pound during the third quarter of 2010.

Income Taxes.  We recorded an income tax provision for the third quarter of 2010 of $544,000 at an effective tax rate of 34.1%, compared to an income tax provision during the third quarter of 2009 of $597,000 at an effective tax rate of 33.5%.  Our effective tax rate for the third quarter of 2010 was higher because it did not include any benefit from the federal research and development tax credit, which is normally included in our tax rate, as this credit expired at the end of 2009.  If this credit is not reinstated, we expect our annual effective tax rate for 2010 to be between 35% and 36%.  In addition, our effective tax rate for the third quarter of 2010 was favorably impacted by the recognition of $38,000 of certain discrete tax benefits.

Net Income.  We reported net income during the third quarter of 2010 of $1,052,000, or $0.11 per diluted share, compared to $1,184,000, or $0.13 per diluted share, for the third quarter of 2009.

Net Sales.  Net sales, which include printer sales and sales of replacement parts, consumables and repair services, by market for the nine months ended September 30, 2010 and 2009 were as follows:

Net sales for the first nine months of 2010 increased $2,600,000, or 6%, from the same period last year due primarily to higher printer sales into our casino and gaming (an increase of $5,266,000, or 40%) and lottery markets (an increase of $23,000, or less than 1%), partially offset by a $2,417,000, or 18%, decrease from our banking and point-of-sale market and a $272,000, or 2%, decrease from TSG.  Overall, international sales increased $4,391,000, or 49%, largely due to higher international shipments of our casino and gaming printers.  During the first nine months of 2010, our printer sales volume increased 18% to 143,000 units compared to 121,000 units in the first nine months of 2009.  This increase in unit volume was led by the casino and gaming market where our unit volume increased 47% as comp ared to the first nine months of 2009.  The average selling price of our printers decreased 8% for two reasons: (1) we sold more banking printers, which have higher average selling prices than our other printers in the first nine months of 2009 compared to the first nine months of 2010 and (2) we experienced a lower average selling price of our casino printers due primarily to an unfavorable customer mix in the first nine months of 2010 compared to the first nine months of 2009.

Sales of our banking and POS printers worldwide decreased approximately $2,417,000, or 18%.

Domestic banking and POS printer revenue decreased to $10,775,000, representing a $2,148,000, or 17%, decrease from the first nine months of 2009 primarily driven by an 82% decrease in sales of banking printers in the first nine months of 2010 compared to the first nine months of 2009 due to the completion of a project by one of our large banking customers utilizing our BANKjet® 1500 bank teller printers in the fourth quarter of 2009. This decrease was somewhat offset by the first period of volume sales of our BANKjet® 2500 printer occurring in the first nine months of 2010.  Although we are currently pursuing several banking opportunities, due to the project-oriented nature of these sales, we cannot predict the level of future sales.  Domestic sales of our POS printers increased 61% primarily due to a 104 % increase in sales of our two printer products for McDonalds for its combined beverage initiative and its POS system upgrade and grill initiatives.  We expect sales for McDonalds in the fourth quarter of 2010 to remain consistent with those of the third quarter of 2010, as McDonalds continues the pace of the roll-out of its new POS system, which includes the grill initiative printer upgrades, to all of its U.S. stores.

International banking and POS printer revenue decreased $269,000, or 31%, to $588,000, due primarily to lower legacy impact printer sales to our international distributor in Latin America in the first nine months of 2010.

Sales of our casino and gaming products increased $5,266,000, or 40%, from the first nine months of 2009.

Domestic sales of our casino and gaming printers increased $805,000, or 14%, due largely to an increase in sales of our thermal casino printers.  We believe that our increased casino printer sales during the first nine months of 2010 resulted from market share gains, as we believe the overall replacement cycle of slot machines was lower in the first nine months of 2010 as compared to the first nine months of 2009.  We anticipate little to no improvement in the domestic slot machine replacement cycle during the remainder of 2010.  We believe the current uncertain economic environment could continue to negatively impact the casino industry’s level of capital expenditures in 2010, and as a result, our future sales to the domestic casino and gaming market could be unpredictable and adversely affected.

International casino and gaming printer sales increased $4,461,000, or 62%, to $11,673,000 in the first nine months of 2010.  This increase was due primarily to a 237% increase in our thermal casino printer sales to our OEM and distributor customers in Canada and Europe, partially offset by a 27% decrease in casino printer sales to our distributor in Australia.  The increase in sales to our customers in Canada and Europe was primarily due to the sales of gaming machines into Italy, where the Italian government has approved gambling operators to install approximately 50,000 VLT games.  We expect the majority of these games to be installed over the next couple of years, with significant installations planned for 2011.  In addition, sales for the first nine months of 2010 included sales of our off-p remise gaming printers to a new customer for use in gaming machines in the U.K.

Sales of our lottery products increased $23,000, or less than 1%, from the first nine months of 2009, due primarily to higher sales of lottery printers to GTECH domestically.

Domestic and international printer sales to GTECH, which include thermal on-line and other lottery printers, increased $23,000, or less than 1%, in the first nine months of 2010 compared to the first nine months of 2009, due to the timing of orders, with domestic sales increasing $136,000 and international sales decreasing $113,000. Our quarterly sales to GTECH are directly dependent on the timing and number of new and upgraded lottery terminal installations GTECH performs, and as a result, may fluctuate significantly year over year.  Our sales to GTECH are not indicative of GTECH’s overall business or revenue.  We expect total sales to GTECH to decrease in the fourth quarter of 2010 compared to the third quarter of 2010.  

Sales from TSG decreased $272,000, or 2%, from the first nine months of 2009.

Domestic revenue from TSG decreased $584,000, or 6%, largely due to a decrease of 21% in sales of replacement parts and a 5% decrease in consumable products compared to the same period in 2009.  The decrease in replacement part sales was primarily due to lower demand for certain legacy printers, as the installed base of these legacy printers in the market continues to decline.  The decrease in consumable products sales was primarily due to a significant stocking order for inkjet cartridges from a large recurring customer in the first nine months of 2009 that did not repeat to the same extent in the first nine months of 2010, largely offset by higher sales of inkjet cartridges to newly acquired customers.

Internationally, TSG revenue increased $312,000, or 57%, to $860,000, due primarily to increased sales of replacement parts and printer accessories.

Gross Profit. Gross profit information is summarized below (in thousands, except percentages):

Gross profit increased $2,394,000, or 17%, to $16,901,000 and gross margin increased to 35.9% from 32.7%.  Both our gross profit and gross margin increased due to (1) a 6% increase in sales, (2) an increase in sales of contract manufactured products with lower overall product costs, including lower labor costs, resulting from the move of production for the majority of our products to a low cost contract manufacturer in China and (3) a more favorable sales mix as we sold more higher margin casino printer products and fewer lower margin banking printers in the first nine months of 2010 compared to the first nine months of 2009.

Engineering and Product Development. Engineering and product development information is summarized below (in thousands, except percentages):

Engineering, design and product development expenses increased $218,000, or 11%, to $2,261,000 due primarily to higher employee compensation related expenses resulting largely from annual salary increases and higher incentive compensation of $96,000, higher outside testing and pre-production expenses related to new product development of $93,000, and $21,000 higher consulting costs compared to the first nine months of 2009.  

Selling and Marketing. Selling and marketing information is summarized below (in thousands, except percentages):

Selling and marketing expenses for the first nine months of 2010 increased $454,000, or 11%, due primarily to approximately $154,000 of higher employee compensation related expenses associated with increased headcount within the sales departments and higher sales commissions resulting from higher sales volume, $238,000 of increased travel related expenses, $50,000 of increased tradeshow expenses, and $28,000 of higher demonstration printer expenses.  These increases were somewhat offset by $18,000 decrease in marketing consulting expenses compared to the prior year period.

General and Administrative. General and administrative information is summarized below (in thousands, except percentages):

General and administrative expenses increased $326,000, or 6%, due primarily to $282,000 in increased employee compensation related expenses due largely to annual salary increases and higher incentive compensation, as well as $92,000 of higher legal expenses related to business development and an increase of $90,000 in certain state and local taxes.  These increases were largely offset by a reduction of professional fee expenses of $95,000 and a reduction of depreciation expense of $47,000.  

Operating Income.  Operating income information is summarized below (in thousands, except percentages):

During the first nine months of 2010, we reported operating income of $4,411,000, or 9.4% of net sales, compared to operating income of $3,015,000, or 6.8% of net sales in the first nine months of 2009.  The increase in our operating income and operating margin was primarily due to higher gross profit resulting from the 6% increase in net sales and improved gross margin in the first nine months of 2010 compared to that of 2009.

Interest.  We recorded net interest expense of $13,000 in the first nine months of 2010 compared to net interest expense of $48,000 in the first nine months of 2009.  The decrease in net interest expense is due to increased interest income earned on a higher average cash balance in the

first nine months of 2010 compared to the first nine months of 2009, partially offset by $24,000 of interest expense incurred in the third quarter of 2010 related to certain prior years’ state and local tax liabilities.  Interest expense related to the unused revolving credit line fee and amortization of the deferred financing costs on our revolving credit facility with TD Bank remained consistent in the first nine months of 2010 compared to the first nine months of 2009.   See “Liquidity and Capital Resources” below for more information.

Other Income (Expense).  We recorded other expense of $6,000 in the first nine months of 2010 compared to other expense of $28,000 in the first nine months of 2009.  The decrease was primarily due to a foreign currency transaction exchange loss recorded by our U.K. subsidiary resulting from a 10% weakening of the U.S. dollar against the British pound in the first nine months of 2009, as compared to a foreign currency transaction gain in the first nine months of 2010 resulting from a 1% strengthening of the U.S. dollar against the British pound.

Income Taxes.  We recorded an income tax provision for the first nine months of 2010 of $1,566,000 at an effective tax rate of 35.7% compared to an income tax provision for the first nine months of 2009 of $985,000 at an effective tax rate of 33.5%.  Our effective tax rate for the first nine months of 2010 was higher because it did not include any benefits from the federal research and development tax credit, which is normally included in our tax rate, as this credit expired at the end of 2009.  If this credit is not reinstated, we expect our annual effective tax rate for 2010 to be between 35% and 36%.

Net Income.  We reported net income during the first nine months of 2010 of $2,826,000, or $0.30 per diluted share, compared to net income of $1,954,000, or $0.21 per diluted share, for the first nine months of 2009.

In the first nine months of 2010, our cash flows primarily reflected higher sales volume, resulting in higher accounts receivable balances and increased inventory investment.  Our cash balance decreased $428,000, or 4%, from December 31, 2009 and we ended the first nine months of 2010 with $9,589,000 in cash and cash equivalents and no debt outstanding.

Operating activities:  The following significant factors affected our net cash provided by operations of $346,000 in the first nine months of 2010 as compared to our net cash provided by operations of $3,938,000 in the first nine months of 2009:

During the first nine months of 2010:

During the first nine months of 2009:

Investing activities:  Our capital expenditures were $896,000 and $478,000 in the first nine months of 2010 and 2009, respectively.  Expenditures in 2010 included $615,000 for the purchase of new product tooling, $230,000 for the purchase of computer equipment and software, and the remaining amount primarily for the purchase of engineering and manufacturing equipment.  Expenditures in 2009 included approximately $224,000 for the purchase of new product tooling, approximately $170,000 for the purchase of computer, networking equipment, and software, approximately $56,000 for the purchase of manufacturing equipment, and the remaining amount primarily for the purchase of engineering equipment.< /font>  Capital expenditures for 2010 are expected to be approximately $1,100,000 to $1,300,000, primarily for new product tooling and tooling enhancements for our existing products.

Financing activities:  We generated $116,000 of net cash from financing activities during the first nine months of 2010 primarily from proceeds from stock option exercises of $261,000 offset by the repurchase of $177,000 of Company stock compared to $55,000 of net cash generated from financing activities from proceeds from stock option exercises during the first nine months of 2009.

Our working capital increased to $23,943,000 at September 30, 2010 from $20,474,000 at December 31, 2009.  The increase in our working capital was largely due to an increase in our inventories and receivables balances, partially offset by higher accounts payable and accrued liabilities as well as lower cash and cash equivalents.  Our current ratio decreased slightly to 3.6 at September 30, 2010 compared to 3.7 at December 31, 2009.

On November 28, 2006, we signed a five-year $20,000,000 credit facility (the “TD Bank Credit Facility”) with TD Bank, N.A. (“TD Bank”). The credit facility provides for a $20,000,000 revolving credit line expiring on November 28, 2011.  Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are collateralized by a lien on all of our assets.  We also pay a fee of 0.25% on unused borrowings under the revolving credit line.  The total deferred financing costs relating to expenses incurred to complete the TD Bank Credit Facility was $94,000.  The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness, the payment of d ividends on our common stock and the creation of other liens.  We were in compliance with all financial covenants of the TD Bank Credit Facility at September 30, 2010.  The following table lists the financial covenants and the performance measurements at September 30, 2010:

As of September 30, 2010, we had no balances outstanding on the revolving credit line.  Undrawn commitments under the TD Bank Credit facility were $20,000,000 at September 30, 2010.

On May 27, 2010, our Board of Directors approved a new stock repurchase program (the “Stock Repurchase Program”).  Under the Stock Repurchase Program, we are authorized to repurchase up to $10,000,000 of our outstanding shares of common stock from time to time in the open market over a three-year period ending May 27, 2013, depending on market conditions, share price and other factors.

During the three and nine months ended September 30, 2010, we repurchased 22,338 shares of our common stock for $177,000 at an average price per share of $7.95.  As of September 30, 2010, approximately $9,823,000 remains authorized for future repurchases under this program.

The disclosure of payments we have committed to make under our contractual obligations is set forth under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations" in our Form 10-K for the fiscal year ended December 31, 2009.  There have been no material changes in our contractual obligations outside the ordinary course of business since December 31, 2009.  We have no material off-balance sheet arrangements as defined in Regulation S-K 303(a)(4)(ii).

We believe that our cash on hand, cash flows generated from operations, and borrowings available under the TD Bank Credit Facility will provide sufficient resources to meet our working capital needs, finance our capital expenditures and meet our liquidity requirements through at least the next twelve months.  

The disclosure of our exposure to market risk is set forth under the heading “Quantitative and Qualitative Disclosures about Market Risk” in our Form 10-K for the fiscal year ended December 31, 2009.  There has been no material changes in our exposure to market risk during the nine months ended September 30, 2010.

The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report.  Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2010.  There has been no change in the Company’s internal control over financial reporting during the quarter ended September 30, 2010, that has materially affected, or is reasonably likely t o materially affect, the Company’s internal control over financial reporting.

None.

Information regarding risk factors appears in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009.  There have been no material changes from the risk factors previously disclosed in that Annual Report on Form 10-K.   The risks described in our Annual Report on Form 10-K are not the only risks facing our Company.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

On May 27, 2010, our Board of Directors approved a new stock repurchase program (the “Stock Repurchase Program”).  Under the Stock Repurchase Program, management was authorized to repurchase up to $10,000,000 of our outstanding shares of common stock from time to time in the open market over a three-year period ending May 27, 2013, depending on market conditions, share price and other factors.

During the three and nine months ended September 30, 2010, we repurchased 22,338 shares of our common stock for $177,000 at an average price per share of $7.95.  As of September 30, 2010, approximately $9,823,000 remains authorized for future repurchases under this program.  The following table summarizes the repurchase of our common stock in the three months ended September 30, 2010:

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

EXHIBIT LIST

The following exhibits are filed herewith.