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 December 31, 2006

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to ________

Commission file number1-13550

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

(Registrant’s telephone number, including area code)

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.

x YES  o NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (See definition of “accelerated filer and large accelerated filer’ in Rule 12b-2 of the Exchange Act).

o LARGE ACCELERATED FILER  o ACCELERATED FILER  x NON-ACCELERATED FILER

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange act).

1

o YES  x NO

As of January 31, 2007, 9,823,181 shares of .01 par value Common Stock of the registrant were outstanding.

2

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements	Page no.
Condensed Consolidated Balance Sheets - December 31, 2006 (unaudited) and September 30, 2006	5
Condensed Consolidated Statements of Income - Three Months ended December 31, 2006 (unaudited) and 2005 (unaudited)	6
Condensed Consolidated Statements of Other Comprehensive Income - Three months ended December 31, 2006 (unaudited) and 2005 (unaudited)	7
Condensed Consolidated Statements of Cash Flows - Three Months ended December 31 , 2006 (unaudited) and 2005 (unaudited)	8
Notes to Condensed Consolidated Financial Statements	9 -15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	16 -20
Item 3. Quantitative and Qualitative Disclosures about Market Risk	20-21
Item 4. Controls and Procedures	21

3

PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 4. Submission of Matters to a Vote of Security Holders	22
Item 6. Exhibits	23
Signatures	24

4

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	December 31, 2006 (unaudited)			September 30, 2006
Assets:
Cash and cash equivalents	$	9,857,227		$	9,020,941
Receivables, net of various allowances		28,085,968			16,132,928
Inventories		12,649,471			9,905,746
Prepaid expenses and other current assets		839,848			895,223
Total current assets		51,432,514			35,954,838
Property, plant and equipment, net		616,760			612,311
Security deposits and other non current assets		84,491			83,239
Total assets	$	52,133,765		$	36,650,388
Liabilities and Stockholders’ Equity:
Current Liabilities:
Accounts payable	$	23,518,087		$	12,011,232
Accrued expenses -licensing fees		6,671,039			5,481,005
Accrued expenses		1,456,372			1,174,323
Income taxes payable		211,726			204,103
Total current liabilities		31,857,224			18,870,663
Stockholders' Equity:
Common stock $.01 par value; 25,000,000 shares authorized, 10,406,338 and 10,260,464 issued, respectively		104,063			102,605
Additional paid-in capital		14,543,945			14,222,890
Retained earnings		7,924,235			5,721,500
Accumulated other comprehensive (loss)		(537,751	)		(509,319	)
Treasury Stock, at cost, 607,547 shares		(1,757,951	)		(1,757,951	)
Total stockholders' equity		20,276,541			17,779,725
Total liabilities and stockholders' equity	$	52,133,765		$	36,650,388

See accompanying notes to condensed consolidated financial statements

5

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three months ended December 31,
	2006		2005
Net sales	$	29,919,133	$	25,044,990
Cost of sales		23,101,596		19,813,206
Gross profit		6,817,537		5,231,784
Selling, general and administrative expenses		3,802,223		3,381,070
Research and development expenses		753,445		794,001
Income from operations		2,261,869		1,056,713
Other income:
Interest income		12,391		5,206
Foreign currency		12,027		964
Other income		24,418		6,170
Income before taxes on income		2,286,287		1,062,883
Tax provision		83,552		42,411
Net income	$	2,202,735	$	1,020,472
Net income per share:
Basic	$	0.23	$	0.11
Diluted	$	0.22	$	0.10

See accompanying notes to condensed consolidated financial statements

6

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME

(UNAUDITED)

	Three months ended December 31,
	2006			2005
Net income	$	2,202,735		$	1,020,472
Foreign currency translation gain (loss)		56,265			(743,271	)
Forward exchange contracts marked to market		(84,697	)		(104,138	)
Other comprehensive income	$	2,174,303		$	173,063

See accompanying notes to condensed consolidated financial statements

7

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Three months ended December 31,
	2006			2005
Net income	$	2,202,735		$	1,020,472
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		52,456			45,070
Stock compensation expense		108,868			100,878
Other non cash items		(1,252	)		1,387
Changes in current assets and liabilities:
Accounts receivable		(11,953,040	)		(7,436,483	)
Inventories		(2,743,725	)		(591,450	)
Prepaid expenses and other current assets		55,375			50,401
Accounts payable		11,506,855			5,312,183
Accrued expenses and other current liabilities		1,479,706			988,046
Total adjustments		(1,494,757	)		(1,529,968	)
Net cash provided by (used in) operating activities		707,978			(509,496	)
Cash Flows From Investing Activities:
Purchases of property, plant and equipment		(56,905	)		(41,580	)
Net cash used in investing activities		(56,905	)		(41,580	)
Cash Flows From Financing Activities:
Proceeds from the exercise of stock options and employee stock purchases		213,645			24,081
Net cash provided by financing activities		213,645			24,081
Effect of exchange rates on cash		(28,432	)		(847,409	)
Net increase (decrease) in cash and cash equivalents		836,286			(1,374,404	)
Cash and cash equivalents, beginning of period		9,020,941			7,567,393
Cash and cash equivalents, end of period	$	9,857,227		$	6,192,989
Supplemental disclosures:
Income taxes paid	$	84,451		$	16,776

See accompanying notes to condensed consolidated financial statements

8

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1. Basis of presentation

The accompanying unaudited condensed consolidated financial statements for Hauppauge Digital Inc. (the “Company”) 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 Company’s consolidated financial position, results of operations and cash flows as of and for the interim periods 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, 2006 Form 10-K.

The operating results for the three months ended December 31, 2006 are not necessarily indicative of the results to be expected for the September 30, 2007 year end.

Certain reclassifications have been made to the prior condensed consolidated financial statements to conform to the current presentation.

Note 2. Receivables

Accounts and other receivables as of December 31, 2006 and September 30, 2006 consisted of :

	December 31,			September 30,
	2006			2006
Trade receivables	$	20,222,728		$	13,910,101
Receivable from contract manufacturers		10,478,797			4,916,402
GST and VAT taxes receivables		815,421			616,119
Allowances and reserves		(3,495,000	)		(3,377,000	)
Other		64,022			67,306
	$	28,085,968		$	16,132,928

Note 3. Foreign currency translations and transactions

The Company’s Asian subsidiary reports its financial position and results of operations in the reporting currency of the Company.

The financial position and results of operations of the Company’s European subsidiaries are determined using Euros as the functional currency. Assets and liabilities of these subsidiaries are translated at the exchange rate in effect at each period end. Income statement accounts are translated at the prevailing average spot rate. For periods prior to April 2006, the Company translated sales amounts at the average forward exchange contract rate. The change in this accounting treatment was immaterial to the Company’s current and prior financial statements. Translation adjustments arising from the translation to U.S. dollars at differing exchange rates are included in the accumulated other comprehensive income (loss) account in stockholders’ equity. Gains and losses resulting from transactions that are denominated in currencies other than Euros are included in earnings as a component of other income. The Company had a translation loss of $531,289 recorded on the balance sheet as of September 30, 2006. For the three months ended December 31, 2006, the Company recorded on the balance sheet deferred translation gains of $56,265, resulting in a translation loss of $475,024 recorded as a component of accumulated other comprehensive income as of December 31, 2006. 

9

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 4. Inventories

Inventories have been valued at the lower of average cost or market on a first in first out basis. The components of inventory consist of:

	December 31,		September 30,
	2006		2006
Component parts	$	7,294,806	$	4,868,483
Finished goods		5,354,665		5,037,263
	$	12,649,471	$	9,905,746

Note 5. 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 shares of common stock 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 December 31
		2006	2005
Weighted average shares outstanding-basic		9,678,869	9,508,100
Number of shares issued on the assumed exercise of stock options		555,762	507,157
Weighted average shares outstanding-diluted		10,234,631	10,015,257

Options to purchase 10,172 and 92,876 shares of common stock, at a price of $8.75 and ranging from $3.88 to $8.75, were outstanding for the three months ended December 31, 2006 and 2005, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive.

Note 6. Accumulated other comprehensive income (loss)

Accumulated other comprehensive income (loss) consists of two components: translation gains and losses and FAS 133 mark to market gains and losses on our open foreign exchange contracts. As of December 31, 2006, appearing in the equity section under “ Accumulated other comprehensive income (loss)” reflected a loss of $537,751, which consisted of a deferred translation loss of $475,024 and a deferred loss of $62,727 due to the mark to market differences between the value of the Company’s open forward exchange contracts at the contract rates versus the same contracts valued at the period ending forward rate.

The table below details the gains and losses that make up the accumulated other comprehensive loss of $537,751 recorded on our balance sheet as of December 31, 2006:

10

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Accumulated other comprehensive income (loss)	Balance as of			Oct 06 to Dec 06			Balance as of
Fiscal 2007 activity	Sept 30 2006			gains (losses)			Dec 31, 2006
Translation gains and losses	$	(531,289	)	$	56,265		$	(475,024	)
FAS 133 mark to market adjustment		21,970			(84,697	)		(62,727	)
	$	(509,319	)	$	(28,432	)	$	(537,751	)

Note 7. Revenue recognition

The Company sells through a sales channel which consist of retailers, PC manufacturers and distributors. The majority of our customers are granted lines of credit. The product is shipped on account with the majority of customers primarily given 30 to 60 day 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 Company sells analog, hybrid video recorders or digital computer boards that are stocked on the shelves of retailers and are subject to the normal consumer traffic that retail stores attract. Aside from normal store promotions such as advertisements in the store’s circular, the Company has no further obligation to assist in the resale of the products.

The Company offers some of its customers a right of return. The Company’s accounting complies with SFAS 48 Revenue Recognition when Right of Return Exists, as typically at the end of every quarter the Company, based on historical data, evaluates its sales reserve level based on the previous six months sales. Due to seasonal nature of the business coupled with the changing economic environment, management exercises some judgment with regard to the historical data to arrive at the reserve.

The Company offers mail-in rebates on certain products at certain times as determined by the Company. The rebates are recorded as a reduction to sales. The Company also participates in limited cooperative advertising programs with retailers and distributors and accounts for these in accordance with EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)”.

Note 8. Product segment and geographic information

The Company operates in one business segment, which is the development, marketing and manufacturing of analog and digital TV receiver products for the personal computer market. The products are similar in function and share commonality of component parts and manufacturing processes. The Company’s products are either sold, or can be sold, by the same retailers and distributors in our marketing channel. The Company also sells product directly to PC manufacturers. The Company evaluates its product lines under the functional categories of analog TV receivers, digital TV receivers and other non-TV tuner products.

11

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Company’s products fall under three product categories:

Analog TV receivers

Digital TV receivers

Other non-TV receiver products

The Company’s analog TV receiver products enable, among other things, a PC user to watch TV in a resizable window on a PC.

The Company’s digital TV receiver products enable, among other things, a PC user to watch digital TV in a resizable window on a PC.

The Company’s other non-TV receiver products enable, among other things, a PC user to video conference, watch and listen to PC based videos, music and pictures on a TV set through a home network, and record TV shows on a PC for playback on portable video players.

Sales by functional category are as follows:

	Three months ended December 31
	2006		2005
Product line sales
Analog sales	$	11,215,097	$	14,893,280
Digital sales		18,195,597		9,542,040
Other non-TV tuners products		508,439		609,670
Total sales	$	29,919,133	$	25,044,990

The Company sells its products through a domestic and international network of distributors and retailers. It maintains sales offices in both Europe and Asia. Sales percent by geographic region are as follows:

	Three months ended December 31,
Sales percent by geographic region	2006			2005
United States		42	%		41	%
Europe		56	%		56	%
Asia		2	%		3	%
Total		100	%		100	%

Note 9. Stock-based compensation

Prior to October 1, 2005, the Company accounted for employee stock option plans based on the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, " Accounting for Stock Issued to Employees," and related Interpretations and had adopted the disclosure requirements of SFAS No. 123, " Accounting for Stock-Based Compensation" (SFAS No.123). Accordingly, compensation cost for stock options was measured as the excess, if any, of the quoted market price of the Company’s stock at the grant date over the amount an employee must pay to acquire the stock. The Company granted stock options with exercise prices equal to the market price of the underlying stock on the date of grant, therefore, the Company did not record stock-based compensation expense under APB Opinion No. 25.

12

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Effective October 1, 2005, the Company adopted SFAS No. 123R, “Share-Based Payments” using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. Therefore, prior period financial statements have not been restated. The fair value of stock options were determined using the Black-Scholes valuation model, which is consistent with our valuation techniques previously utilized for stock options in footnote disclosures required under SFAS No. 123. Such fair value is recognized as expense over the service period, net of estimated forfeitures. The adoption of SFAS No.123R resulted in no cumulative change in accounting as of the date of adoption.

Note 10.  Arrangements with off-balance sheet risk - guarantees

The Company occupies a facility located in Hauppauge New York which is used for its executive offices and for the testing, storage and shipping of the Company’s products. Hauppauge Computer Works, Inc. (“HCW’), a wholly owned subsidiary of Hauppauge Digital Inc., leases this facility from Ladokk Realty, LLC (“Ladokk”), the members of which are Kenneth Plotkin, the Company’s Chairman of the Board, Chief Executive Officer, President, Chief Operating Officer and Vice President of Marketing, Director and the holder of approximately 8.1% of the Company’s Common Stock as of December 31, 2006, Dorothy Plotkin, the wife of Kenneth Plotkin and holder of approximately 5.8% of the Company’s Common Stock as of December 31, 2006, and Laura Aupperle, believed by the Company to be the holder of approximately 9.5% of the Company’s Common Stock, including Common Stock attributed to the Estate of Kenneth R. Aupperle.

On February 17, 2004, HCW and Ladokk terminated the 1990 Lease and HCW entered into a new lease agreement with Ladokk (the “2004 Lease”). The 2004 Lease term was for five years and terminated on February 16, 2009. The annual rent under the 2004 Lease was $360,000, payable monthly. The Company was also obligated to pay real estate taxes and operating costs of maintaining the premises subject to such lease. Concurrently with the new lease, Ladokk completed a refinancing of its mortgages, and the new lender did not require us to sign a guarantee. Accordingly, we no longer guarantee the landlord’s mortgages.

On October 17, 2006, HCW executed an amendment to the 2004 Lease with Ladokk for the premises (the “Lease Amendment”). The Lease Amendment commenced as of September 1, 2006 and ends on August 31, 2011. The base rent under the Lease Amendment for the first year of the term is $300,000, payable monthly in the amount of $25,000. Rent is subject to an annual increase of 3% over the term. The execution of the Lease Amendment was approved by the Company’s Board of Directors , following the recommendation of the Company’s Audit Committee.

The Lease Amendment provides for the payment of rent arrearages in the aggregate amount of $168,667 (the “Arrearage”) to be paid in the amount of $5,000 per month tendered with rent until the Arrearage is paid in full. Subject to the terms and conditions of the 2004 Lease, HCW is obligated to pay for utilities, repairs to the building, and taxes during the term.

13

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Lease Amendment provides that HCW has the option to renew the current lease term for an additional 5 year term after the expiration of the current lease term upon written notice given to Ladokk between six and twelve months prior to expiration of the current lease. Rent due during the first year of the renewal term is to be equal to the market rate at the end of the current lease, but not less than rent paid during the last year of the current lease, and is subject to rent increases for the second through fifth years of the renewal term by CPI plus 1% per annum.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THREE MONTH PERIOD ENDED DECEMBER 31, 2006 COMPARED TO

DECEMBER 31, 2005

Results of operations for the three months ended December 31, 2006 compared to December 31, 2005 are as follows:

	Three			Three
	Months			Months
	Ended			Ended			Variance			Percentage of sales
	12/31/06			12/31/05			$			2006			2005			Variance
Net sales	$	29,919,133		$	25,044,990		$	4,874,143			100.00	%		100.00	%		-
Cost of sales		23,101,596			19,813,206			3,288,390			77.21	%		79.11	%		-1.90	%
Gross profit		6,817,537			5,231,784			1,585,753			22.79	%		20.89	%		1.90	%
Gross profit %		22.79	%		20.89	%		1.90	%
Selling , general and administrative expenses:
Sales and marketing		2,707,222			2,356,572			350,650			9.05	%		9.41	%		-0.36	%
Technical support		136,405			132,079			4,326			0.46	%		0.53	%		-0.07	%
General and administrative		890,983			824,818			66,165			2.98	%		3.29	%		-0.31	%
Stock compensation expense		67,613			67,601			12			0.23	%		0.27	%		-0.04	%
Total selling, general and administrative expense		3,802,223			3,381,070			421,153			12.72	%		13.50	%		-0.78	%
Research and development		712,190			760,724			(48,534	)		2.38	%		3.04	%		-0.66	%
Research and stock compensation expense		41,255			33,277			7,978			0.14	%		0.13	%		0.01	%
Total expenses		4,555,668			4,175,071			380,597			15.24	%		16.67	%		-1.43	%
Net operating income		2,261,869			1,056,713			1,205,156			7.55	%		4.22	%		3.33	%
Other income :
Interest income		12,391			5,206			7,185			0.04	%		0.02	%		0.02	%
Foreign currency		12,027			964			11,063			0.04	%		0.00	%		0.04	%
Total other income		24,418			6,170			18,248			0.08	%		0.02	%		0.06	%
Income before taxes on income		2,286,287			1,062,883			1,223,404			7.63	%		4.24	%		3.39	%
Taxes on income		83,552			42,411			41,141			0.28	%		0.17	%		0.11	%
Net income	$	2,202,735		$	1,020,472		$	1,182,263			7.35	%		4.07	%		3.28	%

Net sales for the three months ended December 31, 2006 increased $4,874,143 compared to the three months ended December 31, 2005 as shown in the table below.

	Three Months		Three Months		Increase (decrease)			Increase			Percentage of sales by
	ended		ended		Dollar			(decrease)			geographic region
Location	12/31/06		12/31/05		variance			variance %			2006			2005
Domestic	$	12,472,831	$	10,204,935	$	2,267,896			22	%		42	%		41	%
Europe		16,920,057		14,176,926		2,743,131			19	%		56	%		56	%
Asia		526,245		663,129		(136,884	)		-21	%		2	%		3	%
Total	$	29,919,133	$	25,044,990	$	4,874,143			19	%		100	%		100	%

15

Net sales to domestic customers were 42% and 41% of net sales for the three months ended December 31, 2006 and 2005, respectively. Net sales to European customers were 56% of net sales for the three months ended December 31, 2006 and 2005, respectively. Net sales to Asian customers were 2% and 3% of net sales for the three months ended December 31, 2006 and 2005, respectively. We experienced an increase in unit sales of about 36% while the dynamics of new production and changes in sales mix lowered the average sales price by about 12%.

Gross profit

Gross profit increased $1,585,753 for the three months ended December 31, 2006 compared to the three months ended December 31, 2005.

The increases and (decreases) in the gross profit are detailed below:

	Increase
	(decrease)
Increased sales	$	1,304,072
Higher gross profit on sales mix		572,700
Production and production related costs		(291,019	)
Total increase in gross profit	$	1,585,753

Gross profit percentage for the three months ended December 31, 2006 was 22.79% compared to 20.89% for the three months ended December 31, 2005, an increase of 1.90%.

The increases and (decreases) in the gross profit percent are detailed below:

	Increase
	(decrease)
Higher gross profit on sales mix		1.65	%
Production and production related costs		0.25	%
Net decrease in gross profit percent		1.90.	%

The increase in the gross profit percent of 1.90 % for the three months ended December 31, 2006 compared to the three months ended December 31, 2005 was primarily due to:

· A higher sales percentage of higher gross profit margin products contributed to a 1.65% increase in gross profit

· Production and shipping costs declined as a percentage of sales which contributed to a 0.25% increase in gross profit percent. The increase in net sales was about 19% while the increase in production costs was about 16%

Selling, general and administrative expenses

The chart below illustrates the components of Selling, general and administrative expense.

	Three months ended December 31,
	Dollar Costs						Percentage of Sales
					Increase								Increase
	2006		2005		(decrease)		2006			2005			(decrease)
Sales and marketing	$	2,707,222	$	2,356,572	$	350,650		9.05	%		9.41	%		-0.36	%
Technical support		136,405		132,079		4,326		0.46	%		0.53	%		-0.07	%
General and administrative		890,983		824,818		66,165		2.98	%		3.29	%		-0.31	%
Stock compensation expense		67,613		67,601		12		0.23	%		0.27	%		-0.04	%
Total	$	3,802,223	$	3,381,070	$	421,153		12.72	%		13.50	%		-0.78	%

16

Selling, general and administrative expenses increased $421,153 from the prior year. As a percentage of sales, Selling, general and administrative expenses decreased by 0.78% when compared to the three months ended December 31, 2005. The increase in sales and marketing expense of $350,650 was mainly due to higher sales based expenses such as commission, cooperative advertising and promotional expenses. The increase in technical support expenses of $4,326 was primarily due to compensation related costs. The increase in general and administrative expenses of $66,165 was primarily due to compensation increases for additional managerial and support staff and incentive related expenses.

Research and development expenses

Research and development expenses decreased $40,556. The decrease was mainly due decreased third party development costs offset somewhat by an increase in stock compensation expense.

Other income

Net other income for the three months ended December 31, 2006 was $24,418 compared to net other income of $6,170 for the three months ended December 31, 2005. The change was primarily driven by higher interest income and foreign currency transaction gains.

Tax provision

Our net tax provision for the three months ended December 31, 2006 and 2005 is as follows:

	Three months ended December 31,
	2006		2005
AMT Tax attributable to U.S operations	$	31,000	$	10,000
Tax expense European operations		47,552		27,411
State taxes		5,000		5,000
Net tax provision	$	83,552	$	42,411

The deferred tax assets and the offsetting tax valuation allowance is attributable to the Company’s domestic operations. For three out of the last five fiscal years, the Company’s domestic operation incurred tax losses. Fiscal 2005 was the first year out of the last five years in which the Company’s domestic operations had pre tax income. As of December 31, 2006, we evaluated the future realization of our deferred tax assets and the corresponding valuation allowance. The Company took into consideration:

· the tax losses incurred by our domestic operations in three out of the last five years

· the seasonal nature and cyclical nature of the business, which makes it difficult to predict the future realization of the deferred tax asset

· the dynamic market and technological changes that occur in our industry

After evaluating the circumstances listed above, it was the Company’s opinion that as of December 31, 2006, the valuation allowance was still applicable.

We recorded net income of $2,202,735, for the three months ended December 31, 2006, which resulted in basic net income per share of $0.23 and diluted net income per share of $0.22 on weighted average basic and diluted shares of 9,678,869 and 10,234,631, respectively, compared to a net income of $1,020,472 for the three months ended December 31, 2005, which resulted in basic net income per share of $0.11 and diluted net income per share of $0.10, respectively, on weighted average basic and diluted shares of 9,508,100 and 10,015,257, respectively.

17

Options to purchase 10,172 and 92,876 shares of common stock, at a price of $8.75 and ranging from $3.88 to $8.75, were outstanding for the three months ended December 31, 2006 and 2005, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive.

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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 54%, 54% and 66% of sales for the years ended September 30, 2006, 2005 and 2004, 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 as of December 31, 2006 and September 30, 2006 is set forth below:

	December 31, 2006		September 30, 2006
Cash	$	9,857,227	$	9,020,941
Working Capital		19,575,290		17,084,175
Stockholders’ Equity		20,276,541		17,779,725

We had cash and cash equivalents as of December 31, 2006 of $9,857,227, a increase of $836,286 from September 30, 2006.

The increase in cash was due to :

Sources of cash:
Net income adjusted for non cash items	$	2,362,807
Increase in accounts payable and accrued expenses		12,986,561
Proceeds from employee stock purchases		213,645
Decrease in prepaid expenses and other current assets		55,375
Less cash used for:
Increase in account receivables		(11,953,040	)
Increase in inventories		(2,743,725	)
Effect of exchange rates on cash		(28,432	)
Capital equipment purchases		(56,905	)
Net cash increase	$	836,286

Net cash of $707,978 provided by operating activities was primarily due to net income adjusted for non cash items of $2,362,807, increases in accounts payable and accrued expenses of $12,986,561 and a decrease of $55,375 in prepaid expenses and other current assets. Offsetting these increases in cash were increases in accounts receivable of $11,953,040, due primarily to a 35% sales increase for the first quarter of fiscal 2007 over the fourth quarter of fiscal 2006, and increases in inventory of $2,743,725 needed to fund the increase in sales.

Cash of $56,905 was used to purchase fixed assets. Proceeds from stock purchased by employees through the purchase of options and through the employee stock purchase plan provided additional cash of $213,645. The effect of exchange rates used cash of $ 28,432.

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We believe that our cash and cash equivalents as of December 31, 2006, our internally generated cash flow and our $3,000,000 bank line of credit will provide us with sufficient liquidity to meet our currently foreseeable short-term and long-term capital needs.

Future contractual obligations

The following table shows our contractual obligations related to lease obligations as of December 31, 2006:

			Payments due by period
	Total		Less than 1 year		1-3 years		3 to 5 years
Operating lease obligations	$	2,170,998	$	553,754	$	905,484	$	711,760

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.

Item 3. Quantitative and qualitative disclosures about market risks

For each of the past three fiscal years, at least 50 % of the Company’s sales were generated by our European subsidiary and were invoiced and collected in local currency, which was primarily the Euro. On the supply side, since the Company predominantly deals with North American and Asian suppliers and contract manufacturers, approximately 90% of the Company’s inventory required to support our European sales are purchased and paid in U.S. Dollars.

The combination of sales billed in Euros supported by inventory purchased in U.S. dollars results in an absence of a natural local currency hedge. Consequently, the Company’s financial results are subject to market risks resulting from the fluctuations in the Euro to U.S. Dollar exchange rates.

The Company attempts to reduce these risks by entering into foreign exchange forward contracts with financial institutions. The purpose of these forward contracts is to hedge the foreign currency market exposures underlying the U.S. Dollar denominated inventory purchases required to support our European sales.

The Company does not try to hedge against all possible foreign currency exposures because of the inherent difficulty in estimating the volatility of the Euro, the contracts the Company procures are specifically entered into to as a hedge against forecasted or existing foreign currency exposure. The Company does not enter into contracts for speculative purposes. Although the Company maintains these programs to reduce the short term impact of changes in currency exchange rates, long term strengthening or weakening of the U.S. dollar against the Euro impacts the Company’s sales, gross profit, operating income and retained earnings. Factors that could impact the effectiveness of our hedging program are:

· volatility of the currency markets

· availability of hedging instruments

· accuracy of our inventory forecasts

Additionally, there is the risk that foreign exchange fluctuations will make our products less competitive in foreign markets, which would substantially reduce the Company’s sales.

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As of December 31, 2006, we had foreign currency contracts outstanding of approximately $2,051,000 against the delivery of the Euro. These contracts expire from January 2007 through February 2007. 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)”. We recorded a deferred loss of $84,697 for the three months ended December 31 2006. As of December 31, 2006, a deferred loss of $62,727, reflecting the cumulative mark to market gains of our derivatives, was recorded on our balance sheet as a component of accumulated other comprehensive income in our equity section.

Item 4. Controls and procedures

Our Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2006 in alerting them in a timely manner to material information required to be included in our SEC reports. In addition, no change in our internal control over financial reporting occurred during the fiscal quarter ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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,” “anticipated,” “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, 2006), many of which are beyond our control, that may influence the accuracy of the statements and the projections upon which the statements are based. Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward looking statements made by us ultimately prove to be accurate. 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. All cautionary statements made in this Quarterly Report should be read as being applicable to all related forward-looking statements wherever they appear.

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PART II. OTHER INFORMATION

Item 1A. Risk factors

There have been no material changes with respect to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2006.

Item 2. Unregistered sales of equity securities and use of proceeds

On November 8, 1996, we approved a stock repurchase program. The program authorizes us to repurchase up to 850,000 shares of our own stock. The stock repurchase program was extended by a resolution of our Board of Directors on December 17, 1997.

The Company did not repurchase any of its common stock our stock repurchase program during the quarter ended December 31, 2006.

Item 4. Submission of matters to a vote of security holders

The following proposals were submitted to the stockholders for approval at the Annual Meeting of Stockholders held on October 17, 2006 at our offices:

Proposal No. 1: Election of directors

The following directors were elected by the votes indicated:

	For		Withheld
Kenneth Plotkin		8,857,136		105,519
Bernard Herman		8,650,220		311,435
Robert S. Nadel		8,149,821		811,834
Christopher G. Payan		8,871,379		90,276
Neal Page		8,863,129		98,526
Seymour G. Siegel		8,780,100		181,555

Proposal No. 2: Proposal to ratify the amendment to the Company’s 2003 Performance and Equity Plan

The proposal to ratify the amendment to the Company’s 2003 Performance and Equity to increase the number of shares of Common Stock authorized under the plan by an additional 1,000,000 shares was ratified by the Company’s stockholders’ per the following vote:

For	Against	Abstain	Broker non-votes
3,233,193	772,049	73,640	4,876,953

Proposal No. 3: Proposal to ratify the amendment to the Company’s Employee Stock Purchase Plan

The proposal to ratify the amendment to the Company’s Employee Stock Purchase Plan to increase the number shares of Common Stock available under the plan from 260,000 to 420,000 and to change the termination date of the Company’s Employee Stock Purchase Plan to December 31, 2010 from December 31, 2006 was ratified by the Company’s stockholders’ per the following vote:

For	Against	Abstain	Broker non-votes
3,794,521	206,345	78,016	4,876,953

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Item 6. Exhibits

31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32. Certification 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

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SIGNATURES

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

		HAUPPAUGE DIGITAL INC. Registrant
Date: February 9, 2007	By	/s/  Kenneth Plotkin
		KENNETH PLOTKIN
		Chief Executive Officer, Chairman of the Board,
		President (Principal Executive Officer) and Director
Date: February 9, 2007	By	/s/  Gerald Tucciarone
		GERALD TUCCIARONE
		Treasurer, Chief Financial Officer,
		(Principal Accounting officer) and Secretary

24

EX-31.1

 

Exhibit 31.1

CERTIFICATION

I, Kenneth Plotkin, certify that:

1.I have reviewed this Form 10-Q of Hauppauge Digital, Inc.;

2.Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15-(e)) for the registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 9, 2007	/s/ Kenneth Plotkin
	Kenneth Plotkin
	Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Gerald Tucciarone, certify that:

1.I have reviewed this Form 10-Q of Hauppauge Digital, Inc.;

2.Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15-(e)) for the registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 9, 2007	/s/ Gerald Tucciarone
	Gerald Tucciarone
	Chief Financial Officer
	Treasurer and Secretary

EX-32

Exhibit 32

CERTIFICATION 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

The undersigned hereby certifies, pursuant to, and as required by, 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Hauppauge Digital, Inc. (the “Company”) on Form 10-Q for the period ended December 31, 2006 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: February 9, 2007	/s/ Kenneth Plotkin
	Kenneth Plotkin
	Chief Executive Officer
	/s/ Gerald Tucciarone
	Gerald Tucciarone
	Chief Financial Officer, Treasurer
	and Secretary