10-Q 1 q33103.txt FORM 10-Q, MARCH 31, 2003 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, 2003 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 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes No X -- - As of April 28, 2003, 8,863,265 shares of .01 par value Common Stock of the registrant were outstanding, not including treasury shares. HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES INDEX PART I. FINANCIAL INFORMATION Item 1.Financial Statements Page No. Condensed Consolidated Balance Sheets- March 31, 2003 (unaudited) and September 30, 2002 3 Condensed Consolidated Statements of Income- Six Months ended March 31, 2003 (unaudited) and 2002 (unaudited) 4 Condensed Consolidated Statements of Income- Three Months ended March 31, 2003 (unaudited) and 2002 (unaudited) 5 Condensed Consolidated Statements of Other Comprehensive Income - Three months and six months ended March 31, 2003 (unaudited) and 2002 (unaudited) 6 Condensed Consolidated Statements of Cash Flow- Six Months ended March 31 , 2003 (unaudited) and 2002 (unaudited) 7 Notes to Condensed Consolidated Financial Statements 8-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-25 Item 3. Quantitative and Qualitative Disclosures about Market Risks 25 Item 4. Controls and Procedures 26 PART II. OTHER INFORMATION Item 1. Legal Proceedings 26 Item 6. Exhibits and Reports on form 8-K 26 SIGNATURES 27 CERTIFICATIONS 28-29 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, September 30 2003 2002 (Unaudited) ----------------------------------------- Assets: Current Assets: Cash and cash equivalents $ 4,660,775 $ 4,964,522 Accounts receivable, net of various allowances of $2,887,000 7,056,504 5,182,738 Income taxes receivable 501,000 501,000 Inventories 8,897,662 8,091,495 Prepaid expenses and other current assets 612,278 416,734 --------------------------------------- Total current assets 21,728,219 19,156,489 Property, plant and equipment, net 599,093 611,054 Security deposits and other non current assets 78,376 78,616 --------------------------------------- $ 22,405,688 $19,846,159 ======================================= Liabilities and Stockholders' Equity : Current Liabilities: Accounts payable $ 7,209,169 $ 6,105,588 Accrued expenses 2,144,443 1,442,475 Income taxes payable 362,666 331,484 --------------------------------------- Total current liabilities 9,716,278 7,879,547 Stockholders' Equity Common stock $.01 par value; 25,000,000 shares authorized, 9,405,322 and 9,392,164 issued, respectively 94,053 93,923 Additional paid-in capital 12,265,542 12,233,170 Retained earnings 1,831,006 914,019 Accumulated other comprehensive income ( loss) (3,975) 187,074 Treasury Stock, at cost, 542,067, and 514,317 shares, respectively (1,497,216) (1,461,574) --------------------------------------- Total stockholders' equity 12,689,410 11,966,612 --------------------------------------- $ 22,405,688 $19,846,159 =======================================
3 See accompanying notes to consolidated financial statements HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED (UNAUDITED)
Six months ended March 31, ---------------------------------- 2003 2002 ---------------------------------- Net Sales $29,439,344 $22,811,233 Cost of Sales 22,148,910 17,068,511 --------------------------------- Gross Profit 7,290,434 5,742,722 Selling, General and Administrative Expenses 5,430,774 4,461,373 Research & Development Expenses 941,324 723,437 --------------------------------- Income from operations 918,336 557,912 Other Income (expense): Interest income 10,005 21,628 Foreign currency (15,494) 18,036 Non operational USD to Euro currency re-measurement 43,140 (54,140) --------------------------------- Other income (expense) 37,651 (14,476) --------------------------------- Income before taxes on income 955,987 543,436 Tax provision 39,000 42,500 --------------------------------- Net income $916,987 $500,936 ================================= Net income per shares: Basic and Diluted $0.10 $0.06 =================================
See accompanying notes to consolidated financial statements 4 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three months ended March 31, --------------------------------- 2003 2002 --------------------------------- Net Sales $13,918,858 $10,748,433 Cost of Sales 10,549,386 7,924,737 --------------------------------- Gross Profit 3,369,472 2,823,696 Selling, General and Administrative Expenses 2,724,472 2,294,614 Research & Development Expenses 448,251 364,413 --------------------------------- Income from operations 196,749 164,669 Other Income (expense): Interest income 4,034 12,338 Foreign currency (3,147) 10,455 Non operational USD to Euro currency re-measurement 75,396 49,492 --------------------------------- Other income (expense) 76,283 72,285 --------------------------------- Income before taxes on income 273,032 236,954 Tax provision 12,517 20,000 --------------------------------- Net income $ 260,515 $ 216,954 ================================= Net income per shares: Basic and Diluted $0.03 $0.02 =================================
See accompanying notes to consolidated financial statements 5 HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (UNAUDITED)
Three months ended March 31, 2003 2002 ---- ---- Net income $ 260,515 $ 216,954 Forward exchange contracts marked to market 163,879 - Foreign currency translation gain (loss) 13,318 (105,381) -------------------------------------------- Other comprehensive income $ 437,712 $ 111,573 ============================================ Six months ended March 31, 2003 2002 ---- ---- Net income $ 916,987 $ 500,936 Forward exchange contracts marked to market (355,095) - Foreign currency translation gain (loss) 164,046 (110,398) -------------------------------------------- Other comprehensive income $ 725,938 $ 390,538 ============================================
See accompanying notes to consolidated financial statements 6 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
Six months ended March 31, 2003 2002 ------------------------------------ Net income $916,987 $500,936 ------------------------------------ Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 137,530 167,161 Provision for uncollectible accounts receivable - 20,000 Other non cash items 19,241 20,008 Changes in current assets and liabilities: Accounts receivable (2,064,815) 1,207,347 Inventories (806,167) 384,022 Prepaid expenses and other current assets (195,544) (11,046) Accounts payable and other current liabilities 1,836,731 146,490 ------------------------------------ Total adjustments (1,073,024) 1,933,982 ------------------------------------ Net cash (used in) provided by operating activities (156,037) 2,434,918 ------------------------------------ Cash Flows From Investing Activities: Purchases of property, plant and equipment (125,569) (46,503) ------------------------------------ Net cash used in investing activities (125,569) (46,503) ------------------------------------ Cash Flows From Financing Activities: Proceeds from employee stock purchases 13,501 15,304 Purchase of treasury stock (35,642) (41,011) ------------------------------------ Net cash used in financing activities (22,141) (25,707) ------------------------------------ Net( decrease) increase in cash and cash equivalents (303,747) 2,362,708 Cash and cash equivalents, beginning of period 4,964,522 4,422,239 ------------------------------------ Cash and cash equivalents, end of period $ 4,660,775 $ 6,784,947 ==================================== Supplemental disclosures: Income taxes paid $ 4,945 $ 25,386 =================================== 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 periods ended March 31, 2003 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, 2002 Form 10-K. The operating results for the three and six month periods ended March 31, 2003 are not necessarily indicative of the results to be expected for the September 30, 2003 year end. Note 2. Derivative Financial Instruments 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 use derivatives to reduce our exposure to fluctuations in foreign currencies. Foreign currency forward contracts are used to hedge the foreign currency market exposures underlying forecasted sales transactions with customers. As of March 31, 2003, we had foreign currency contracts outstanding of approximately $3,716,900 against the delivery of the Euro. The contracts expire through June 2003. Our accounting policies for these instruments designate such instruments as cash flow hedging transactions. We do not enter into such contracts for speculative purposes. We record all derivative gains and losses on the balance sheet as a component of stockholders' equity under the caption "Accumulated other comprehensive income (loss)". The Company recorded a deferred gain of $163,879 for the three months ended March 31, 2003. As of March 31, 2003, a deferred loss of $164,176, reflecting the cumulative mark to market loss of our derivatives, was recorded as a component of accumulated other comprehensive income on the balance sheet. For the three months and six months ended March 31, 2003, we recorded a decrease in sales of $ 609,100 and $1,158,700, respectively, related to our contracts that closed during these periods and the changes in the fair value of our derivative contracts. For the three months and six months ended March 31, 2002, we recorded an increase in sales of $ 62,300 and $97,000, respectively, related to our contracts that closed during these periods and the changes in the fair value of our derivative contracts 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, 2003 2002 ---- ---- Component Parts $ 2,640,095 $2,842,460 Work in Progress - 42,616 Finished Goods 6,257,567 5,206,419 --------- --------- $8,897,662 $8,091,495 ========== ========== 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, 2003 2002 2003 2002 ---- ---- ---- ---- Weighted average shares outstanding-basic 8,862,774 8,893,147 8,860,578 8,890,175 Number of shares issued on the assumed exercise of stock options 97,047 127,184 57,357 174,622 --------- --------- --------- --------- Weighted average shares outstanding-diluted 8,959,821 9,020,331 8,917,935 9,064,797 ========= ========= ========= =========
Options to purchase 1,240,122 and 1,145,322 shares of common stock at prices ranging $1.47 to $ 10.06 and $1.91 and $10.06, respectively, were outstanding for the three month periods ending March 31, 2003 and 2002, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive. Options to purchase 1,455,425 and 1,025,822 shares of common stock at prices ranging $1.35 to $ 10.06 and $2.31 and $10.06, respectively, were outstanding for the six month periods ending March 31, 2003 and 2002, 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 subsidiary, Hauppauge Digital Europe Sarl. Assets and liabilities of this subsidiary are translated to U.S. Dollars at the spot 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 translating accounts at the spot, historical and average exchange rates results in foreign currency translation gains or losses. These translation gains losses are recorded on the balance sheet under accumulated other comprehensive income. The company uses forward exchange contracts to reduce our exposure to fluctuations in foreign currencies. Mark to market gains and losses on these open contracts result from the difference between the USD value of our open foreign currency forward contracts at the average contract rate as opposed to the same contracts translated at the month end spot rate. The Company qualifies for cash flow hedge accounting as prescribed under FAS 133, which allows the Company to record the mark to market gains and losses in the equity section of our balance sheet under accumulated other comprehensive income. As of March 31, 2003, appearing in the equity section under " Accumulated other comprehensive income (loss)" was a deferred loss of $3,975, which consisted of a deferred translation gain of $160,201 and a deferred loss of $164,176 due to the mark to market losses on the difference between the value of our open forward exchange contracts at the contract rates versus the same contracts valued at the period ending forward rate. 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. Revenue Recognition We sell through a sales channel which consist of retailers and distributors. Our prices are fixed consistently over the entire sales channel. The majority of our customers are granted open payment terms. Those customers deemed as large credit risks either pay in advance or issue us a letter of credit. The Company requires the customer to submit a purchase order to the Company. The price of the product and payment terms are fixed per the terms of the purchase order. Upon shipment of the order to the customer, the title to the goods is passed to the customer. The customer is legally obligated to pay for the order within the payment terms stated on the customer's purchase order. The obligation to insure the boards and the cost of any pilferage while in the customer's possession is the responsibility of the customer. The product we sell is a plug and play computer board that is stocked on the shelves of retailers, and is subject to the normal consumer traffic that retail stores attract. Aside from normal store promotions such as end-caps and advertisements in the store's circular, the Company has no further obligation to assist in the resale of the product. The Company offers it customers a right of return, but does not offer stock balancing. Our accounting complies with SFAS 48 as typically at the end of every quarter, the Company, based on historical data, creates a sales reserve based on the previous six months sales. Due to seasonal nature of our business coupled with the changing economic environment, management exercises some judgement with regard to the historical data to arrive at the reserve. Note 7. Product segment and Geographic Information The Company sells a family or group of products called WinTV boards. Using a television signal source which can be either through a cable hookup, terrestrial antenna or digital satellite, the WinTV family of products allow a PC user to watch TV in a resizable window on their PC. Our products are either sold, or can be sold by the same retailers and distributors in our marketing channel, and are sold directly to OEM customers. The company evaluates its product lines under the functional categories of analog and digital products. Sales by functional category are as follows:
Three months ended March 31, Six months ended March 31, 2003 2002 2003 2002 ---- ---- ---- ---- Product line sales ------------------ Analog sales $ 10,245,978 $ 9,054,595 $ 21,539,440 $ 19,532,712 Digital sales 3,672,880 1,693,838 7,899,904 3,278,521 ---------- ---------- ---------- ---------- $ 13,918,858 $ 10,748,433 $ 29,439,344 $ 22,811,233 ============== ============== ============== ============
The Company sells its product through a worldwide network of distributors and retailers. European sales accounted for 68% and 77% of sales for the three moths ended March 31, 2003 and 2002 and 69% and 77% of sales for the six months ended March 31, 2003 and 2002, respectively. Sales by geographic region are as follows:
Three months ended March 31, Six months ended March 31, Sales percent by geographic region 2003 2002 2003 2002 ---------------------------------- ---- ---- ---- ---- United States 30% 21% 29% 21% Germany 34% 40% 32% 40% United Kingdom 13% 9% 15% 12% France/Italy 9% 16% 10% 12% Spain/Portugal 4% 4% 4% 4% Sweden/Finland 3% 3% 3% 3% Belgium/Switzerland/Holland 4% 4% 4% 4% Asia 1% 2% 2% 2% Other 2% 1% 1% 2% -- -- -- -- Total 100% 100% 100% 100% ==== ==== ==== ====
10 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 8. Stock-Based Compensation The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", ("APB 25"), and related interpretations in accounting for its employee stock options. Under APB 25, no compensation expense is recorded so long as the quoted market price of the stock at the date of the grant is equal to the exercise price. Pro forma information regarding net income and earnings per share has been determined as if the Company had accounted for its employee stock options under the fair value method of Financial Accounting Standards Board Statement No. 123 "Accounting for Stock-Based Compensation", ("FAS 123"). The weighted average fair value of options granted during the three months and six months ended March 31, 2003 and March 31, 2002 was $0.43 and $0.42, respectively. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for the three and six months ended March 31, 2003 and March 31, 2002: risk-free interest rates of 3.25%, volatility factor of the expected market price of the Company's Common Stock of 40%, assumed dividend yield of 0%, and a weighted-average expected life of the option of 5 years. Under the accounting provisions of FAS 123, the Company's net income and net income per share would have been adjusted to the pro forma amounts indicated below:
Three months ended Six months ended -------------------------------- ---------------------------- March 31, March 31, March 31, March 31, 2003 2002 2003 2002 -------------------------------- ---------------------------- Net income (loss) as reported....................... $260,515 $216,954 $916,987 $500,936 Deduct: Total stock-based employee compensation expense determined under fair value method, net of related taxes .......................... (11,626) (19,865) (23,252) (39,730) -------- -------- -------- -------- Pro forma net income (loss) $248,889 $197,089 $893,735 $461,206 ========= ======== ======== ======== Net income per share - as reported: Basic and diluted................................... $ 0.03 $ 0.02 $ 0.10 $ 0.06 ======== ======== ======== ======= Net income per share - pro forma: Basic and diluted................................... $ 0.03 $ 0.02 $ 0.10 $ 0.05 ======== ======== ======== =======
Note 9. Arrangements with Off-Balance Sheet Risk - Guarantees In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others, which clarifies the requirements of SFAS No. 5, Accounting for Contingencies, relating to a guarantor's accounting for and disclosures of certain guarantees issued. FIN 45 requires enhanced disclosures for certain guarantees. It also requires certain guarantees that are issued or modified after December 31, 2002, including certain third-party 11 HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 9. Arrangements with Off-Balance Sheet Risk - Guarantees-continued guarantees, to be initially recorded on the balance sheet at fair value. For guarantees issued on or before December 31, 2002, liabilities are recorded when and if payments become probable and estimable. FIN 45 has the general effect of delaying recognition for a portion of the revenue for product sales that are accompanied by certain third-party guarantees. The financial statement recognition provisions became effective prospectively beginning January 1, 2003. The Company has not entered into any new guarantees, not have they ammended their existing guarantee since the effective date. We occupy a facility located in Hauppauge, New York and use it as our executive offices and for the testing, storage, and shipping of our products. The building is owned by a partnership comprised of certain of our principal stockholders' and is leased to us under a lease agreement expiring on January 31, 2006, which may be extended, at our option, for an additional three years. The premises are subject to two mortgages which have been guaranteed by us upon which the outstanding principal amount due as of March 31, 2003 was $787,000. The two mortgages guaranteed expire on Janauary 31, 2010, at which time the related gurantees expire. 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Six Month Period ended March 31, 2003 Compared to March 31, 2002 Results of operations for the six months ended March 31, 2003 compared to March 31, 2002 are as follows:
Six Six Months Months Ended Ended Variance Percentage of sales 3/31/03 3/31/02 $ 2003 2002 Variance ------- ------- -------- ---- ---- -------- Net Sales $ 29,439,344 22,811,233 6,628,111 100.0% 100.0% - Cost of sales 22,148,910 17,068,511 5,080,399 75.2% 74.8% 0.4% ------------- ---------- --------- ------ ------ ------ Gross Profit 7,290,434 5,742,722 1,547,712 24.8% 25.2% -0.4% Gross Profit % 24.76% 25.17% -0.41% Costs: Sales & Marketing 3,701,409 2,872,261 829,148 12.6% 12.5% 0.1% Technical Support 199,775 191,343 8,432 0.7% 0.9% -0.2% General & Administrative 1,529,590 1,397,769 131,821 5.2% 6.2% -1.0% ------------- ---------- --------- ------ ------ ------ Total Selling General and Administrative costs 5,430,774 4,461,373 969,401 18.5% 19.6% -1.1% Research & Development 941,324 723,437 217,887 3.2% 3.2% 0.0% ------------- ---------- --------- ------ ------ ------ Total Costs 6,372,098 5,184,810 1,187,288 21.7% 22.8% -1.1% ------------- ---------- --------- ------ ------ ------ Net operating income 918,336 557,912 360,424 3.1% 2.4% 0.7% Other income (expense) Interest income 10,005 21,628 (11,623) 0.0% 0.1% -0.1% Foreign currency (15,494) 18,036 (33,530) -0.1% 0.2% -0.3% Non operational USD to Euro re-measurement 43,140 (54,140) 97,280 0.1% -0.2% 0.3% ------------ ---------- --------- ------ ------ ------ Total other income (expense) 37,651 (14,476) 52,127 0.0% 0.1% -0.1% ------------ ---------- --------- ------ ------ ------ Income before taxes 955,987 543,436 412,551 3.1% 2.5% 0.6% Taxes on income 39,000 42,500 (3,500) 0.1% 0.2% -0.1% ------------ ---------- --------- ------ ------ ------ Net income 916,987 500,936 416,051 3.0% 2.3% 0.7% ============ ========== ========= ====== ====== ======
Net sales for the six months ended March 31, 2003 increased $6,628,111 compared to last year. Domestic and European sales increased by $3,868,052 and $2,899,067 while Asian sales decreased $139,008 as follows
Increase (decrease) Increase Percentage of sales Six Months Six Months Dollar (decrease) Geographic region Location ended 3/31/03 ended 3/31/02 Variance Variance % 2003 2002 ------------- ------------- ---------- ---------- --------------------- Domestic $ 8,675,369 $ 4,807,317 $3,868,052 80% 29% 21% Europe 20,381,092 17,482,025 2,899,067 17% 69% 77% Asia 382,883 521,891 (139,008) -27% 2% 2% ----------- ----------- ---------- ---- --- --- Total $29,439,344 $22,811,233 $6,628,111 29% 100% 100% =========== =========== ========== ==== ==== ===
The primary forces contributing to the sales increase were: - Digital and digital satellite products:$4,621,383 - Analog and personal video recorder sales:$2,006,728 13 Six Month Period ended March 31, 2003 Compared to March 31, 2002-continued Net sales to domestic customers were 29% of net sales for the six months ended March 31, 2003 compared to 21% for the six months ended March 31, 2002. Net sales to European customers were 69% of net sales compared to 77% for same period of last year. Net sales to Asian customers were 2% for both years. Gross profit increased $1,547,712 for the six months ended March 31, 2003. Gross profit percentage for the six months ended March 31, 2003 was 24.76% compared to 25.17% for the prior year. The increases and (decreases) in the gross profit are detailed below: Increase (decrease) ---------- Due to increased sales $2,152,873 Due to higher margins on assembled boards 140,934 Due to OEM sales (423,311) Due to increases in labor related and other costs (322,784) --------- Total increase in gross profit $1,547,712 ========== The decrease in gross profit percentage of (0.41)% for the six months ended March 31, 2003 compared to the six months ended March 31, 2002 is as follows: Increase (decrease) ---------- Due to higher margins on assembled boards 0.51% Due to OEM sales (1.51)% Due to labor related and other costs as a lower percent of sales 0.59% ----- Net decrease (0.41%) The improved margin percentage on assembled boards was primarily derived from unit price reductions from our suppliers and subcontractors coupled with a larger sales mix of digital video satellite and analog video products, which yield a higher gross margin, offset somewhat by sales of lower average margin digital entertainment products. OEM sales require minimal sales promotional and advertising support compared to boards sold to retailers, but also yield a lower margin. OEM sales were minimal during the first six months of fiscal 2002. The higher mix of OEM boards sold during the first six months of fiscal 2003 resulted in a 1.51% margin decrease. The increase in the gross margin percent of 0.59% due to labor related and other costs is due to the increase in net sales of 29.06% being in excess of the increase in labor related and other costs of 18.87%. The chart below illustrates the components of Selling, General and Administrative expenses:
Six months ended March 31, Dollar Costs Percentage of Sales ------------------------------------------------------------------------------------------- Increase Increase 2003 2002 (Decrease) 2003 2002 (Decrease) ---- ---- ---------- ---- ---- ---------- Sales and Marketing $3,701,409 $2,872,261 $829,148 12.6% 12.5% 0.1% Technical Support 199,775 191,343 8,432 0.7% 0.9% -0.2% General and Administrative 1,529,590 1,397,769 131,821 5.2% 6.2% -1.0% ----------- ---------- --------- ---- ---- ----- Total $5,430,774 $4,461,373 $969,401 18.5% 19.6% -1.1% =========== =========== ========= ===== ===== =====
Selling, General and Administrative expenses increased $969,401 from the prior year. As a percentage of sales, Selling, General and Administrative expenses decreased by 1.1% when compared to the six months ended March 31, 2002. 14 Six Month Period ended March 31, 2003 Compared to March 31, 2002-continued The increase in Sales and Marketing expense of $829,148 which accounted for about 85% of the total increase in Selling, General and Administrative expenses, was mainly due to: - Higher advertising costs of $610,033 due to higher sales based co-operative advertising, higher customer rebate realization and increased special promotions - Higher commissions payments of $140,288 due to increased sales - Increased European sales office costs of $195,417 - Lower trade show costs of $130,051 due to smaller show presence and frequency The increase in General and Administrative expenses of $131,821 was primarily due to: - Addition of senior executive officer $94,168 - Higher legal costs of $31,349 - Increased travel costs of $21,641 - Decreased amortization costs of $30,631 due to amortization in full of an intangible asset during fiscal 2002 Research and Development expenses increased $217,887 or approximately 30%. The increase was mainly due to higher compensation costs attributable to additional staff and increased material and contract services cost for current projects under development. Other income (expense) Net other income for the six months ended March 31, 2003 was $37,651 compared to net other expense of ($14,476) for the six months ended March 31, 2003 as detailed below: Six months ended March 31, 2003 2002 ---- ---- Interest income $10,005 $ 21,628 Foreign currency transaction gains (losses) (15,494) 18,036 Non operational USD to Euro currency re-measurement 43,140 (54,140) ------- -------- Total other income (expense) $37,651 $(14,476) ======= ======== The decrease in total other expense was due to the lower losses resulting from the Non operational USD to Euro currency re-measurements and lower interest income due to lower investment yields. Non Operational USD to Euro currency re-measurement We follow the rules prescribed in paragraph 15 of SFAS 52 "Foreign Currency Translation", which states that accounts denominated in a currency other than an entities functional currency need to be re-measured into the entities functional currency, and any gain or loss from this re-measurement are included in the determination of net income. Since the functional currency of Hauppauge Digital Europe Sarl ("HDE Sarl") is the Euro, any asset, liability or equity accounts which are invested in or purchased using U.S. Dollars or Great British Pounds by HDE Sarl are revalued into Euros at the end of each period. The gains or losses on HDE Sarl's books resulting from the revaluation of U.S. Dollar and Great British Pound accounts into Euros are booked on the Company's profit and loss statement in the other income (loss) section under the description "Non operational USD to Euro currency re-measurement." Primarily due to a decrease in U.S Dollar denominated inventory and an increase in U.S denominated liabilities on HDE Sarl's books, HDE Sarl experienced a net asset decrease of $1,458,833 for the six month period ending September 30, 2002. The increase in the value of the Euro versus the U.S. Dollar coupled with the decrease in net assets resulted in a re-measurement gain of $43,240 for the six months ended March 31, 2003. 15 Six Month Period ended March 31, 2003 Compared to March 31, 2002-continued Accumulated other comprehensive income (loss) The Euro is the functional currency of the Company's European subsidiary, HDE Sarl. Assets and liabilities of this subsidiary are translated to U.S. Dollars at the exchange rate in effect at the 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. Since the Euro accounts on books result in a net asset position (total Euro assets are in excess of Euro liabilities), an increase in the Euro value results in a deferred gain for the translation of Euro accounts to U.S. Dollars. For the six months ended March 31, 2003, the Company recorded deferred translation gains $164,046. Recorded as a component of accumulated other comprehensive income on the balance sheet as of March 31, 2003 was a cumulative translation gain of $160,201. The Company uses forward exchange contracts to reduce our exposure to fluctuations in foreign currencies. Mark to market gains and losses on these open contracts result from the difference between the USD value of our open foreign currency forward contracts at the average contract rate as opposed to the same contracts translated at the month end forward rate. The Company qualifies for cash flow hedge accounting as prescribed under FAS 133, which allows the Company to record the mark to market gains and losses in the equity section of our balance sheet under accumulated other comprehensive income. For the six months ended March 31, 2003, the Company recorded as part of other comprehensive income a mark to market loss of $355,095, reflecting the difference between open contracts at September 30, 2002 and March 31, 2003. Recorded as a component of accumulated other comprehensive income on the balance sheet as of March 31, 2003 was a cumulative mark to market loss for open contracts of $164,176. As stated above, accumulated other comprehensive income (loss) consists of two components: - Translation gains and losses - FAS 133 mark to market gains and losses on our open foreign exchange contracts The table below details the gains and losses recorded for the components that make up accumulated other comprehensive income (loss):
Balance October to Balance January to Balance Accumulated other comprehensive income (loss) as of December 2002 as of March 2003 as of September 30, Gains December 31, Gains March 31, 2002 (losses) 2002 (losses) 2003 ------------- ------------ ------------ ---------- ---------- Translation gains and (losses) $ (3,845) $ 150,728 $ 146,883 $ 13,318 $ 160,201 FAS 133 mark to market adjustments 190,919 (518,974) (328,055) 163,879 (164,176) --------- --------- --------- -------- --------- $187,074 $(368,246) $(181,172) $177,197 $ (3,975) ======== ========== ========== ======== =========
Tax provision Our net tax provision for the six months ended March 31, 2003 and 2002 is as follows: Six months ended March 31, 2003 2002 ------ ------ Tax (benefit) attributable to U.S operations $(212,000) $(477,000) Tax expense European operations 39,000 42,500 Deferred tax asset valuation allowance 212,000 477,000 --------- --------- Net tax provision $39,000 $ 42,500 ========= ========= 16 Six Month Period ended March 31, 2003 Compared to March 31, 2002-continued 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 three fiscal years, our domestic operation has incurred losses. We analyzed the future realization of our deferred tax assets as of March 31, 2003 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 all of the above items mentioned in the Management's Discussion and Analysis of Financial Condition and Results of Operations, we recorded net income of $916,987 for the six months ended March 31, 2003, which resulted in basic and diluted net income per share of $0.10 on weighted average basic and diluted shares of 8,860,578 and 8,917,935, respectively, compared to a net income of $500,936 for the six months ended March 31, 2002, which resulted in basic and diluted net loss per share of $0.06 on weighted average basic and diluted shares of 8,890,175 and 9,064,797, respectively. Options to purchase 1,455,425 and 1,025,822 shares of common stock at prices ranging $1.35 to $ 10.06 and $2.31 and $10.06, respectively, were outstanding for the six month periods ending March 31, 2003 and 2002, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive. Results of operations-three Month Period ended March 31, 2003 Compared to March 31, 2002 Results of operations for the three months ended March 31, 2003 compared to March 31, 2002 are as follows:
Three Three Months Months Ended Ended Variance Percentage of sales 3/31/03 3/31/02 $ 2003 2002 Variance -------- ---------- -------- ---- ---- -------- Net Sales $13,918,858 $10,748,433 $3,170,425 100.0% 100.0% - Cost of sales 10,549,386 7,924,737 2,624,649 75.8% 73.8% 2.0% ----------- ---------- ---------- ----- ----- ---- Gross Profit 3,369,472 2,823,696 545,776 24.2% 26.2% -2.0% Gross Profit % 24.21% 26.27% -2.06% Costs: Sales & Marketing 1,838,397 1,494,242 344,155 13.2% 13.9% -0.7% Technical Support 101,415 94,108 7,307 0.7% 0.9% -0.2% General & Administrative 784,660 706,264 78,396 5.5% 6.5% -1.0% ----------- ----------- ---------- ----- ----- ----- Total Selling General and Administrative costs 2,724,472 2,294,614 429,858 19.4% 21.3% -1.9% Research & Development 448,251 364,413 83,838 3.2% 3.4% -0.2% ----------- ----------- ---------- ----- ----- ----- Total Costs 3,172,723 2,659,027 513,696 22.6% 24.7% -2.1% ----------- ----------- ---------- ----- ----- ----- Net operating income 196,749 164,669 32,080 1.6% 1.5% 0.1% Other income (expense) Interest income 4,034 12,338 (8,304) 0.0% 0.1% -0.1% Foreign currency (3,147) 10,455 (13,602) 0.0% 0.1% -0.1% Non operational USD to Euro re-measurement 75,396 49,492 25,904 0.5% 0.5% 0.0% ----------- ----------- --------- ----- ----- ---- Total other income (expense) 76,283 72,285 3,998 0.5% 0.7% -0.2% ----------- ----------- --------- ----- ----- ----- Income before taxes 273,032 236,954 36,078 2.1% 2.2% -0.1% Taxes on income 12,517 20,000 (7,483) 0.1% 0.2% -0.1% ----------- ----------- --------- ----- ----- ----- Net income 260,515 216,954 $ 43,561 2.0% 2.0% -0.0% =========== =========== ========= ===== ===== =====
17 Three Month Period ended March 31, 2003 Compared to March 31, 2002-continued Net sales for the three months ended March 31, 2003 increased $3,170,425 compared to March 31, 2002. Domestic and European sales increased by $1,946,496 and $1,256,053 while Asian sales decreased $32,124 as follows:
Increase (decrease) Increase Percentage of sales Location Three Months Three Months Dollar (decrease) Geographic region ended 3/31/03 ended 3/31/02 Variance Variance % 2003 2002 ------------- ------------- ------------- --------- -------- ------ Domestic $ 4,195,241 $ 2,248,745 $ 1,946,496 87% 30% 21% Europe 9,526,393 8,270,340 1,256,053 15% 68% 77% Asia 197,224 229,348 (32,124) -14% 2% 2% -------------- ------------- -------------- ---- --- --- Total $ 13,918,858 $ 10,748,433 $ 3,170,425 29% 100% 100% ============== ============= ============== === ==== ====
The primary forces contributing to the sales increase were: - Sales of digital and digital satellite product:$1,979,042 - Analog and personal video recorder sales:$1,191,383 Net sales to domestic customers were 30% of net sales for the quarter ended March 31, 2003 compared to 21% for the quarter ended March 31, 2003. Net sales to European customers were 68% of net sales compared to 77% for the same quarter of last year. Net sales to Asian customers were 2% for both quarters. Gross profit increased $545,776 for the three months ended March 31, 2003. Gross profit percentage for the three months ended March 31, 2003 was 24.21% compared to 26.27% for the prior year's second quarter. The increases and (decreases) in the gross profit are detailed below: Increase (decrease) ---------- Due to increased sales $1,011,554 Due to higher margins on assembled boards 54,025 Due to OEM sales (257,906) Due to increases in labor related and other costs (261,897) -------- Total increase in gross profit $ 545,776 ========== The decrease in gross profit percentage of 2.06% for the three months ended March 31, 2003 compared to the three months ended March 31, 2002 was as follows: Increase (decrease) ---------- Due to higher margins on assembled boards 0.44% Due to OEM sales (2.42)% Due to labor related and other costs as a higher percent of sales (0.08)% ------- Net decrease (2.06)% ======= The improved margin percentage on assembled boards was primarily derived from unit price reductions from our suppliers and subcontractors coupled with a larger sales mix of digital video satellite and analog video products, which yield a higher gross margin, offset somewhat by sales of lower average margin digital entertainment products. OEM sales require minimal sales promotional and advertising support compared to boards sold to retailers, but also yield a lower margin. OEM sales were minimal during the three month period ending March 31, 2002. The higher mix of OEM boards sold during the three month period ending March 31, 2003 resulted in a 2.42% margin decrease. The decrease in the gross margin percent of 0.08% relating to labor related and other costs is due to the increase in labor related and other costs of 30.75% being in excess of the increase in net sales of 29.50%. 18 Three Month Period ended March 31, 2003 Compared to March 31, 2002-continued The chart below illustrates the components of Selling, General and Administrative expenses:
Three months ended March 31, Dollar Costs Percentage of Sales ---------------------------------------- ------------------------------ Increase Increase 2003 2002 (Decrease) 2003 2002 (Decrease) ---- ---- ---------- ---- ---- ---------- Sales and Marketing $1,838,397 $1,494,242 $ 344,155 13.2% 13.9% -0.7% Technical Support 101,415 94,108 7,307 0.7% 0.9% -0.2% General and Administrative 784,660 706,264 78,396 5.5% 6.5% -1.0% ---------- ---------- ---------- ---- ---- ---- Total $2,724,472 $2,294,614 $ 429,858 19.4% 21.3% -1.9% ========== ========== ========== ==== ==== ====
Selling, General and Administrative expenses increased $429,858 from the prior year's second quarter. As a percentage of sales, Selling, General and Administrative expenses decreased by 1.9% when compared to the three months ended March 31, 2002. The increase in Sales and Marketing expense of $344,155, which accounted for about 80% of the total increase in Selling, General and Administrative expenses, was mainly due to: - Higher advertising costs of $259,986 due to higher sales based co-operative advertising, higher customer rebate realization and increased special promotions - Higher commissions payments of $70,291 due to increased sales - Increased European sales office costs of $67,896 - Lower trade show costs of $64,206 due to smaller show presence and frequency The increase in General and Administrative expenses of $78,396 was primarily due to: - Addition of senior executive officer $47,085 - Higher legal costs of $11,293 - Increased insurance of $9,084 - Increased travel costs of $7,241 - Decreased amortization costs of $15,725 due to amortization in full of an intangible asset during fiscal 2002 Research and Development expenses increased $83,838 or approximately 23%. The increase was mainly due to higher compensation costs attributable to additional staff and increased material and contract services cost for current development projects. Other income (expense) Net other income for the three months ended March 31, 2003 was $76,283 compared to net other income of $72,285 for the three months ended March 31, 2002 as detailed below: Three months ended March 31, 2003 2002 ---- ---- Interest income $ 4,034 $12,338 Foreign currency transaction gains (losses) (3,147) 10,455 Non operational USD to Euro currency re-measurement 75,396 49,492 ------ ------- Total other income (expense) $76,283 $72,285 ======= ======= The increase in total other income was due to the higher gains resulting from the Non operational USD to Euro currency re-measurements and lower interest income due to lower investment yields. 19 Three Month Period ended March 31, 2003 Compared to March 31, 2002-continued Non Operational USD to Euro currency re-measurement We follow the rules prescribed in paragraph 16 of SFAS 52 "Foreign Currency Translation", which states that accounts denominated in a currency other than an entities functional currency need to be re-measured into the entities functional currency, and any gain or loss from this re-measurement are included in the determination of net income. Since the functional currency of Hauppauge Digital Europe Sarl ("HDE Sarl") is the Euro, any asset, liability or equity accounts which are invested in or purchased using U.S. Dollars or Great British Pounds by HDE Sarl are revalued into Euros at the end of each period. The gains or losses on HDE Sarl's books resulting from the revaluation of U.S. Dollar and Great British Pound accounts into Euros are booked in the Company's profit and loss statement in the other income (loss) section under the description " Non operational USD to Euro currency re-measurement." Primarily due to a decrease in U.S Dollar denominated inventory and receivables on the books on HDE Sarl's books, HDE Sarl experienced a net asset decrease of $1,173,678 for the three month period ending March 31, 2003. The increase in the Euro versus the U.S Dollar coupled with the decrease in net assets resulted in a re-measurement gain of $75,396 for the three months ended March 31, 2003. Accumulated other comprehensive income (loss) The Euro is the functional currency of the Company's European subsidiary, HDE Sarl. Assets and liabilities of this subsidiary are translated to U.S. Dollars at the exchange rate in effect at the 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. Since the Euro accounts on Sarl's books result in a net asset position (total Euro assets are in excess of Euro liabilities), an increase in the Euro value results in a deferred gain for the translation of Euro accounts to U.S. Dollars. For the three months ended March 31, 2003, the Company recorded deferred translation gains of $13,218. Recorded as a component of accumulated other comprehensive income on the balance sheet as of March 31, 2003 was a cumulative translation gain of $160,201. The Company uses forward exchange contracts to reduce our exposure to fluctuations in foreign currencies. Mark to market gains and losses on these open contracts result from the difference between the USD value of our open foreign currency forward contracts at the average contract rate as opposed to the same contracts translated at the month end forward rate. The Company qualifies for cash flow hedge accounting as prescribed under FAS 133, which allows the Company to record the mark to market gains and losses in the equity section of our balance sheet under accumulated other comprehensive income. For the three months ended March 31, 2003, the Company recorded as part of other comprehensive income a mark to market gain of $163,879, reflecting the difference between open contracts at December 31, 2002 and March 31, 2003. Recorded as a component of accumulated other comprehensive income on the balance sheet as of March 31, 2003 was a cumulative mark to market loss for open contracts of $164,176. As stated above, accumulated other comprehensive income (loss) consists of two components: - Translations gains and losses - FAS 133 mark to market gains and losses on our open foreign exchange contracts 20 Three Month Period ended March 31, 2003 Compared to March 31, 2002-continued The table below details the gains and losses recorded for the components that make up accumulated other comprehensive income (loss):
Balance October to Balance January to Balance Accumulated other comprehensive income as of December 2002 as of March 2003 as of (loss) September 30, Gains December 31, Gains March 31, 2002 (losses) 2002 (losses) 2003 ---- -------- ---- -------- ---- Translation gains and (losses) $ (3,845) $ 150,728 $ 146,883 $ 13,318 $160,201 FAS 133 mark to market adjustments 190,919 (518,974) (328,055) 163,879 (164,176) --------- --------- --------- -------- -------- $187,074 $(368,246) $(181,172) $177,197 $ (3,975) ========= ========= ========= ======== =========
Tax provision Our net tax provision for the three months ended March 31, 2003 and 2002 is as follows: Three months ended March 31, 2003 2002 ------ ------ Tax (benefit) attributable to U.S operations $(155,500) $(248,000) Tax expense European operations 12,517 20,000 Deferred tax asset valuation allowance 155,500 248,000 --------- --------- Net tax provision $ 12,517 $ 20,000 ========= ========= 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 three fiscal years, our domestic operation has incurred losses. We analyzed the future realization of our deferred tax assets as of March 31 2003 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 all of the above items mentioned in the Management's Discussion and Analysis of Financial Condition and Results of Operations, we recorded net income of $260,515 for the three months ended March 31, 2003, which resulted in basic and diluted net income per share of $0.03 on weighted average basic and diluted shares of 8,862,774 and 8,959,821, compared to a net income of $216,954 for the three months 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. Options to purchase 1,240,122 and 1,145,322 shares of common stock at prices ranging $1.05 to $ 10.06 and $1.91 and $10.06, respectively, were outstanding for the three month periods ending March 31, 2003 and 2002, 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 21 Seasonality-continued in the European market, were 73%, 77% and 71% of sales for the years ended September 30, 2002, 2001 and 2000, 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 seasonal nature of our retail sales. Liquidity and Capital Resources Our cash, working capital and stockholders' equity position is disclosed below: March 31 September 30 2003 2002 ---- ---- Cash $ 4,660,775 $ 4,964,522 Working Capital 12,011,941 11,276,942 Stockholders' Equity 12,689,410 11,966,612 We had cash and cash equivalents as of March 31, 2003 of $4,660,775, a decrease of $303,747 over September 30, 2002. The decrease was due to: Net income adjusted for non cash items $ 1,073,758 Increase in accounts payable and other current liabilities 1,836,731 Proceeds from employee stock purchases 13,501 Less cash used for: Increase in accounts receivable (2,064,815) Increase in inventories (806,167) Increase in prepaid expenses and other current assets (195,544) Purchases of fixed assets (125,569) Purchase of treasury stock (35,642) ------------ Net increase in cash $ (303,747) =========== Net cash of $156,037 used in operating activities was primarily due to cash used to fund increases in accounts receivable of $2,064,815, increase in inventory of $806,167 and increases in prepaid assets and other current assets of $195,544 offset somewhat by an increase in accounts payable and other current liabilities of $1,836,731 and net income adjusted for non cash items of $1,073,758. The increase in accounts receivable was the result of an increase in sales of $3,170,425 for the three months ended March 31, 2003 over the three months ended March 31, 2002. Cash of $125,569 and $35,642 was used to purchase fixed assets and purchase treasury stock. Proceeds from the stock purchased by employees through the employee stock purchase plan provided additional cash of $13,501. Our bank facility with JP Morgan Chase expired in April 2002. It is the intention of the Company to procure a new credit facility on terms acceptable to the Company, however, there can be no assurance that we will secure a replacement line of credit at competitive terms. On November 8, 1996, we approved a stock repurchase program. The program, as amended, authorizes the Company to repurchase up to 850,000 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, 2003, we held 542,067 treasury shares purchased for $1,497,216 at an average purchase price of approximately $2.76 per share. We believe that our cash and cash equivalents as of March 31, 2003 and our internally generated cash flow will provide us with sufficient liquidity to meet our currently foreseeable short-term and long-term capital needs. 22 Future Contractual Obligations The following table shows the Company's contractual obligations related to lease obligations as of March 31, 2003: Payments due by period Contractual obligations Total 1 year 1-3 years ----------------------- -------- --------- --------- Operating lease obligations $ 2,146,471 $ 670,098 $ 1,476,373 =========== =========== =========== Critical Accounting Policies and Estimates Financial Reporting Release No. 60, 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. 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. Since October 1, 1999, our European subsidiary has historically accounted for approximately 68% to 77 % 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. 23 Critical Accounting Policies and Estimates-continued We do not enter into contracts for speculative purposes. We enter into monthly window contracts covering an average period of three months based on existing or anticipated future sales and inventory purchases. 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 - Historical volatility of the Euro has the potential to 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. Dollar 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 currency re-measurement". The extent of these 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. Inflation While inflation has not had a material effect on our operations in the past, there can be no assurance that we will be able to continue to offset the effects of inflation on the costs of our products or services through price increases to our customers without experiencing a reduction in the demand for our products; or that inflation will not have an overall effect on the computer equipment market that would have a material affect on us. Euro On January 1, 1999, the Euro was adopted in Europe as the common legal currency among 11 of the 15 member countries of the European Community. On that date, the participating countries established fixed Euro conversion rates (i.e. the conversion exchange rate between their existing currencies and the Euro). The Euro now trades on currency exchanges and is available for non-cash transactions. A new European Central Bank was established to direct monetary policy for the participating countries. 24 Euro-continued Prior to the adoption of the Euro, we billed our European customers in German Marks or British Pounds, depending upon which currency the customer preferred to be billed in. Effective January 1, 1999, we began invoicing our customers who are located in the eleven member countries in Euros. We continue to bill customers located in the United Kingdom in British Pounds. The benefits to billing customers in Euros were twofold: - Our foreign currency hedging program was streamlined to the Euro and the British Pound - The pricing from country to country was harmonized, eliminating price differences between countries due to the fluctuating local currencies We handled the conversion to the Euro without any material disruptions to our operations. Item 3. Quantitative and Qualitative Disclosures about Market Risks Derivatives and Hedging Activities 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. 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. 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 use derivatives to reduce our exposure to fluctuations in foreign currencies. Foreign currency forward contracts, are used to hedge the foreign currency market exposures underlying forecasted sales transactions with customers. As of March 31, 2003, we had foreign currency contracts outstanding of approximately $3,716,900 against the delivery of the Euro. The contracts expire through June 2003. Our accounting policies for these instruments are based on its designation of such instruments as cash flow hedging transactions. We do not enter into such contracts for speculative purposes. We record all derivative gains and losses on the balance sheet as a component of stockholders' equity under the caption "Accumulated other comprehensive income (loss)". As of March 31, 2003, a deferred loss of $164,176 reflecting the net mark to market loss of our derivatives was recorded as a component of accumulated other comprehensive income on our balance sheet. For the three months and six months ended March 31, 2003, we recorded a decrease in sales of $609,100 and $1,158,700 related to our contracts that closed during these periods and the changes in the fair value of our derivative contracts. For the three months and six months ended March 31, 2002, we recorded an increase in sales of $62,300 and $97,000 related to our contracts that closed during these periods and the changes in the fair value of our derivative contracts. 25 Item 4. Controls and Procedures The Company's Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of a date within 90 days prior to the filing date of this report, that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of such evaluation including any corrective actions with regard to significant deficiencies and material weaknesses. Special Note Regarding Forward Looking Statements This Quarterly Report contains forward-looking statements as that term is defined in the federal securities laws. The events described in forward-looking statements contained in this Quarterly Report may not occur. Generally these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, projected or anticipated benefits from acquisitions to be made by us, or projections involving anticipated revenues, earnings or other aspects of our operating results. The words "may," "will," "expect," "believe," "anticipate," "project," "plan," "intend," "estimate," and "continue," and their opposites and similar expressions are intended to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences (including, but not limited to, those set forth in our Annual Report on Form 10-K for the year ended September 30, 2002), many of which are beyond our control, that may influence the accuracy of the statements and the projections upon which the statements are based. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. PART II. OTHER INFORMATION Item 1. Legal Proceedings We were 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. We are proceeding to arbitrate the claims. Based on the preliminary information presented to us, management believes that the claim and the basis for proceeding with arbitrating such claim is without merit and will vigorously defend it. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 99.1 Certificate of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on form 8-K None 26 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 15, 2003 By: /s/ Kenneth Plotkin ------------ --------------------------- KENNETH PLOTKIN Chief Executive Officer and Director Date: May 15, 2003 By: /s/ Gerald Tucciarone ------------- --------------------------- GERALD TUCCIARONE Treasurer and Chief Financial Officer 27 CERTIFICATIONS I, KENNETH PLOTKIN, certify that: 1. I have reviewed this quarterly report on Form 10-Q of HAUPPAUGE DIGITAL, INC.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. By: /s/ Kenneth Plotkin Date: May 15, 2003 --------------------- KENNETH PLOTKIN Chief Executive Officer and Director I, GERALD TUCCIARONE, certify that: 1. I have reviewed this quarterly report on Form 10-Q of HAUPPAUGE DIGITAL, INC.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. By: /s/ Gerald Tucciarone Date: May 15, 2003 -------------------------------- ------------ GERALD TUCCIARONE Treasurer and Chief Financial Officer