10-Q 1 q1033102.txt 03/31/02 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: March 31, 2002 ---------------- OR [ ] 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 1-13550 ------- HAUPPAUGE DIGITAL, INC. ----------------------- (Exact Name of registrant as specified in its charter) Delaware 11-3227864 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 91 Cabot Court, Hauppauge, New York 11788 ----------------------------------------- (Address of principal executive offices) (631) 434-1600 -------------- (Issuer's telephone number) Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 ------------------ ------------------- As of April 22, 2002, 8,893,490 shares of $.01 par value Common Stock of the registrant were outstanding, not including treasury shares. 1 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES ---------------------------------------- INDEX -----
PART I. FINANCIAL INFORMATION ----------------------------- Item 1.Financial Statements Page No. -------- Condensed Consolidated Balance Sheets- March 31, 2002 (unaudited) and September 30, 2001 3 Condensed Consolidated Statements of Income- Six Months ended March 31, 2002 (unaudited) and 2001 (unaudited) 4 Condensed Consolidated Statements of Income- Three Months ended March 31, 2002 (unaudited) and 2001 (unaudited) 5 Condensed Consolidated Statements of Comprehensive Income - Three and six months ended March 31, 2002 (unaudited) and 2001 (unaudited) 6 Condensed Consolidated Statements of Cash Flow- Six Months ended March 31 , 2002 (unaudited) and 2001 (unaudited) 7 Notes to Condensed Consolidated Financial Statements 8-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-22 Item 3. Quantitative and Qualitative Disclosures about Market Risks 22 PART II. OTHER INFORMATION -------------------------- Item 1. Legal Proceedings 23 Item 6. Exhibits and Reports on form 8-K 24 SIGNATURES 25 ----------
2 PART I. FINANCIAL INFORMATION ----------------------------- Item 1. Financial Statements HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2002 September 30, (Unaudited) 2001 ----------------------------------------- ASSETS Current Assets: Cash and cash equivalents $ 6,784,947 $ 4,422,239 Accounts receivable, net of various allowances of $2,887,000 and $2,867,000 2,905,849 4,243,594 Income taxes receivable 501,000 501,000 Inventories 7,787,545 8,171,567 Prepaid expenses and other current assets 529,311 518,265 ------- ------- Total current assets 18,508,652 17,856,665 Property, plant and equipment, net 717,789 825,847 Other intangible assets-net 3,800 16,400 Security deposits and other non current assets 84,222 85,228 ------ ------ $ 19,314,463 $ 18,784,140 ============= ============ Liabilities and Stockholders' Equity : Current Liabilities: Accounts payable $ 5,921,940 $ 5,732,971 Accrued expenses 1,527,237 1,585,023 Income taxes payable 295,835 280,528 ------- ------- Total current liabilities 7,745,012 7,598,522 Stockholders' Equity Common stock $.01 par value; 25,000,000 shares authorized, 9,381,507 and 9,364,359 issued, respectively 93,815 93,644 Additional paid-in capital 12,198,378 12,164,243 Retained earnings 1,067,433 566,497 Accumulated other comprehensive income ( loss) (377,602) (267,204) Treasury Stock, at cost, 488,017, and 465,086 shares, respectively (1,412,573) (1,371,562) ---------- ---------- Total stockholders' equity 11,569,451 11,185,618 ---------- ---------- $ 19,314,463 $ 18,784,140 ============= =====================
See accompanying notes to consolidated financial statements 3 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Six months ended March 31, 2002 2001 ----- ---- Net Sales $ 22,811,233 $ 32,390,983 Cost of Sales 17,068,511 25,216,671 ---------- ---------- Gross Profit 5,742,722 7,174,312 Selling, General and Administrative Expenses 4,461,373 5,463,890 Research & Development Expenses 723,437 741,028 ------- ------- Income from operations 557,912 969,394 Other Income (expense): Interest income 21,628 18,546 Interest expense - (19,720) Foreign currency 18,036 (120,024) Non operational USD to Euro currency remeasurement (54,140) - ------- -------- Other income (expense) (14,476) (121,198) ------- -------- Income before taxes on income 543,436 848,196 Taxes provision (benefit) 42,500 (212,300) ------ -------- Income before cumulative effect of a change in accounting principle 500,936 1,060,496 Cumulative effect of a change in accounting principle, net of taxes - 204,000 ------- ------- Net income $ 500,936 $ 1,264,496 =========== =========== Net income per share-basic: Income before cumulative effect of a change in accounting principle $0.06 $0.12 Cumulative effect of a change in accounting principle $0.00 $0.02 ----- ----- Net income per share-basic $0.06 $0.14 ----- ----- Net income per share-diluted Income before cumulative effect of a change in accounting principle $0.06 $0.12 Cumulative effect of a change in accounting principle $0.00 $0.02 ----- ----- Net income per share-basic $0.06 $0.14 ===== =====
See accompanying notes to consolidated financial statements 4 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three months ended March 31, ------------------------------ 2002 2001 ------------------------------ Net Sales $ 10,748,433 $ 14,495,209 Cost of Sales 7,924,737 11,291,068 --------- ---------- Gross Profit 2,823,696 3,204,141 Selling, General and Administrative Expenses 2,294,614 2,618,042 Research & Development Expenses 364,413 347,768 ------- ------- Income from operations 164,669 238,331 Other Income (expense): Interest income 12,338 9,715 Interest expense - (7,870) Foreign currency 10,455 (70,674) Non operational USD to Euro currency re-measurement 49,492 - ------ ------ Other income (expense) 72,285 (68,829) ------ ------- Income before taxes on income 236,954 169,502 Taxes provision (benefit) 20,000 (130,214) ------ -------- Net income $ 216,954 $ 299,716 =========== =========== Net income per shares: Basic $0.02 $0.03 Diluted $0.02 $0.03 ===== =====
See accompanying notes to consolidated financial statements 5 HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME
Three months ended March 31, Six months ended March 31, ------------------------------- -------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- Other comprehensive income: ------------------------------------------ Net income $ 216,954 $299,716 $ 500,936 $1,264,496 Foreign currency translation gain (loss) (105,381) 37,185 (110,398) 37,185 -------------------------------------------------------------------- Other comprehensive income $ 111,573 $336,901 $ 390,538 $1,301,681 ====================================================================
See accompanying notes to consolidated financial statements 6 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
Six months ended March 31, 2002 2001 ---------------------------------- Cash Flows From Operating Activities: Net income $ 500,936 $ 1,264,496 ----------- ------------- Adjustments to reconcile net income to net cash Provided by (used in) operating activities: Depreciation and amortization 167,161 198,052 Provision for uncollectible accounts receivable 20,000 10,000 Other non cash items 20,008 19,002 Changes in current assets and liabilities: Accounts receivable 1,317,745 724,897 Inventories 384,022 (822,678) Prepaid expenses and other current assets (11,046) (767,683) Accounts payable and other current liabilities 146,490 350,031 ------- ------- Total adjustments 2,044,380 (288,379) --------- -------- Net cash provided by operating activities 2,545,316 976,117 --------- ------- Cash Flows From Investing Activities: Purchases of property, plant and equipment (46,503) (120,338) ------- -------- Net cash used in investing activities (46,503) (120,338) ------- -------- Cash Flows From Financing Activities: Loan repayments - (640,000) Proceeds from employee stock purchases 15,304 27,382 Purchase of treasury stock (41,011) - ------- -------- Net cash used in financing activities (25,707) (612,618) ------- -------- Net increase in cash and cash equivalents 2,473,106 243,161 --------- ------- Effect of exchange rate changes on cash and cash equivalents (110,398) - Cash and cash equivalents, beginning of period 4,422,239 2,744,855 --------- --------- Cash and cash equivalents, end of period $ 6,784,947 2,988,016 =========== ========= Supplemental disclosures: Interest paid $ - $ 13,681 Income taxes paid $ 25,386 $ 4,506 =========== =============
See accompanying notes to consolidated financial statements 7 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements included herein have been prepared in accordance with generally accepted accounting principles for interim period reporting in conjunction with the instructions to Form 10-Q. Accordingly, these statements do not include all of the information required by generally accepted accounting principles for annual financial statements. In the opinion of management, all known adjustments (consisting of normal recurring accruals and reserves) necessary to present fairly the financial position, results of operations and cash flows for the three and six month period ended March 31, 2002 have been included. It is suggested that these interim statements be read in conjunction with the financial statements and related notes included in the Company's September 30, 2001 Form 10-K. The operating results for the three and six month period ended March 31, 2002 are not necessarily indicative of the results to be expected for the September 30, 2002 year end. Note 2. Derivative Financial Instruments The Company uses derivatives to reduce its exposure to fluctuations in foreign currencies. Derivative products, such as foreign currency forward contracts, are used to hedge the foreign currency market exposures underlying forecasted Euro sales transactions with customers. The Company's accounting policies for these instruments are based on its designation of such instruments as hedging transactions. The Company does not use derivative instruments for purposes other than hedging. The Company records all derivatives on the balance sheet at fair value. As of March 31, 2002, a current asset of $7,349 reflecting the fair value of the Company's outstanding foreign currency forward contracts was recorded on the balance sheet. The Company recognizes gains and losses on derivative contracts as an adjustment to net sales. For the three and six month periods ended March 31, 2002 and 2001, the Company recorded as an increase to net sales of approximately $ 62,300 and $66,000, respectively and $ 97,000 and $788,000, respectively. To date, none of the Company's derivatives qualify for hedge accounting. The effect of implementing SFAS No.133, "Accounting for Derivative Instruments and Hedging Activities", which was adopted on October 1, 2000, is presented in this form 10-Q as a cumulative effect of a change in accounting principle for the six months ended March 31, 2001. Note 3. Inventories Inventories have been valued at the lower of average cost or market. The components of inventory consist of: March 31, September 30, 2002 2001 ---- ---- Component Parts $ 3,103,944 $ 2,421,420 Work in Progress 9,173 92,070 Finished Goods 4,674,428 5,658,077 --------- --------- $ 7,787,545 $ 8,171,567 =========== =========== 8 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 4. Net Income Per Share Basic net income per share includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects, in the periods in which they have a dilutive effect, the dilution which would occur upon the exercise of stock options. A reconciliation of the shares used in calculating basic and diluted net income per share is as follows:
Three Months Ended Six Months Ended March 31, March 31, 2002 2001 2002 2001 ---- ---- ---- ---- Weighted average shares outstanding-basic 8,893,147 8,887,719 8,890,175 8,886,349 Number of shares issued on the assumed exercise of stock options 127,184 353,100 174,622 384,791 ------- ------- ------- ------- Weighted average shares outstanding-diluted 9,020,331 9,240,819 9,064,797 9,271,140 ========= ========= ========= =========
Options to purchase 1,145,222 and 530,222 shares of common stock at prices ranging $1.91 to $ 10.06 and $3.94 and $10.06, respectively, were outstanding for the three month period ending March 31, 2002 and 2001, respectively but were not included in the computation of diluted earnings per share because they were anti-dilutive. Options to purchase 1,025,822 and 530,222 shares of common stock at prices ranging $2.31 to $ 10.06 and $3.94 and $10.06, respectively, were outstanding for the six month period ending March 31, 2002 and 2001, respectively but were not included in the computation of diluted earnings per share because they were anti- dilutive. Note 5. Accumulated other comprehensive income ( loss) The Euro is the functional currency of the Company's European subsidiaries. Assets and liabilities of these subsidiaries are translated to U.S. dollars at the exchange rate in effect at end of each reporting period, while equity accounts are translated to U.S. dollars at the historical rate in effect at the date of the contribution. Operating results are translated to U.S. dollars at the average prevailing exchange rate for the period, with the exception of sales which are translated to U.S. dollars at the average monthly forward exchange contract rate. The use of differing exchange rates results in foreign currency translation gains or losses, which are shown as a component of stockholders' equity under the caption "accumulated other comprehensive income (loss)". Accumulated other comprehensive loss reflected in the equity section was a charge of $367,602 at March 31, 2002 compared to a charge of $267,204 at September 30, 2001. The increase in the other comprehensive loss of $110,398 was primarily due to the decline in the Euro to US dollar month end exchange rate at March 31, 2002 compared to the month end exchange rate at September 30, 2001. The Company's Asian subsidiary reports its financial position and results of operations in the reporting currency of the Company. 9 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 6. Recent Accounting Pronouncements In April 2001, the Emerging Issues Task Force ("EITF") issued EITF No. 00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products," which was later codified along with other similar issues, into EITF 01-09, "Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products" ("EITF 01-09"). EITF 01-09 clarifies the income statement classification of costs incurred by a vendor in connection with the reseller's purchase or promotion of the vendor's products, resulting in certain cooperative advertising and product placement costs. EITF 01-09 is effective for the Company in the quarter ended March 31, 2002. The majority of vendor consideration granted by the Company relates to co-op advertising agreements with the Company's retail customers. Based on the requirements of EITF 01-09, the Company has properly included these costs as a component of selling, general and administrative expenses for all periods presented. In the opinion of management, it appears that the effect of all other vendor consideration arrangements would not have a material effect on the statement of operations based on the requirements of the pronouncement. 10 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ----------------------------------------------------------------- Results of Operations --------------------- Six Month Period ended March 31, 2002 compared to March 31, 2001 ------------------------------------------------------------------- Results for the six month period ended March 31, 2002 are detailed in the table below:
Six Months Six Months Ended Ended Variance Percentage of sales 3/31/02 3/31/01 $ 2002 2001 Variance ------- ------- -------- ---- ---- -------- Sales $ 22,811,233 $ 32,390,983 (9,579,750) 100.0% 100.0% - Cost of sales 17,068,511 25,216,671 (8,148,160) 74.8% 77.9% -3.1% ---------- ---------- ---------- ---- ---- --- Gross Profit 5,742,722 7,174,312 (1,431,590) 25.2% 22.1% 3.1% Gross Profit % 25.17% 22.15% 3.03% Selling, General and Administrative expenses: Sales & Marketing 2,872,261 3,581,356 (709,095) 12.6% 11.1% 1.5% Technical Support 191,343 194,327 (2,984) 0.8% 0.6% 0.2% General & Administrative 1,397,769 1,688,207 (290,438) 6.2% 5.2% 1.0% --------- --------- -------- --- --- --- Selling, General and Administrative expenses 4,461,373 5,463,890 (1,002,517) 19.6% 16.9% 2.7% Research & Development expenses 723,437 741,028 (17,591) 3.2% 2.3% 0.9% ------- ------- ------- --- --- --- Total Selling, General and Administrative expenses 5,184,810 6,204,918 (1,020,108) 22.8% 19.2% 3.6% --------- --------- ---------- ---- ---- --- Income from operations 557,912 969,394 (411,482) 2.4% 2.9% -0.5% Other income (expense) Interest income 21,628 18,546 3,082 0.1% 0.1% 0.0% Interest expense - (19,720) 19,720 0.0% -0.1% 0.1% Foreign currency 18,036 (120,024) 138,060 0.1% -0.4% 0.5% Non operational USD to Euro re-measurement gain (loss) (54,140) - (54,140) -0.2% 0.0% -0.2% ------- -------- ------- --- --- --- Other income (expense) (14,476) (121,198) 106,722 -0.0% -0.4% 0.4% ------- -------- ------- --- --- --- Income before taxes on income 543,436 848,196 (304,760) 2.4% 2.5% -0.1% Taxes provision (benefit) 42,500 (212,300) 254,800 0.2% -0.8% -1.0% ------ -------- ------- --- --- --- Income before cumulative effect of change in accounting 500,936 1,060,496 (559,560) 2.2% 3.3% -1.1% principle Cumulative effect of a change in accounting principle, net of taxes - 204,000 (204,000) 0.0% 0.6% -0.6% ------- ------- -------- --- --- --- Net income 500,936 1,264,496 (763,560) 2.2% 3.9% -1.7% ======= ========= ======== === === ===
Sales decreased $ 9,579,750 for the six months ended March 31, 2002 compared to the same period of the prior fiscal year as detailed in the table below:
Percentage of sales by Six months ended March 31, $ Percent geographic region 2002 2001 (Decrease) (Decrease) 2002 2001 -------------------------------------------------------------------------------------------- Domestic $ 4,807,317 $ 6,593,476 $ (1,786,159) (27)% 21% 20% Europe 17,482,025 23,310,935 (5,828,910) (25)% 76% 72% Asia 521,891 2,486,572 (1,964,681) (79)% 3% 8% ------- --------- ---------- --- - - Total $ 22,811,233 $ 32,390,983 $ (9,579,750) (30)% 100% 100% ============ ============ ============ === === ===
11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations- continued -------------------------------- The primary forces causing the sales decrease were: - Sluggish worldwide economic conditions - Reduction in analog board sales - Lower OEM sales activity - Lower Asian sales Sales to domestic customers were 21% of net sales compared to 20% for the same period last year. Sales to European customers were 76% of net sales compared to 72% for the same period of last year. Sales to Asian customers were 3% compared to 8% for the same period last year. Gross margins decreased $ 1,431,590 for the six months ended March 31, 2002. Gross margin percentage for the six months ended March 31, 2002 was 25.17% compared to 22.15% for the six months ended March 31, 2001. The components of the margin decrease are detailed below: Increase (decrease) Decrease due to lower sales $ (2,777,122) Increase due to higher margins on assembled boards 504,796 Increase due to decrease in labor and other related costs 840,736 ------- Total decrease in margins $ (1,431,590) ============= The increase in gross margin percentage of 3.03% for the six months ended March 31, 2002 compared to the same period of fiscal 2001 is as follows: Increase (decrease) Increase in margin on assembled boards 3.69% Labor and other related costs as a larger percent of sales (0.66%) ----- Net increase 3.03% ==== The improved margin percentage on assembled boards was primarily derived from unit price reductions from our subcontractors and larger sales mix of higher gross margin product. The decrease in the margin percentage attributable to labor and related costs was due to the percentage decrease in sales for the six month period of fiscal 2002 compared to last year being greater than the percentage decrease in labor and other related costs for the same time periods. The chart below illustrates the components of selling, general and administrative expenses:
Six months ended March 31, ---------------------------- Dollar Costs Percentage of Sales ------------ ------------------- 2002 2001 (Decrease) 2002 2001 Increase ---- ---- ---------- ---- ---- -------- Sales and Promotional $ 2,872,261 $ 3,581,356 $ (709,095) 12.6% 11.1% 1.5% Customer Support 191,343 194,327 (2,984) 0.8% 0.6% 0.2% General and Administrative 1,397,769 1,688,207 (290,438) 6.2% 5.2% 1.0% --------- --------- -------- --- --- --- Total $ 4,461,373 $ 5,463,890 $ (1,002,517) 19.6% 16.9% 2.7% ============ ============ ============ ==== ==== ===
12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations- continued -------------------------------- Selling General and Administrative expenses decreased $1,002,517 from the prior year. As a percentage of sales, Selling, General and Administrative expenses for the six months ended March 31, 2002 increased by 2.7% when compared to the six months ended March 31, 2001. The decrease in sales and promotional expense of $709,095 was mainly due to : - Lower advertising costs of $517,004 due to lower co-operative advertising and reduced special promotions - Lower commission payments of $ 100,117 due to lower sales - Decreased compensation costs of $82,042 due to personnel reductions The decrease in General and Administrative expenses of $ 290,438 was primarily due to: - Decrease in compensation costs of $196,853 due to personnel reductions for administrative personnel coupled with corporate personnel reductions - Decreased amortization costs of $30,891 mainly due to the write off of goodwill during the fourth quarter of fiscal 2001 - Lower rent costs of $ 27,362 and lower communication costs of $19,821 due to the consolidation of the Eskape Labs office in California into the Hauppauge California office Research and development expenses decreased $17,591 or approximately 2.4%. The decrease was due to lower worldwide compensation costs offset somewhat by material and contract services consumed. Other income (expense) Net other expense for the six months ended March 31, 2002 was $14,476 compared to net other expense of $121,198 for the prior year's six months ended March 31, 2001 as detailed below: Six months ended March 31, 2002 2001 ---- ---- Interest income $ 21,628 $ 18,546 Interest expense - (19,720) Foreign currency transaction gains (losses) 18,036 (120,024) Non operational USD to Euro currency re-measurement (54,140) - ------- ------- Total other (expense) $ (14,476) $ (121,198) ========= ========== The decrease in total other expense was due to foreign currency transactions gains in fiscal 2002 as opposed to losses in fiscal 2001, offset by losses from the "Non operational USD to Euro currency re- measurement". "Non operational USD to Euro currency re-measurement" results from the revaluing from U.S. dollars to Euros any U.S. dollar denominated assets and liabilities on the books of our Luxembourg based subsidiary, Hauppauge Digital Europe SARL. Since the functional currency of Hauppauge Digital Europe SARL is the Euro, any asset, liability or equity accounts which are invested in or purchased using U.S. dollars by 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations- continued -------------------------------- Hauppauge Digital Europe SARL need to be revalued into Euros at the end of each reporting period. This revaluation of U.S. dollar denominated accounts into Euros results in a non transactional re-measurement gain or loss, which we have classified as " Non operational USD to Euro currency re-measurement." Tax provision (benefit) Our net tax provision (benefit) for the six months ended March 31, 2002 and 2001 is as follows: Six months ended March 31, 2002 2001 ---- ---- Tax (benefit) attributable to U.S.operations $ (477,000) $ (369,000) Tax expense Asian operations - 42,500 Tax expense European operations 42,500 114,200 Deferred tax asset valuation allowance 477,000 - ------- -------- Net tax provision (benefit) $ 42,500 $ (212,300) ========== =========== Effective October 1, 1999, we restructured our foreign operations. The result of the restructuring eliminated the foreign sales corporation and established a new Luxembourg corporation, which functions as the entity which services our European customers. The new structure created separate domestic and foreign tax entities, with the Luxembourg entity paying a license fee to our domestic operation for use of the Hauppauge name. For the last two fiscal years, our domestic operation has incurred losses. We analyzed the future realization of our deferred tax assets as of March 31, 2002 and we concluded that under the present circumstances, it would be appropriate for us to record a valuation allowance against the increase in the deferred tax asset attributable to the current quarter's loss from domestic operations. The adoption of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities", on October 1, 2000 resulted in a $204,000 gain, net of taxes of $115,000, due to the cumulative effect of a change in accounting principle. As a result of the above, we recorded net income of $500,936 for the six months ended March 31 , 2002, which resulted in basic and diluted net income per share of $0.06 on weighted average basic and diluted shares of 8,890,175 and 9,064,797, respectively, compared to a net income of $1,264,496 for the six months ended March 31, 2001, which resulted in basic and diluted net income per share of $0.14 on weighted average basic and diluted shares of 8,886,349 and 9,271,140 respectively. Options to purchase 1,025,822 and 530,222 shares of common stock at prices ranging $3.94 to $ 10.06, respectively, were outstanding as of March 31, 2002 and 2001, respectively but were not included in the computation of diluted earnings per share because they were anti-dilutive. 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations- continued -------------------------------- Three Month Period ended March 31, 2002 compared to March 31, 2001 -------------------------------------------------------------------- Results for the three month period ended March 31, 2002 are detailed in the table below:
Three Months Three Months Ended Ended Variance Percentage of sales 3/31/02 3/31/01 $ 2002 2001 Variance ------- ------- - ---- ---- -------- Sales $ 10,748,433 $ 14,495,209 $ (3,746,776) 100.0% 100.0% - Cost of sales 7,924,737 11,291,068 (3,366,331) 73.7% 77.9% -4.2% --------- ---------- ---------- ---- ---- --- Gross Profit 2,823,696 3,204,141 (380,445) 26.3% 22.1% 4.2% Gross Profit % 26.27% 22.10% 4.17% Selling, General and Administrative expenses: Sales & Marketing 1,494,242 1,684,562 (190,320) 13.9% 11.6% 2.3% Technical Support 94,108 94,895 (787) 0.9% 0.7% 0.2% General & Administrative expenses 706,264 838,585 (132,321) 6.6% 5.8% 0.8% ------- ------- -------- --- --- --- Selling, General and Administrative expenses 2,294,614 2,618,042 (323,428) 21.4% 18.1% 3.3% Research & Development expenses 364,413 347,768 16,645 3.4% 2.4% 1.0% ------- ------- ------ --- --- --- Total Selling, General and Administrative expenses 2,659,027 2,965,810 (306,783) 24.8% 20.5% 4.3% --------- --------- -------- ---- ---- --- Income from operations 164,669 238,331 (73,662) 1.5% 1.6% -0.1% Other income (expense) Interest income 12,338 9,715 2,623 0.1% 0.1% 0.0% Interest expense - (7,870) 7,870 0.0% -0.1% 0.1% Foreign currency 10,455 (70,674) 81,129 0.1% -0.5% 0.6% Non operational USD to Euro re-measurement gain (loss) 49,492 - 49,492 0.5% 0.0% 0.5% ------ ------- ------ --- --- --- Other income (expense) 72,285 (68,829) 141,114 0.7% -0.5% 1.2% ------ ------- ------- --- --- --- Income before taxes on income 236,954 169,502 67,452 2.2% 1.1% 1.1% Taxes provision (benefit) 20,000 (130,214) 150,214 0.2% -0.9% -1.1% ------ -------- ------- --- --- --- Net income $ 216,954 299,716 (82,762) 2.0% 2.0% 0.0% ============ ======= ======= === === ===
Sales decreased $ 3,746,776 for the three months ended March 31, 2002 compared to the same quarter of the prior fiscal year as detailed geographically in the table below:
Percentage of sales by Three months ended March 31, Percent geographic region 2002 2001 (Decrease) (Decrease) 2002 2001 ---- ---- ---------- ---------- ---- ---- Domestic $ 2,248,745 $ 2,236,384 $ 12,361 1% 21% 15% Europe 8,270,340 11,135,462 (2,865,122) -26% 77% 77% Asia 229,348 1,123,363 (894,015) -80% 2% 8% ------- --------- -------- -- - - Total $ 10,748,433 $ 14,495,209 $(3,746,776) -26% 100% 100%
The primary forces causing the sales decrease were: - Sluggish worldwide economic conditions - Reduction in analog board sales - Lower OEM sales activity - Lower Asian sales 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations-continued ------------------------------- Sales to domestic customers were 21% of net sales compared to 15% for the same period last year. Sales to European customers were 77% of net sales compared to 77% for the same period of last year. Sales to Asian customers were 2% compared to 8% for the same period last year. Gross margins decreased $ 380,445 for the three months ended March 31, 2002. Gross margin percentage for the three months ended March 31, 2002 was 26.27% compared to 22.10% for the three months ended March 31, 2001. The components of the margin decrease are detailed below: Increase (decrease) ---------- Decrease due to lower sales $ (1,108,728) Increase due to higher margins on assembled boards 494,645 Increase due to decrease in labor and other related costs 233,638 ------- Total (decrease) in margins $ (380,445) ============ The increase in gross margin percentage of 4.17% for the three months ended March 31, 2002 compared to the first quarter of fiscal 2001 is as follows: Increase (decrease) ---------- Increase in margin on assembled boards 4.60% Labor and other related costs as a larger percent of sales (0.43%) ----- Net increase 4.17% ==== The improved margin percentage on assembled boards was primarily derived from unit price reductions from our subcontractors and a larger sales mix of higher gross margin product. The decrease in the margin percentage attributable to labor and related costs was due to the percentage decrease in sales for the second quarter of fiscal 2002 compared to the second quarter of fiscal 2001 being greater than the percentage decrease in labor and other related costs for the same time periods. The chart below illustrates the components of selling, general and administrative expenses:
Three months ended March 31, Dollar Costs Percentage of Sales ----------------------------------------------------------------------------------- 2002 2001 (Decrease) 2002 2001 Increase ---- ---- ---------- ---- ---- -------- Sales and Promotional $ 1,494,242 $ 1,684,562 $ (190,320) 13.9% 11.6% 2.3% Customer Support 94,108 94,895 (787) 0.9% 0.7% 0.2% General and Administrative 706,264 838,585 (132,321) 6.6% 5.8% 0.8% ------- ------- -------- --- --- --- Total $ 2,294,614 $ 2,618,042 $ (323,428) 21.4% 18.1% 3.3% ============= =========== ============ ==== ==== ===
16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations- continued -------------------------------- Selling General and Administrative expenses decreased $323,428 from the prior year's second fiscal quarter. As a percentage of sales, Selling, General and Administrative expenses for the three months ended March 31, 2002 increased by 3.3% when compared to three months ended March 31, 2001. The decrease in sales and promotional expense of $190,320 was mainly due to: - Lower advertising costs of $133,573 due to lower co-operative advertising and reduced special promotions - Lower commission payments of $48,489 due to lower sales - Decreased compensation costs of $41,307 due to personnel reductions The decrease in General and Administrative expenses of $132,321 was primarily due to: - Decrease in compensation costs of $100,664 due to personnel reductions for administrative personnel coupled with corporate personnel reductions - Decreased amortization costs of $17,743 mainly due to the write off of goodwill during the fourth quarter of fiscal 2001 - Lower rent costs of $13,832 and lower communication costs of $12,123 due to the consolidation of the Eskape Labs office in California into the Hauppauge California office Research and development expenses increased $16,645 or approximately 4.8%. The increase was due to lower worldwide compensation costs offset by increased material and contract services consumed. Other income (expense) Net other income for the three months ended March 31, 2002 was $72,285 compared to net other expense of $ 68,829 for the prior year's second fiscal quarter as detailed below: Three months ended March 31, 2002 2001 ---- ---- Interest income $ 12,338 $ 9,715 Interest expense - (7,870) Foreign currency transaction gains (losses) 10,445 (70,674) Non operational USD to Euro currency re-measurement 49,492 - ------ -------- Total other income (expense) $ 72,285 $ (68,829) ======== ========= The increase in total other income was due to foreign currency transactions gains in fiscal 2002 as opposed to losses in fiscal 2001 coupled with gains during the quarter ended March 31, 2002 for the "Non operational USD to Euro currency re-measurement". "Non operational USD to Euro currency re-measurement" results from the revaluing from U.S. dollars to Euros any U.S. dollar denominated assets and liabilities on the books of our Luxembourg based subsidiary, Hauppauge Digital Europe SARL. Since the functional currency of Hauppauge Digital Europe SARL is the Euro, any asset, liability or equity accounts which are invested in or purchased using U.S. dollars by 17 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations- continued -------------------------------- Hauppauge Digital Europe SARL need to be revalued into Euros at the end of each reporting period. This revaluation of U.S. dollar denominated accounts into Euros results in a non transactional re-measurement gain or loss, which we have classified as " Non operational USD to Euro currency re-measurement." Tax provision (benefit) Our net tax provision (benefit) for the three months ended March 31, 2002 and 2001 is as follows: Three months ended March 31, 2002 2001 ---- ---- Tax (benefit) attributable to U.S operations $ (248,000) $ (190,214) Tax expense European operations 20,000 60,000 Deferred tax asset valuation allowance 248,000 - ------- -------- Net tax provision (benefit) $ 20,000 $ (130,214) =========== ========== Effective October 1, 1999, we restructured our foreign operations. The result of the restructuring eliminated the foreign sales corporation and established a new Luxembourg corporation, which functions as the entity which services our European customers. The new structure created separate domestic and foreign tax entities, with the Luxembourg entity paying a license fee to our domestic operation for use of the Hauppauge name. For the last two fiscal years, our domestic operation has incurred losses. We analyzed the future realization of our deferred tax assets as of March 31, 2002 and we concluded that under the present circumstances, it would be appropriate for us to record a valuation allowance against the increase in the deferred tax asset attributable to the current quarter's loss from domestic operations. As a result of the above, we recorded net income of $216,954 for the quarter ended March 31 , 2002, which resulted in basic and diluted net income per share of $0.02 on weighted average basic and diluted shares of 8,893,147 and 9,020,331, respectively, compared to a net income of $299,716 for the three months ended March 31, 2001, which resulted in basic and diluted net income per share of $0.03 on weighted average basic and diluted shares of 8,887,719 and 9,240,819 respectively. Options to purchase 1,145,222 and 530,222 shares of common stock at prices ranging $1.91 to $ 10.06 and $3.94 and $10.06, respectively, were outstanding for the three month period ending March 31, 2002 and 2001, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive. Seasonality ----------- As our sales are primarily to the consumer market, we have experienced certain seasonal revenue trends. Our peak sales quarter, due to holiday season sales of computer equipment, is our first fiscal quarter (October to December), followed by our fourth fiscal quarter (July to September). In addition, our international sales, mostly in the European market, were 77%, 71% and 73 % of sales for the years ended September 30, 2001, 2000 and 1999, respectively. Our fiscal fourth quarter sales (July to September) can be potentially impacted by the reduction of activity experienced in Europe during the July and August summer holiday period. To offset the above cycles, we target a wide range of customer types in order to moderate the seasonality of retail sales. 18 Liquidity and Capital Resources ------------------------------- Our cash, working capital and stockholders' equity position is disclosed below: March 31, September 30, 2002 2001 ---- ---- Cash $ 6,784,947 $ 4,422,239 Working Capital 10,763,640 10,258,143 Stockholders' Equity 11,569,451 11,185,618 The Company had cash and cash equivalents as of March 31, 2002 of $6,784,947, an increase of $2,362,708 over September 30, 2001. The increase was due to: Net income adjusted for non cash items $ 708,105 Decrease in inventories 384,022 Proceeds from employee stock purchases 15,304 Decrease in accounts receivable 1,317,745 Increase in accounts payable and accrued expenses 146,490 Less cash used for: Increase in prepaid and other current assets (11,046) Purchases of fixed assets (46,503) Purchase of treasury stock (41,011) Effect of exchange rate changes on cash and cash equivalents (110,398) -------- Net increase in cash $ 2,362,708 =========== Net cash of $2,545,316 provided by operating activities was primarily due to a decrease in accounts receivable and inventory of $1,317,745 and $384,022, respectively, net income adjusted for non cash items of $708,105 and an increase in accounts payable and accrued expenses of $146,490, offset somewhat by an increase in prepaid assets of $11,046. Cash of $46,503 and $41,022 was used to purchase fixed assets and purchase treasury stock. Proceeds from the exercise of stock options and stock purchased by employees from the employee stock purchase plan provided additional cash of $15,304. The change in accumulated other comprehensive loss decreased cash by $110,398. On April 5, 2001, we extended our agreement with Chase Manhattan Bank, to provide us with a $6,500,000 credit facility. The facility is secured by our assets, and expired on March 31, 2002. On January 25, 2002, Chase Manhattan Bank, citing the current economic conditions in the technology sector coupled with our two years of non profitability, verbally informed us that our line of credit had been terminated. No amounts were outstanding under the credit facility on January 25, 2002. It is our intention to replace the terminated line with a new credit facility. On November 8, 1996, we approved a stock repurchase program for the repurchase of up to 600,000 shares of our own stock. We intend to use the repurchased shares for certain employee benefit programs. On December 17, 1997, the stock repurchase program was extended by a resolution of our Board of Directors. As of March 31, 2002, we held 488,017 treasury shares purchased for $1,412,573 at an average purchase price of approximately $2.89 per share. 19 Critical Accounting Policies and Estimates ------------------------------------------ Financial Reporting Release No. 60, which was recently released by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of the our financial statements: - Revenue Recognition - Management's estimates - Hedging program for sales denominated in a foreign currency - Translation of assets and liabilities denominated in non functional currencies on our European financial statements Revenue Recognition ------------------- Our revenues are primarily derived from the sale of computer boards which enable you to view television programs on your personal computer. Sales of computer boards are commonly classified as computer hardware. Our sales are primarily to retailers, distributors and original equipment manufacturers. Sales to our customers are documented by a purchase order which describes the conditions of sale. Sales are recorded when products are shipped to our customers, as we generally have no significant post delivery obligations, the product price is fixed and determinable, collection of the resulting receivable is probable and product returns are reasonably estimable. Revenue from freight charged to customers is recognized when products are shipped. Provisions for customer returns and other adjustments are provided for in the period the related sales are recorded based upon historical data. Management's Estimates ---------------------- The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and related disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts for revenues and expenses during the reporting period. On an ongoing basis, management evaluates estimates, including those related to sales provisions, as described above, income taxes, bad debts, inventory reserves and contingencies. We base our estimates on historical data, when available, experience, and on various other assumptions that are believed to be reasonable under the circumstances, the combined results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Hedging program for sales denominated in a foreign currency ------------------------------------------------------------- Our European subsidiary accounts for approximately 70% to 75 % of our net sales. All of our European sales are denominated in local currencies, primarily the Euro. As a result of this, we are a net receiver of currencies other than the U.S. dollar. Changes in the exchange rate subject us to market risks resulting from the fluctuation of the Euro to the U.S. dollar. In an attempt to minimize these risks, we enter into forward exchange contracts with financial institutions. 20 Hedging program for sales denominated in a foreign currency-continued ----------------------------------------------------------------------- We do not enter into contracts for speculative purposes. We enter into monthly window contracts covering an average period of six months based on existing or anticipated future sales. Although we enter into these contracts to reduce the short term impact of currency rate changes, the following risks are still inherent in hedging the Euro sales. - Actual sales may fluctuate from our estimates, resulting in contracts in excess of collections - Short term volatility of currency markets has the potential to reduce the effectiveness of our hedging program - Continued long term decline of the Euro has the potential to negatively impact our revenues, gross margins and operating income - The magnitude of the success of our hedging program is dependent upon movements in the Euro exchange rates. These movements are difficult to predict over an extended period of time. Translation of assets and liabilities denominated in non functional currencies ------------------------------------------------------------------------------- on our European financial statements ------------------------------------ The functional currency of our European subsidiary is the Euro. In preparing our consolidated financial statements, we are required to translate assets and liabilities denominated in a non functional currency, mainly U.S. dollars, to Euros on the books of our European subsidiary. This process results in exchange gains and losses depending on the changes in the Euro to U.S. exchange rate. Under the relevant accounting guidance, we are obligated to include these gains and losses on our statement of operations, which we report in other income or expense under the caption "Non operational USD to Euro re- measurement gain or (loss)." The extent of the gains and losses can fluctuate greatly from month to month depending on the change in the exchange rate, causing results to vary widely. Due to the past volatility of the Euro, it is difficult to forecast the long term trend of these gains and losses. Future Contractual Obligations ------------------------------ The following table shows the Company's contractual obligations related to lease obligations as of March 31, 2002: Payments due by period Contractual obligations Total 1 year 1-3 years 4-5 years Operating lease obligations $ 2,518,067 $ 659,349 $ 1,300,001 $ 558,718 ----------- --------- ----------- --------- We believe that our cash and cash equivalents as of March 31, 2002 and our internally generated cash flow will provide us with sufficient liquidity to meet our currently foreseeable short-term and long-term capital needs. Inflation --------- While inflation has not had a material effect on the Company's operations in the past, there can be no assurance that the Company will be able to continue to offset the effects of inflation on the costs of its products or services through price increases to its customers without experiencing a reduction in the demand for its products; or that inflation will not have an overall effect on the computer equipment market that would have a material affect on the Company. 21 Effect of New Accounting Pronouncements --------------------------------------- In April 2001, the Emerging Issues Task Force ("EITF") issued EITF No. 00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products," which was later codified along with other similar issues, into EITF 01-09, "Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products" ("EITF 01-09"). EITF 01-09 clarifies the income statement classification of costs incurred by a vendor in connection with the reseller's purchase or promotion of the vendor's products, resulting in certain cooperative advertising and product placement costs. EITF 01-09 is effective for the Company in the quarter ended March 31, 2002. The majority of vendor consideration granted by the Company relates to co-op advertising agreements with the Company's retail customers. Based on the requirements of EITF 01-09, the Company has properly included these costs as a component of selling, general and administrative expenses for all periods presented. In the opinion of management, it appears that the effect of all other vendor consideration arrangements would not have a material effect on the statement of operations based on the requirements of the pronouncement. Item 3. Quantitative and Qualitative Disclosures about Market Risks -------------------------------------------------------------------- Due to extensive sales to European customers with payment made to us in those local currencies and limited expenses paid in local currencies, we are a net receiver of currencies other than the U.S. dollar. As such, we benefit from a weak dollar and are negatively affected by a strong dollar relative to the major worldwide currencies, especially the Euro and British Pound Sterling. Consequently, changes in exchange rates expose us to market risks resulting from the fluctuations in the foreign currency exchange rates to the U.S. dollar. We attempt to reduce these risks by entering into foreign exchange forward contracts with financial institutions to protect against currency exchange risks associated with our foreign denominated sales. The strength or weakness of the U.S. dollar against the Euro and British Pound Sterling impacts our financial results. Changes in exchange rates may positively or negatively affect our revenues, gross margins, operating income and retained earnings (which are all expressed in U.S. dollars). We engage in hedging programs aimed at limiting, in part, the impact of currency fluctuations. By selling foreign currency forward, we fix the rate of exchange at the time we enter into the contract. We deliver these currencies to the financial institutions at a later date when we actually receive the foreign currency. As of March 31, 2002, we had foreign currency forward contracts outstanding of approximately $ 7,449,000 against delivery of the Euro. The contracts expire through August 2002. Although we do not try to hedge against all possible foreign currency exposures because we can not fully estimate the size of our exposure, the contracts we procure are specifically entered into to as a hedge against existing or anticipated foreign currency exposure. We do not enter into contracts for speculative purposes. Although we maintain these programs to reduce the short term impact of changes in currency exchange rates, when the U.S. dollar sustains a long term strengthening position against the foreign currencies in countries where we sell our products, our revenues, gross margins, operating income and retained earnings can be adversely affected. Factors that could impact the effectiveness of our hedging program include volatility of the currency markets and availability of hedging instruments. For the three and six month periods ended March 31, 2002 and 2001, the Company recorded an increase to net sales of approximately $62,300 and $66,000, respectively, and $97,000 and $788,000, respectively. 22 Special Note Regarding Forward Looking Statements ------------------------------------------------- Certain statements in this Release constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, those described in the Company's filings with the Securities and Exchange Commission, including but not limited to the Company's Annual Report in Form 10-K for the fiscal year ended September 30, 2001. PART II. OTHER INFORMATION --------------------------- Item 1 Legal Proceedings ----------------- In January 1998, Advanced Interactive Incorporated ("AII") contacted us and attempted to induce us into entering a patent license or joint venture agreement with AII relative to certain of our products. AII alleged that such products infringe U.S. Patent No. 4,426,698 (the "AII Patent"). At such time, our engineering staff analyzed the AII Patent and determined that our products did not infringe any such patent. Accordingly, we rejected AII's offer. On October 6, 1998, we received notice that AII had commenced an action against us and multiple other defendants in the United States District Court for the Northern District of Illinois (the "District Court"), alleging that certain of our products infringed on certain patent rights allegedly owned by the plaintiff (the "Complaint"). The Complaint sought unspecified compensatory and statutory damages with interest. We denied such allegations and vigorously defended this action. On December 22, 1998, we filed our answer (the "Answer"). We denied that our products infringed AII's patent rights and asserted certain affirmative defenses. On June 26, 2000, the District Court granted the Defendant's Motion for Partial Adjudication of Claim Constructions Issues and entered a Final Judgment of Non-infringement to us. On July 25, 2000, AII filed a Notice of Appeal with the U.S. Court of Appeals for the Federal Circuit, appealing the District Court's Order granting the Motion for Partial Adjudication of Claim Construction Issues and Order entering Final Judgment of Non infringement. On July 16, 2001, the Federal Circuit entered a Circuit Rule 36 Judgment of Affirmance Without Opinion. Accordingly, the Federal Circuit affirmed the District Court's finding of non-infringement. As of December 13, 2001, the time limit permitting AII to file a petition with the U.S. Supreme Court for a Writ of Certiorari to review the Federal Circuit judgment has lapsed. This litigation is now over without the possibility of further appeals. We have been informed by counsel for the estate of the late Mr. Kenneth Aupperle ("Estate") that they have filed a Demand for Arbitration with the American Arbitration Association claiming property rights and interest in the Company, certain amounts due and owing to the Estate based on various corporate agreements with Mr. Aupperle and certain insurance policies, such amount to be no less than $2,500,000. As of the date of filing, we have not received a formal acknowledgement from the American Arbitration Association of the said Demand for Arbitration. Management is unable to comment on the merits of the claim without more information from the Estate and/or its counsel. However, based on the preliminary information presented to us, management believes that the claim is without merit and will vigorously defend it. 23 Item 6 Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits -------- None (b) Reports on form 8-K ------------------- None 24 SIGNATURES ---------- Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HAUPPAUGE DIGITAL, INC. ----------------------- Registrant Date: May 3, 2002 By: -------------- --------------------------- KENNETH PLOTKIN President and Chief Executive Officer Date: May 3, 2002 By: ------------- --------------------------- GERALD TUCCIARONE Treasurer and Chief Financial Officer 25