TRANSACT TECHNOLOGIES INC - Quarter Report: 2008 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: June 30, 2008

OR

For the transition period from:              to:             

Commission file number: 0-21121

TRANSACT TECHNOLOGIES INCORPORATED

(Exact name of registrant as specified in its charter)

One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT 06518

(Address of principal executive offices)

(Zip Code)

(203) 859-6800

(Registrant’s telephone number, including area code)

(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  x    No  ¨

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  ¨    No  x

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

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TRANSACT TECHNOLOGIES INCORPORATED

INDEX

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PART I—FINANCIAL INFORMATION

TRANSACT TECHNOLOGIES INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

See notes to condensed consolidated financial statements.

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TRANSACT TECHNOLOGIES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

See notes to condensed consolidated financial statements.

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TRANSACT TECHNOLOGIES INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

See notes to condensed consolidated financial statements.

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TRANSACT TECHNOLOGIES INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

TransAct Technologies Incorporated (“TransAct” or the “Company”), which has its headquarters in Hamden, CT and its primary operating facility in Ithaca, NY, operates in one industry segment, market-specific printers for transaction-based industries. These industries include casino, gaming, lottery, banking, kiosk and point-of-sale. Our printers are designed based on market specific requirements and are sold under the Ithaca^® and Epic product brands. We distribute our products through original equipment manufacturers, value-added resellers, selected distributors, and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. We also generate revenue from the after-market side of the business, providing printer service, supplies and spare parts.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These accounting principles were applied on a basis consistent with those of the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. In our opinion, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to fairly state TransAct’s financial position as of June 30, 2008, the results of our operations for the three and six months ended June 30, 2008 and 2007, and our cash flows for the six months ended June 30, 2008 and 2007. The December 31, 2007 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 America. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2007 included in our Annual Report on Form 10-K.

The financial position and results of operations of our two foreign subsidiaries are measured using local currency as the functional currency. Assets and liabilities of such subsidiaries 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 operations.

The results of operations for the three and six months ended June 30, 2008 are not necessarily indicative of the results to be expected for the full year.

Stock option activity. The 1996 Stock Plan, 1996 Directors’ Stock Plan, 2001 Employee Stock Plan and 2005 Equity Incentive Plan option activity is summarized below:

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TRANSACT TECHNOLOGIES INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

As of June 30, 2008, unrecognized compensation cost related to stock options totaled $1,325,000, which is expected to be recognized over a weighted average period of 4.1 years. The total intrinsic value of stock options exercised was $5,000 during the three months ended June 30, 2008. No stock options were exercised during the three months ended June 30, 2007. The total intrinsic value of stock options exercised was $11,000 and $1,000, during the six months ended June 30, 2008 and 2007, respectively.

Restricted stock activity. Under the 1996 Stock Plan, 2001 Employee Stock Plan and 2005 Equity Incentive Plan, we have granted shares of restricted common stock, for no consideration, to our officers, directors and certain key employees. Restricted stock activity for the 1996 Stock Plan, 2001 Employee Stock Plan and 2005 Equity Incentive Plan is summarized below:

As of June 30, 2008, unrecognized compensation cost related to restricted stock totaled $581,000, which is expected to be recognized over a weighted average period of 1.9 years. The intrinsic value of restricted stock that vested was $133,000 and $43,000, during the three months ended June 30, 2008 and 2007, respectively. The intrinsic value of restricted stock that vested was $274,000 and $280,000, during the six months ended June 30, 2008 and 2007, respectively.

Share-based compensation expense. During the three months ended June 30, 2008 and 2007, we recognized compensation expense of $84,000 and $61,000, respectively, for stock options and $123,000 and $124,000, respectively, for restricted stock, which was recorded in our condensed consolidated statements of operations in accordance with SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”). The income tax benefits from share-based payments recorded in the condensed consolidated statements of operations totaled $77,000 and $68,000 for the three months ended June 30, 2008 and 2007, respectively. During the six months ended June 30, 2008 and 2007, we recognized compensation expense of $157,000 and $104,000, respectively, for stock options and $252,000 and $257,000, respectively, for restricted stock. The income tax benefits from share-based payments recorded in the condensed consolidated statements of operations totaled $152,000 and $133,000 for the six months ended June 30, 2008 and 2007, respectively.

Assumptions for estimating fair value of share-based payments. We use the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield and exercise price. Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. In addition, we estimate forfeitures when recognizing compensation expense, and we will adjust our estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative true-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods. Under the assumptions indicated below, the weighted-average fair value of stock option grants for the three and six months ended June 30, 2008 was $5.31 and $3.43, respectively. The weighted-average fair value of stock option grants for the three and six months ended June 30, 2007 was $4.68 and $5.81, respectively.

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TRANSACT TECHNOLOGIES INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The table below indicates the key assumptions used in the option valuation calculations for options granted in the respective periods:

The components of inventories, net of allowances, are:

The following table summarizes the activity recorded in the accrued product warranty liability during the three and six months ended June 30, 2008 and 2007.

The current portion of the accrued product warranty liability is included in accrued liabilities in the condensed consolidated balance sheets.

In February 2001, we undertook a plan to consolidate all manufacturing and engineering into our existing Ithaca, NY facility and to close our Wallingford, CT manufacturing facility (the “Consolidation”). As of December 31, 2001, substantially all Wallingford product lines were successfully transferred to Ithaca, NY. We applied the consensus set forth in EITF 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)” in recognizing the accrued restructuring expenses relating to the Consolidation.

In November 2006, we executed an agreement effective May 1, 2007 to terminate the lease agreement for our Wallingford, CT facility (the “Release Agreement”). Prior to the execution of the Release Agreement, we accrued for the remaining non-cancelable lease payments and other related costs for the unused portion of this

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TRANSACT TECHNOLOGIES INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

facility through the expiration date of the lease (March 31, 2008). As a result of the Release Agreement and the early termination of the lease, we were released from the legal obligation for lease payments after May 1, 2007 and, accordingly, we reversed approximately $479,000 of previously accrued restructuring reserve in the fourth quarter of 2006. During the second quarter of 2007, we recorded an additional $12,000 of expense to finalize the termination of the lease agreement. As of December 31, 2007, all non-cancelable lease payments related to our Wallingford, CT facility had been made.

The following table summarizes the activity recorded in accrued restructuring expenses during the three and six months ended June 30, 2007.

Basic and diluted earnings per share are calculated in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.”

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.

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TRANSACT TECHNOLOGIES INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

For the three months ended June 30, 2008, potentially dilutive shares that were excluded from the earnings per share calculation, consisting of out-of-the-money stock options, amounted to 223,750 shares.

For the six months ended June 30, 2008, there were 968,797 potentially dilutive shares (prior to consideration of the treasury stock method), consisting of stock options and unvested restricted stock, that were excluded from the earnings per share calculation as such shares would be anti-dilutive due to the Company’s net loss for the six months ended June 30, 2008.

For the three and six months ended June 30, 2007, potentially dilutive shares that were excluded from the earnings per share calculation, consisting of out-of-the-money stock options, amounted to 315,500 and 248,000 shares, respectively.

The following table summarizes the Company’s comprehensive income (loss):

Changes in stockholders’ equity for the six months ended June 30, 2008 were as follows (in thousands):

On March 25, 2005, our Board of Directors approved a stock repurchase program (“the Stock Repurchase Program”). Under the Stock Repurchase Program, we were authorized to repurchase up to $10 million of our outstanding shares of common stock from time to time in the open market over a three year period, depending on market conditions, share price and other factors.

On November 1, 2007, our Board of Directors approved an increase in our stock repurchase authorization under the Stock Repurchase Program to $15 million from $10 million. In addition, the Board approved a two-year extension of the Stock Repurchase Program to March 31, 2010. During the three and six months ended June 30, 2008, we made no repurchases of common stock. As of June 30, 2008, we have repurchased a total of 1,034,000 shares of common stock for approximately $7,995,000, at an average price of $7.73 per share, since the inception of the Stock Repurchase Program.

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TRANSACT TECHNOLOGIES INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

We have been involved in on going patent litigation with FutureLogic with respect to our patents U.S. Patent 6,924,903 and U.S. Patent 7,099,035. On May 9, 2008, we signed a binding term sheet with FutureLogic that settled this current patent litigation and all other legal matters outstanding between the two parties. Under the binding term sheet, FutureLogic has agreed to license our dual port technology for printers and upgrade kits that utilize the patented technology. The license grants FutureLogic worldwide, perpetual rights for U.S. Patent 6,924,903, U.S. Patent 7,099,035, related applications and patents, and foreign counterparts.

As of June 30, 2008, we had a net deferred tax asset of approximately $4,869,000. In two of the last three years, we have had U.S. taxable losses and there is no assurance that we will generate future taxable income sufficient to realize all of our deferred tax assets. However, based on our current projection of future taxable income as of June 30, 2008, we believe that it is more likely than not that the existing net deferred tax asset will be realized. However, if our future projections of taxable income are less than expected, we may need to establish a valuation allowance for all or a portion of our net deferred tax asset, which may have a material adverse effect on our results of operations and financial condition.

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 matters through 2002. Our federal tax returns for the years 2003 – 2006 remain open to examination, with our 2005 and 2006 federal tax returns currently under 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 condensed consolidated financial statements. No state or foreign tax jurisdictions are currently under examination.

As of June 30, 2008, we had approximately $125,000 of total gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits.

We do not anticipate that the total unrecognized tax benefits will significantly change due to the settlement of audits and the expiration of statute of limitations prior to June 30, 2009.

We recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2008, we have approximately $5,000 of accrued interest related to uncertain tax positions.

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Forward Looking Statements

Certain statements included in this report, including without limitation statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All forward-looking statements generally can be identified by the use of forward-looking terminology, such as “may”, “will”, “expect”, “intend”, “estimate”, “anticipate”, “believe”, “project” or “continue” or the negative thereof or other similar words. Forward-looking statements involve risks and uncertainties, including, but not limited to those listed in Item 1A of our most recently filed Form 10-K. Actual results may differ materially from those discussed in, or implied by, the forward-looking statements. The forward-looking statements speak only as of the date of this report and we assume no duty to update them.

Overview

TransAct designs, develops, assembles, markets and services world-class transaction printers under the Epic and Ithaca^® 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, 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, Australia, the Caribbean Islands and the South Pacific. In addition, we have a strong focus on the after-market side of the business, with a growing commitment to printer service, supplies and spare parts. We operate in one reportable segment, the design, development, assembly and marketing of transaction printers and printer-related service, supplies and spare parts.

Critical Accounting Judgments and Estimates

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, 2007. We have reviewed those policies and determined that they remain our critical accounting policies for the six months ended June 30, 2008.

Results of Operations: Three months ended June 30, 2008 compared to three months ended June 30, 2007

Net Sales. Net sales, which include printer sales and sales of spare parts, consumables and repair services, by market for the three months ended June 30, 2008 and 2007 were as follows:

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Net sales for the second quarter of 2008 increased $2,372,000, or 17%, from the same period last year due primarily to higher printer shipments into our lottery (an increase of approximately $2,304,000, or 93%), and casino and gaming markets (an increase of approximately $416,000, or 8%). Sales from our TransAct Services Group decreased by $288,000, or 9%, and sales from our banking and point-of-sale market decreased by approximately $60,000, or 2%. Overall, international sales decreased by $672,000, or 21%. The decrease in both TSG sales and international sales was due largely to the expiration in November 2007 of a service contract with a single customer in the United Kingdom.

Banking and point-of-sale:

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 and checks at bank teller stations. Revenue from this market also includes sales of inkjet, thermal 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 other inserted media. Sales of our banking and POS printers worldwide decreased approximately $60,000, or 2%.

Domestic banking and POS revenue increased to $2,748,000, representing an $8,000, or less than 1%, increase from the second quarter of 2007. Banking printer sales increased by approximately $200,000 due primarily to incremental sales of our Bankjet® bank teller printer to an existing customer in the second quarter of 2008 compared to the second quarter of 2007. Although we are currently pursuing several banking opportunities, due to the project-oriented nature of these sales, we cannot predict if and when future sales may occur. Increased banking printer sales were also complemented by initial sales of our new Ithaca 8000 receipt/label printer to our global food-service retailer customer. These increases were almost entirely offset by decreased sales of our legacy line of POS impact printers to our distributors. We expect sales of our legacy impact printers for the remainder of 2008 to continue to be lower than those reported for the comparable 2007 period, as these printers are being replaced by our newer thermal and inkjet printers.

International banking and POS printer shipments decreased by approximately $68,000, or 20%, to $265,000, due primarily to lower sales to our international distributors in Europe, partially offset by higher sales to our international POS distributors in Asia.

Casino and gaming:

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 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 products increased by $416,000, or 8%, from the second quarter of 2007.

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Domestic sales of our casino and gaming printers increased by $556,000, or 19%, due largely to an increase in domestic sales of our thermal casino printers, including initial sales resulting from our new status as the default printer provider to IGT beginning April 2008, despite a weak domestic casino market.

International casino and gaming printer sales decreased $140,000, or 7%, to $1,925,000 in the second quarter of 2008. Such sales represented 35% and 41% of total sales into our casino and gaming market during the second quarter of 2008 and 2007, respectively. This decrease was due primarily to decreased sales of our casino printers in Europe, as we received a large order from a customer in the second quarter of 2007 that did not repeat in the second quarter of 2008, as well as lower sales in Asia. This decrease was partly offset by continued growth in sales of our new off-premise gaming printers in Europe.

Lottery:

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. Sales of our lottery products increased by $2,304,000, or 93%, from the second quarter of 2007, due to higher sales of lottery printers to GTECH, both domestically and internationally.

Domestic and international printer sales to GTECH, which include thermal on-line and other lottery printers, increased by $2,304,000, or 93%, in the second quarter of 2008 compared to the second quarter of 2007, with domestic sales increasing approximately $2,183,000 and international sales increasing $121,000. 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 quarter-to-quarter. Our sales to GTECH are not indicative of GTECH’s overall business or revenue.

TransAct Services Group:

Revenue from the TransAct Services Group (“TSG”) includes sales of consumable products (inkjet cartridges, ribbons and receipt paper), replacement parts, maintenance and repair services, refurbished printers, accessories and shipping and handling charges. Sales from TSG decreased by approximately $288,000, or 9%.

Domestic revenue from TSG increased by approximately $297,000, or 11%, largely due to increased sales of consumable products, including higher sales of inkjet cartridges as we continue to benefit from the agreement we signed in August 2006 to supply inkjet cartridges to a leading national office supply chain. This increase was somewhat offset by lower maintenance and repair service revenue.

Internationally, TSG revenue decreased by approximately $585,000, or 80%, to $144,000, due largely to a decrease in maintenance and repair services revenue from a service contract with a single customer in the United Kingdom. The service contract, which represented a substantial portion of our U.K. subsidiary’s revenue in 2007, ended in November 2007 and was not renewed, as the customer replaced our printers with newer technology that we were unable to provide. As a result, we expect international TSG revenue to be lower in 2008 compared to 2007.

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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. Gross profit increased $520,000, or 11%, to $5,460,000 from $4,940,000 due primarily to a 17% increase in sales from the second quarter 2008 compared to the second quarter 2007. Gross margin decreased to 33.5% from 35.4%, due primarily to a less favorable sales mix, and, to a lesser extent, higher freight expenses, partially offset by a higher volume of sales in the second quarter of 2008 compared to the second quarter of 2007.

Engineering and Product Development. Engineering 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 design expenses (including prototype printer expense, outside design and testing services, and supplies). Such expenses for the second quarter 2008 decreased by $88,000, or 11%, due to lower outside design, prototype, development and professional consulting related expenses. Engineering and product development expenses decreased as a percentage of net sales due primarily to a higher volume of sales in the second quarter of 2008 compared to the second quarter of 2007, as well as lower expenses for the respective 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 and other promotional marketing expenses. Selling and marketing expenses for the second quarter of 2008 decreased by $192,000, or 11%, due to a reduced level of sales staff related expenses resulting from the cost reduction actions we took in late 2007 as well as lower promotional marketing expenses. Selling and marketing expenses decreased as a percentage of net sales due primarily to a higher volume of sales as well as lower expenses in the second quarter of 2008 compared to the second quarter of 2007.

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 decreased by $113,000, or 6%, due primarily to lower (1) legal expenses related to general corporate matters, (2) recruitment related expenses, and (3) lower professional fees. These decreases were partially offset by higher compensation-related expenses from the hiring of our new Vice President of Business Development. General and administrative expenses decreased as a percentage of net sales due primarily to a higher volume of sales as well as lower expenses in the second quarter of 2008 as compared to the second quarter of 2007.

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Legal Fees associated with lawsuit. During the second quarter of 2008, we incurred approximately $1,132,000 of legal fees related to our lawsuit with FutureLogic, Inc. compared to approximately $187,000 in the second quarter of 2007. The substantial increase was due primarily to our litigation with FutureLogic, Inc. that we settled in May 2008. As a result of this settlement, we do not expect to incur any additional legal fees related to the lawsuit beyond the second quarter 2008. See “Item 1—Legal Proceedings” in Part II of this report for more information.

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

During the second quarter of 2008, we reported operating income of $399,000, or 2.4% of net sales, compared to operating income of $419,000, or 3.0% of net sales in the second quarter of 2007. The decrease in our operating income and operating margin was due to higher operating expenses (primarily our legal expense of $1,132,000 related to the FutureLogic lawsuit), offset partially by higher gross profit resulting from increased sales, in the second quarter of 2008 compared to that of 2007.

Interest. We recorded net interest expense of $7,000 in the second quarter of 2008 compared to net interest income of $10,000 in the second quarter of 2007. The decrease in our net interest income was largely due to a lower average cash balance in the second quarter of 2008 compared to the second quarter of 2007, coupled with a lower overall rate of return on our invested cash balance due to the decreasing interest rate environment. See “Liquidity and Capital Resources” below for more information.

Other Expense. We recorded other expense of $8,000 in the second quarter of 2008 compared to other income of $13,000 in the second quarter of 2007. The decrease was primarily due to transaction exchange losses recorded by our UK subsidiary resulting from the weakening of the U.S. dollar against the British pound.

Income Taxes. We recorded an income tax provision for the second quarter of 2008 of $94,000 at an effective tax rate of 24.5%, compared to an income tax provision during the second quarter of 2007 of $158,000 at an effective tax rate of 35.7%. The lower effective tax rate for the second quarter of 2008 was largely due to the near breakeven level of income before income taxes for the six months ended June 30, 2008. We expect our annual effective tax rate for 2008 to be between 38% and 40%.

Net Income. We reported net income during the second quarter of 2008 of $290,000, or $0.03 per diluted share, compared to net income of $284,000, or $0.03 per diluted share, for the second quarter of 2007.

Six months ended June 30, 2008 compared to six months ended June 30, 2007

Net Sales. Net sales, which include printer sales and sales of spare parts, consumables and repair services, by market for the six months ended June 30, 2008 and 2007 were as follows:

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Net sales for the first half of 2008 increased $5,189,000, or 20%, from the same period last year due primarily to higher printer shipments into our lottery (an increase of approximately $4,772,000, or 132%) and casino and gaming (an increase of approximately $1,122,000, or 12%) markets. Sales from TSG decreased by $727,000, or 11%. Overall, international sales decreased by $1,086,000, or 19%. The decrease in TSG sales and international sales were due largely to the expiration in November 2007 of a service contract with a single customer in the United Kingdom.

Banking and point-of-sale:

Sales of our banking and POS printers worldwide increased approximately $22,000, or less than 1%.