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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
(x) ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2000
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( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-13550
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HAUPPAUGE DIGITAL, INC.
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(Name of small business issuer in its charter)
Delaware 11-3227864
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(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
91 Cabot Court, Hauppauge, New York 11788
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (631) 434-1600
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Securities registered pursuant to Section 12 (b) of the Act:
None
Securities registered pursuant to Section 12 (g) of the Act:
$.01 par value Common Stock
Check whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15 (d) of the Exchange Act of 1934 during the past twelve
(12) months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to the filing requirements for the past
ninety (90) days.
YES X NO
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Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-K not contained in this form, and no disclosure will be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K: [ ]
State registrant's revenues for its most recent fiscal year: $66,292,491
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of December 19, 2000 was approximately $12,724,768. Non-affiliates
include all stockholders other than officers, directors and 5% stockholders of
the Company. Market value is based upon the price of the Common Stock as of the
close of business on December 19, 2000 which was $2.00 per share as reported by
NASDAQ.
As of December 18, 2000, the number of shares of Common Stock outstanding was
8,882,976 (exclusive of treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Part III which includes Item 10 (Directors, Executive Officers, Promoters and
Control Persons; Compliance with Section 16(a) of the Exchange Act), Item 11
(Executive Compensation), Item 12 (Security Ownership of Certain Beneficial
Owners and Management), and Item 13 (Certain Relationships and Related
Transactions) will be incorporated in the Company's Proxy Statement to be filed
within 120 days of September 30, 2000 and are incorporated herein by reference.
PART I
Special Note Regarding Forward Looking Statements
Certain statements in this Report constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
the Company, or industry results, to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, those discussed
under the subsection entitled "Risk Factors" under Item 7 Management's
Discussion and Analysis of Financial Condition and Results of Operations. In
addition to statements which explicitly describe such risks and uncertainties,
readers are urged to consider statements labeled with the terms "believes,"
"belief," "expects," "plans," "anticipates," or "intends," and derivations
thereof and similar words to be uncertain and forward-looking. All cautionary
statements made in this Form 10-K should be read as being applicable to all
related forward-looking statements wherever they appear.
Item 1. BUSINESS
Hauppauge Digital Inc. (the "Company"), through its subsidiaries, develops,
manufactures, markets and sells products for the Personal Computer market which
allow PC users to watch TV in a resizable window on their PC screen. The
Company's main product line, called the WinTV(R), connects directly to cable TV,
broadcast TV or satellite TV receivers, and is sold primarily through computer
retail stores in the U.S., Europe and Asia. All references herein to the Company
include the Company, its wholly owned subsidiaries and their subsidiaries,
unless otherwise indicated or the context otherwise requires.
Management believes the most common reason for using the WinTV is the
entertainment and information value derived by allowing PC users to watch either
important or otherwise interesting TV shows while they work on their PC's. For
example, a stockbroker can have a financial TV program in a small window on
their PC screen while seeing stock quotes in another window. An end user who
likes to watch music video shows on TV can have the music video TV show in one
window on their PC screen, while surfing the Internet, working on e-mail, or
performing any other PC activity.
In fiscal 2000, the Company shipped its two millionth WinTV board.
Management believes that the Company's sales have grown over the last five years
as a result of, among other things, PC users spending more time working with
their PC's on such activities as Internet surfing and e-mail writing. Management
believes that when a PC user spends time working with their PC, they do not want
to miss the important or entertaining TV shows they would typically watch on a
standard TV set.
In addition to allowing users to watch TV on a PC, the WinTV boards can
also receive certain data that maybe transmitted along with the TV signal. The
transmission of data along with a TV signal is called "Data Broadcasting". As
the United States and Europe transition from analog TV to digital TV, the data
rates supported by Data Broadcasting are expected to increase to well over 1
million bits per second. With such high data rates, Data Broadcasting has the
ability to create new business opportunities for both TV broadcasters and the
Company.
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The United States is in a multi-year transition period from analog to
digital TV. Management believes that the demand for the Company's digital TV
products will grow as: 1) more digital TV stations come "on-line", 2) the amount
of compelling and original digital TV programming increases, and 3) as new
services which use the unique characteristics of digital TV data broadcasts are
introduced. In Europe, similar market dynamics are present, though the standards
and technical characteristics are different from the U.S. market.
The Company markets its products through computer retailers, computer
products distributors and original equipment manufacturers ("OEMs"). Computer
retailers typically stock the products on their shelves and sell them to end
users for installation in their own PC's. Distributors typically stock and sell
the products to retail stores and value added resellers (VARs), while OEMs
typically purchase TV and video conferencing boards to incorporate them into
their own products, which are then ultimately sold to end users.
Company Strategy
Since its entry into the PC digital video market in 1991, the Company has
become a leading provider by focusing on four primary strategic fronts:
innovating and diversifying its product line by developing and exploiting core
technologies; forging strategic relationships with key industry players;
expanding its worldwide sales and distribution channels; and maintaining and
improving profit margins.
Significant product lines include a wide range of analog TV receiver boards
covering a 3:1 range in price across most major world TV standards; digital TV
receiver boards for terrestrial transmissions in the U.S. and satellite
transmissions in Europe; external TV products based on the USB (Universal Serial
Bus); video capture boards for origination and editing of video streams for
Internet and other uses; and an overall software architecture with a human
interface that unites all of the product lines.
Management believes that strategic relationships with key suppliers, OEMs,
broadcasters, and Internet and e-commerce solutions providers give the Company
important advantages in developing new technologies and marketing its products.
Working with a variety of other companies allows the Company to leverage its
investment in research and development and minimize time to market.
The Company's sales organization cultivates a variety of distribution
channels, including retail stores, distributors and other resellers, as well as
OEMs which incorporate the Company's products into their own. Management
believes that rapidly developing and growing its worldwide presence gives the
Company an important strategic position, allows it to benefit many times over
from investments in product development, and more firmly establishes the WinTV
brand name in the global market.
Maintaining and improving the Company's profit margins involves, among
other things, outsourcing production for each geographic region to
subcontractors best suited for the type and volume of work, as well as
leveraging worldwide supplier relationships to ensure being the lowest cost
producer in the category. Engineering products for low cost and high flexibility
in production is another important way that technology leadership contributes to
the bottom line.
Products
The WinTV products are designed so that a PC user can watch TV in a
resizable window on a PC video
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monitor during normal computer use. This activity requires operating software to
control functions such as channel change, volume adjustment, freeze frame, and
channel scan. All required functions, such as video digitizing, windowing, color
space conversion and chroma keying, are performed on the WinTV board, in the
external WinTV-USB, or in the operating software. WinTVs include audio functions
so that sound can be heard while watching TV or video. The audio can be
connected to speakers or to a PC's sound card.
In fiscal 2000, the Company's primary products included the following:
- WinTV-Go - a low cost WinTV, for the mass
consumer market
- WinTV-PCI-FM - a single slot internal plug in
board which enables the user to bring TV and broadcast
data to their PC
- WinTV-Primio - only sold in Europe, it is an
enhanced version of the Company's WinTV-Go board
- WinTV-USB - which brings WinTV capabilities to
desktop and laptop computers by connecting
externally through a PC's USB port
Of these products, the WinTV-Go and WinTV-USB were new product
introductions in fiscal 1999, continuing the Company's strategy of rapidly
exploiting new cutting edge technology development.
In fiscal 2000, product development focused in three areas: a new product
family: personal video recorders which are called "WinTV-PVRs", new digital TV
receivers and an update on the Company's existing analog TV product line to
reduce manufacturing costs.
The WinTV-PVR (Personal Video Recorder) product line include both internal
and external TV receivers products which are designed to add the ability to
record TV shows to a PC's hard disk. The TV recording uses a high quality
hardware MPEG 2 encoder built onto the WinTV-PVR device, which makes the
recorded TV shows consume less hard disk space than an uncompressed file while
providing excellent image quality. The WinTV-PVR user can record TV to disk
using a TV scheduler, play back the shows into the WinTV window (resizable on
playback as well as during live viewing and recording), or record the recorded
TV show onto CD- ROM for playback on a home DVD player or a laptop or desktop
PC. In addition to the recording feature, the WinTV-PVR can also pause live TV
and provide instant replay.
The Company also worked on the development of new digital TV receivers for
the U.S. market and for the international markets. The WinTV-HD is expected to
be shipped to the U.S. consumer market mid-2001. The WinTV-Nova, a lower cost
European satellite receiver and a companion device which enables pay TV channels
to be received and decoded, was also shipped internationally early in fiscal
2001.
The Company also developed a new platform, which went into production late
fiscal 2000, for most of its worldwide analog TV receivers. The purpose of this
development was to reduce the cost to build existing models of WinTV boards,
which continue in high volume production.
The acquisition of certain assets of Eskape Labs, late in the third quarter
of fiscal 2000, also added a number of models to the product line. These models
allow Apple Macintosh users to enjoy many of the same features PC users have
enjoyed using WinTVs.
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Current production models
With the line of analog WinTV boards still generating the bulk of the
Company's revenues, the Company has, as of the end of fiscal 2000, roughly 40
different products in the marketplace, ranging from the VCB for video capture
and video conferencing applications, to WinTV-DVB, the Company's digital TV
receiver boards. The Company normally sells between 4 and 8 models into each
geographic market.
The Company's product can be broadly grouped into the following seven
categories:
Personal video recorder products:
The WinTV-PVRs (Personal Video Recorders) include both internal and
external TV receiver products which are designed to add the ability to
record TV shows to a PC's hard disk. The TV recorder uses a high
quality hardware MPEG 2 encoder built onto the WinTV-PVR device, which
makes the recorded TV shows consume less hard disk space while
providing excellent image quality. The WinTV-PVR user can record TV to
disk using a TV scheduler, play the shows back into the WinTV window
(resizable on playback as well as during live viewing and recording),
or record the recorded TV show onto CD-ROM for playback on a home DVD
player or a laptop or desktop PC. In addition to the recording feature,
the WinTV-PVR can also pause live TV and provide instant replay.
Internal PCI-based WinTV boards for analog TV reception:
The WinTV-pci products are single slot internal plug in boards which
connect to cable TV, a satellite TV receiver or a TV antenna and enable
a user to watch TV in a resizable window on their PC monitor.. The
WinTV has a 125 channel cable ready TV tuner with automatic channel
scan and a video digitizer. The video digitizer allows the user to
capture still and motion video images to a hard disk, creating high
impact presentations, and to videoconference over the Internet (using
the supplied Microsoft NetMeeting software). In Europe, the WinTV
products can be used to receive teletext data broadcasts.
The WinTV-Go is a low cost TV receiver, which has all of the features
mentioned above. The WinTV-Go has mono audio. There are models for the
U.S., European and Asian markets.
WinTV-Primio is only sold in Europe and is an enhanced version of the
Company's WinTV-Go board.
The WinTV-dbx model has all of the features of the WinTV-pci models,
plus offers high quality dbx-TV for stereo decoding, and is sold
primarily in the U.S. In Europe, the WinTV-PCI-stereo offers high
quality NICAM stereo audio, a European audio format.
The WinTV-Radio has all the features of the WinTV-dbx and
WinTV-PCI-stereo models, plus adds an FM radio tuner and FM radio
control software. There are models for the U.S., European and Asian
markets.
The WinTV-Theater has all the features of the WinTV-Radio stereo
models, plus adds a built-in Dolby ProLogic Surround sound decoder.
Many prime time TV shows, as well as many sporting events, are
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broadcast using Dolby ProLogic Surround sound. The WinTV-Theater can be
connected to 5 speakers so that the user can get a complete home
theater experience while working at their PC. There are WinTV- Theater
models for the U.S. and European markets.
External WinTV products for analog TV reception:
The WinTV-USB brings TV-in-a-window to both desktop and laptop PCs
equipped with a USB port. The WinTV-USB connects to a PC via a USB port
and is an external device, so the user does not have to open up the PC
during installation. There are two models for the U.S., European and
Asian markets.
Apple Macintosh Compatible Products:
The Eskape Labs product line, consisting of MyTV, MyView, MyCapture and
MyVideo, all connect to Apple Macintosh computers via USB ports. MyTV
has features comparable to WinTV-USB. MyCapture allows the capture of
composite and S-Video source programs to the Macintosh's hard drive,
MyView outputs video clips from the hard drive to composite and S-Video
devices, and MyVideo combines the features of MyCapture and MyView in
one convenient package.
Internal WinTV boards for digital TV reception:
The WinTV-D, marketed in the United States, and the WinTV-DVB, marketed
in most other parts of the World, are PC-based digital TV receivers.
They can decode digital TV transmissions and format the video portion
of the transmission into a window on the PC screen. The WinTV-D and
WinTV-DVB can simultaneously extract data from the digital TV
transmission and send this data to an application which is running in
the PC. For example, there are Data Broadcast services in Europe which
send Internet web pages in a digital TV transmission. The WinTV-DVB can
extract this data and send it to a Web browser such as Internet
Explorer for display.
The ongoing transition to digital broadcast signals in the United
States is intended to enable networks and broadcasters to package data
along with the broadcast digital signal. Called datacasting, this
technique provides for a range of information formats at speeds several
times faster than cable modems. With over 150 stations currently
broadcasting a digital TV signal, and more expected to sign on
throughout the year 2001, customers will be offered a wide range of
digital content, from TV programming to datacasted music, video games
and e-commerce content. In Europe, the growth in digital TV may provide
similar opportunities to mix TV and data.
ImpactVCB boards for OEM video capturing applications:
The Impact Video Capture Board ("ImpactVCB") is a low cost PCI board
for high performance access to digitized video. Designed for PC based
video conferencing and video capturing in industrial applications, the
ImpactVCB features live video in a window, still image capture and a
Microsoft Video for Windows compatible motion video capture driver.
As of the end of fiscal 2000, 8 different ImpactVCB models were in
production, each with different video input and power configurations.
Most of these models have been developed for specific customers under
OEM arrangements.
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DV Wizard-pro for desktop video editing of home video tapes:
The DV Wizard allows the capture of full frame live video from digital
video camcorders or VCRs and stores it to the hard disk so that it can
be digitally edited on a PC. DV Wizard-pro uses the IEEE1394 (Firewire)
technology to connect to these devices. The compression technology used
in the DV Wizard allows the board to capture 60 fields per second,
resulting in more accurate frame-by-frame video editing and more
realistic video playback. The DV Wizard can also output the edited
video clips from the PC's hard drive, which can be recorded on tape by
a digital video camcorder.
The DV Wizard was designed to be used to edit home video tapes, and to
add flair to home videos. It can also be used by corporate marketing
communication departments, training video developers, trade show
demonstration creators, video hobbyists, CD-ROM title producers and
creators of corporate product literature on CD-ROM.
WinTV products which are sold through the computer retail market are
essentially the same as those which are available to the OEM market. The
differences are in the packaging and in the sophistication of the operating
software. The Company's WinTV boards are primarily sold to the retail market and
are also sold in the OEM market. DV Wizard-pro is sold primarily in the retail
market, and VCB video capture boards are primarily sold in the OEM market.
For the international market, the Company has developed a capability for
most WinTV models called teletext decoding. This capability allows the reception
of digital data which is transmitted along with the live TV signal. Though
relatively unknown in the United States, teletext is standard on most European
TV sets. Examples of teletext data transmitted by TV stations include weather
information, travel schedules, stock market data and home shopping services.
Teletext and several newer services are all forms of data broadcasting. The
Company believes that, due to the capability of its products to receive digital
information in PCs, data broadcasting represents a key growth opportunity.
Technology
The Company has developed five generations of WinTV since first introducing
the products in 1991. The first generation of WinTVs put the TV image on the PC
screen using chroma keying, requiring a dedicated "feature connector cable"
between the WinTV and the VGA board. Despite issues with screen resolution, for
the first time a PC user could watch TV in a resizable window on their PC
screen. Initial customers were mostly professional PC users who spent many hours
on their PC's and found having TV in a window on their desktop useful and
entertaining. For example, Management believes PC users involved in financial
markets need to be able to see stock market related TV shows while they work on
their PCs. Video clip capture and teletext capabilities, valued features in
today's models, can also trace their origins to the first WinTV products.
In 1993, the Company invented a technique called "smartlock", which
eliminated the need for, and the installation problems associated with, the
"feature connector cable." In 1994, the Company introduced its "WinTV-Celebrity"
generation of TV tuner boards based on this "smartlock" technology, greatly
improving customer satisfaction. The CinemaPro series of WinTV boards then used
smartlock and other techniques to
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further reduce cost and improve performance.
In June of 1996, the Company introduced the WinTV-PCI line of TV tuner
boards for PCs. These boards were developed to eliminate the relatively
expensive "smartlock" circuitry and memory used on the WinTV- Celebrity and
CinemaPro boards. The WinTV-PCI used a technique called "PCI Push" and was
designed to be used in the emerging Intel Pentium market. These Pentium based
PCs had a new type of system expansion "bus", called the PCI bus, which allowed
data to be moved at a much higher rate than the older ISA bus, which the
previous WinTV generations used. The "PCI Push" technique moves the video image
30 times per second (in Europe the image is moved 25 times a second) over the
PCI bus. In addition to being less expensive to manufacture, the WinTV-PCI had
higher digital video movie capture performance than the previous generations,
capturing video at up to 30 quarter screen frames per second. With this higher
performance capture capability, the WinTV-PCI found new uses in video
conferencing, video surveillance and Internet streaming video applications.
The fourth generation of WinTV boards, introduced in 1999, are digital TV
receivers. The United States and Europe are in a transition period from analog
TV to digital TV. The Company's WinTV-D board, developed during the 1999 fiscal
year and delivered to the market in the beginning of fiscal 2000, is the first
digital TV receiver for the U.S. market which allows PC's to receive and display
digital TV signals, in addition to conventional analog TV signals. The software
to control the digital TV reception is based on the Company's "WinTV-2000"
software, which was developed during 1999. In fiscal 1999, the Company also
introduced the WinTV-DVB board for the European market. This board brings
digital TV to PCs, and is based on the European Digital Video Broadcast
standard. Both the WinTV-D and the WinTV-DVB have the ability to receive special
data broadcasts which some broadcasters may send along with the digital TV
signal, in addition to displaying digital TV in a resizable window. Data
broadcasts on digital TV are transmitted at several million bits per second. The
Company has developed proprietary software which can decode and display some of
these special data broadcasts, and intends to work on standardized reception and
display software, if such broadcasts become standardized.
The fifth generation of WinTV products are the PVR (Personal Video
Recorder) models, developed during fiscal 2000 and introduced to the market in
early fiscal 2001. The WinTV-PVRs (Personal Video Recorders) include both
internal and external TV receiver products which are designed to add the ability
to record TV shows to a PC's hard disk. The TV recorder uses a high quality
hardware MPEG 2 encoder built onto the WinTV-PVR device, which makes the
recorded TV shows consume less hard disk space while providing excellent image
quality. The WinTV-PVR user can record TV to disk using a TV scheduler, play the
shows back into the WinTV window (resizable on playback as well as during live
viewing and recording), or record the recorded TV show onto CD-ROM for playback
on a home DVD player or a laptop or desktop PC. In addition to the recording
feature, the WinTV-PVR can also pause live TV and provide instant replay.
Research and Development
The Company's development efforts are currently focused on extending the
range and features of the PVR products, additional externally attached TV
products, and high-definition digital TV products. The Company is also
developing more highly integrated versions of its hardware products to further
improve performance and cost points, and new versions of its software to add
features, improve ease of use, and provide support for new operating systems.
The Company is also developing additional capabilities in the data broadcasting
field, in the
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e-commerce area, and enhancing the capabilities of its products in the Apple
Macintosh market.
The Company currently has three Research and Development operations: one
based in the Company's New York headquarters, one based in Pleasanton,
California and one based in Singapore. The Company's Singapore R&D team is
mainly focused on external TV products, and on Asian versions of the Company's
products. The Pleasanton, California R&D operation develops products for the
Apple Macintosh computer, while the New York R&D operation is aimed at the
digital receiver market, the PVR models, user interface software and low level
drivers for all PC products.
The technology underlying the Company's products and other products in the
computer industry, in general, is subject to rapid change, including the
potential introduction of new types of products and technologies, which may have
a material adverse impact upon the Company's business. The Company will need to
maintain an ongoing research and development program, and the Company's success,
of which there can be no assurances, will depend in part on its ability to
respond quickly to technological advances by developing and introducing new
products, successfully incorporating such advances in existing products, and
obtaining licenses, patents, or other proprietary technologies to be used in
connection with new or existing products. The Company continues to increase it
research and development expenditures. The Company expended approximately
$1,666,000, $1,257,000 and $808,000 for research and development expenses for
the years ended September 30, 2000, 1999 and 1998. There can be no assurance
that the Company's research and development will be successful or that the
Company will be able to foresee and respond to such advances in technological
developments and to successfully develop other products. Additionally, there can
be no assurances that the development of technologies and products by
competitors will not render the Company's products or technologies
non-competitive or obsolete. See "Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors."
Product Production and Suppliers
The Company designs the WinTV products and also writes the operating
software to be used in conjunction with many versions of the popular
Microsoft(R) Windows(TM) operating system, including Windows98, WindowsMe,
WindowsNT and Windows2000. The Company subcontracts the manufacturing and
assembly of the WinTV boards to independent third parties at facilities in
various countries. The Company monitors the quality of the completed product at
its facilities in Hauppauge, New York, Singapore, and Ireland before packaging
the product and shipping it to customers.
Although certain components essential to the Company's business are
generally available from multiple sources, other key components (including, but
not limited to, TV tuners, video decoder chips and application-specific
integrated circuits (ASICs)) are currently obtained by the Company from single
or limited sources; in addition, these and other key components (including, but
not limited to, DRAM), while currently available to the Company from multiple
sources, are at times subject to industry wide availability and pricing
pressures. Any availability limitations, interruption in supplies, or price
increases relative to these and other components could have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, new products introduced by the Company often initially utilize custom
components obtained from only one source until the Company has evaluated whether
there is a need for and subsequently qualifies additional suppliers. In
situations where a component or product utilizes new technologies, initial
capacity constraints may exist until such time as the suppliers' yields have
matured. Components are normally acquired through purchase orders, as is common
in the industry, typically covering the Company's requirements
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for periods from 60 to 120 days. However, the Company continues to evaluate the
need for a supply contract in each situation.
If the supply of a key component to the Company were to be delayed or
curtailed or in the event a key manufacturing vendor delays shipment of
completed products to the Company, the Company's ability to ship products in
desired quantities and in a timely manner could be adversely affected. The
Company's business and financial performance could also be adversely affected,
depending on the time required to obtain sufficient quantities from the original
source or, if possible, to identify and obtain sufficient quantities from an
alternative source. The Company attempts to mitigate these potential risks by
working closely with its key suppliers on product introduction plans, strategic
inventories, coordinated product introductions, and internal and external
manufacturing schedules and levels.
The Company has from time to time experienced significant price increases
and limited availability of certain components that are available from multiple
sources. Any similar occurrences in the future could have a material adverse
effect on the Company's business, operating results and financial condition
Manufacturing is performed by a select group of contract manufacturers.
Product design specifications are provided to insure proper assembly. Contract
manufacturing is either done on a consignment basis, in which the Company
provides all the component parts and pays an assembly charge for each board
produced, or on a turnkey basis, in which all components and labor are provided
by the contract manufacturer, and the manufacturing price the Company is charged
includes parts and assembly costs. The Company continuously monitors the quality
of its selected manufacturers. The Company has qualified five contract
manufacturers and utilizes three. These three contract manufacturers are
presently being utilized to handle the majority of production. If demand were to
increase dramatically, the Company believes additional production could be
absorbed by these and other contract manufacturers.
During fiscal 1998, the Company began producing boards for the majority of
its European sales through a subcontractor in Scotland. The production is done
on a turnkey basis with assembly, testing and rework being handled in Scotland.
The packaging and shipping of the product to customers is being performed at the
Company's Ireland location. By shifting its European production to Europe, the
Company anticipates savings on the production costs and shipping costs of the
boards, in addition to the elimination of duties charged on boards entering
Europe from the United States. In fiscal 1999, the Company added a subcontractor
in Malaysia, who is equipped to assemble domestic and international products.
Finally, in fiscal 2000, the Company added a subcontractor in Hungary, who now
produces a significant amount of its product for the European market.
Customers and Markets
The Company primarily markets the WinTV to the consumer market to allow PC
users to watch their favorite TV shows while they work on their PCs. To reach
this consumer market, the Company has expanded its sales through a network of
computer retailers in the U.S., Europe and Asia. The Company uses both direct
sales to retailers and sales through computer products distributors to service
this market. To attract new PC users in the consumer market, the Company
advertises with and runs special promotions with computer retailers. The Company
actively participates in trade shows to educate and train key computer retail
marketing personnel. Most of the Company's sales and marketing budget is aimed
at the consumer market.
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In addition to the consumer market, the Company markets to the professional
stock brokerage market, where the WinTV is primarily used to display financial
TV shows in a window on a stock brokers workstation while they continue to
operate their financial applications. The Company has sold its WinTV products to
two large financial services information providers for incorporation into their
workstations, and several independent financial institutions. This market
segment is typically project based.
The Company also has sold products to PC OEMs, that either embed a WinTV
product in a PC that they resell, or sell the WinTV as an accessory to its PCs.
Distribution to the Retail Market
During fiscal 2000, net sales to distributors and retailers of the Company
totaled approximately $60,214,000 or 91% of the Company's net sales compared to
approximately $52,398,000 or 89% and $33,008,000 or 85% for the years ended
September 30, 1999 and 1998. The Company has no exclusive distributor or
retailer and sells through a multitude of retailers and distributors, no one of
which accounted for more than 10% of the Company's net sales.
Sales to Original Equipment Manufacturers ("OEMs")
The OEM business is one where a PC manufacturer incorporates the Company's
WinTV board or Impact video conferencing board into a product sold under the
OEM's label. Although no assurances can be made, management believes, but there
can be no assurances, the Company's OEM business is expected to increase in the
next few years. Factors which could impact the expansion of the Company's OEM
business include, among other things, the ability to successfully negotiate and
implement agreements with original equipment manufactures. Management believes,
but there can be no assurances, that FCC regulations mandating the digital
broadcasting of TV signals by the year 2006 will attract consumer interest in
devices, such as those models of the Company's WinTV(R) boards which are
equipped to receive digital TV broadcasts.
The Company's OEM business totaled approximately $6,079,000, $ 6,203,000
and $5,749,000 for the years ended September 30, 2000, 1999 and 1998. The
Company sold product to a variety of OEM customers, none of which accounted for
more than 10% of total sales in any of the three years. Sales to OEM customers
accounted for approximately 9%, 11% and 15% of the Company's net sales for 2000,
1999 and 1998, respectively.
Marketing and Sales
The Company sells both domestically and internationally through Company
sales offices in New York, California, Germany, the United Kingdom, France and
Singapore, plus through independent sales representative offices in the
Netherlands and The People's Republic of China. For the fiscal years ended
September 30, 2000, 1999 and 1998, approximately 29%, 27% and 28% of the
Company's net sales were made within the United States, respectively, while
approximately 71%, 73% and 72% were outside the United States (predominately in
Germany, the United Kingdom, France and the Asia) respectively.
For further information on the Company's geographic segments, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in Item 7 and Note 1 to the Consolidated Financial
10
Statements.
The Company advertises its products in a number of PC magazines
internationally. The Company also participates in retailers' market promotion
programs, such as store circulars, promotions and retail store displays. These
in store promotional programs, magazine advertisements plus a public relations
program aimed at editors of key PC computer magazines and an active web site on
the Internet, are the principal means of getting the product introduced to end
users. The sales rate in the computer retail market is closely related to the
effectiveness of these programs, along with the technical capabilities of the
product itself. The Company also lists its products in catalogs of various mail
order companies and attends various worldwide trade shows.
The Company currently has 8 sales persons located in Europe, 2 sales
persons in the Far East and 4 sales persons in the United States, located in New
York and California. The Company also has 4 manufacturer representatives
retained by it on a non-exclusive basis, who work with customers in certain
domestic geographic areas.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" with reference to a discussion on the impact seasonality
has on the Company's sales.
Foreign Currency Fluctuations
Due to extensive sales to European customers denominated in local
currencies, the Company is a net receiver of currencies other than the U.S.
dollar and as such benefits from a weak dollar and is adversely affected by a
strong dollar relative to the major worldwide currencies, especially the Euro
and British Pound Sterling. Consequently, changes in exchange rates expose the
Company to market risks resulting from the fluctuations in the foreign currency
exchange rates to the U.S. dollar. The Company attempts to reduce these risks by
entering into foreign exchange forward contracts with financial institutions to
protect against currency exchange risks associated with its foreign denominated
accounts receivable.
The strength or weakness of the U.S. dollar against the value of the Euro
and British Pound Sterling impact the Company's financial results. Changes in
exchange rates may positively or negatively affect the Company's revenues, gross
margins, operating income and retained earnings (which are expressed in U.S.
dollars). Where it deems prudent, the Company engages in hedging programs aimed
at limiting, in part, the impact of currency fluctuations. Primarily selling
foreign currencies through forward window contracts, the Company attempts to
hedge its foreign sales against currency fluctuations.
As of September 30, 2000, the Company has foreign currency forward
contracts outstanding of approximately $11.3 million for the Euro. The contracts
expire through December 2000. As of September 30, 2000, the Company had
unrecognized gains from foreign currency forward contracts of $319,000.
These hedging activities provide only limited protection against currency
exchange risks. Factors that could impact the effectiveness of the Company's
programs include volatility of the currency markets and availability of hedging
instruments. The contracts the Company procures are specifically entered into to
as a hedge against existing or anticipated 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,
when the U.S. dollar sustains a long term strengthening position against the
currencies
11
in which the Company sells it products, the Company's revenues, gross margins,
operating income and retained earnings can be adversely affected.
Competition
The Company's business is subject to significant competition. Competition
exists from larger and smaller companies that might possess substantially
greater technical, financial, sales and marketing resources than that which the
Company has. The dynamics of competition in this market involve short product
life cycles, declining selling prices, evolving industry standards and frequent
new product introductions. The Company competes in this emerging market against
companies such as ATI Technologies Inc., 3dfx Interactive Inc. and Pinnacle
Systems, Inc., among others. The Company believes that competition from new
entrants will increase as the market for digital video in a PC expands. There
can be no assurances that the Company will not experience increased competition
in the future. Such increased competition may have a material adverse effect on
the Company's ability to successfully market its products.
Though management believes that the delivery of TV via the Internet will
become more popular in the future, it also believes that TV delivered to PC's
via cable, broadcast or satellite will continue to dominate. As the Company's
WinTV products connect directly to cable, broadcast and satellite receivers, and
deliver a higher quality image, management views WinTV as the preferred way to
watch TV on the PC versus the delivery of TV via the Internet.
Patents, Copyrights and Trademarks
With the proliferation of new products and rapidly changing technology,
there has been a significant volume of patents and other intellectual property
rights held by third parties. There are a number of companies that hold patents
for various aspects of the technologies incorporated in some of the PC and TV
industries' standards. Given the nature of the Company's products and
development efforts, there are risks that claims associated with such patents or
intellectual property rights could be asserted against it by third parties. The
Company expects that parties seeking to gain competitive advantages will
increase their efforts to enforce any patent or intellectual property rights
that they may have. The holders of patents from which the Company has not
obtained licenses may take the position that it is required to obtain a license
from them.
If a claimant refuses to offer such a license, or refuses to offer such a
license on terms acceptable to the Company, there is a risk of incurring
substantial litigation or settlement costs regardless of the merits of the
allegations, and regardless of which party eventually prevails. In the event of
litigation, if the Company does not prevail, it may be required to pay
significant damages and/or to cease sales and production of infringing products
and may incur significant defense costs in any event. Additionally, the Company
may need to attempt to design around a given technology, although there can be
no assurances that this would be possible nor economical.
The Company currently uses technology licensed from third parties in
certain of its products. Its business, financial condition and operating results
could be adversely affected by a number of factors relating to these third-party
technologies, including:
- failure by a licensor to accurately develop, timely introduce, promote
or support the technology;
12
- delays in shipment of products;
- excess customer support or product return costs due to problems with
licensed technology; and
- termination of the Company's relationship with such licensors.
The Company may not be able to protect its intellectual property adequately
through patent, copyright, trademark and other protection. If it fails to
adequately protect its intellectual property, it may be misappropriated by
others, invalidated or challenged, which would materially harm its ability to
sell its products. For example, in the event that the Company was to be issued
any patents, they might not be upheld as valid if litigation over any such
patent were initiated. If the Company is unable to protect its intellectual
property adequately, it could allow competitors to duplicate its technology or
may otherwise limit any competitive technological advantage it may have. Because
of the rapid pace of technological change, the Company believes its success is
likely to depend more upon continued innovation, technical expertise, marketing
skills and customer support and service rather than upon legal protection of its
proprietary rights. However, the Company will aggressively assert its
intellectual property rights when necessary.
Even though the Company independently develops its hardware and software
products, the Company's success will depend, in large part, on its ability to
innovate, obtain or license patents, protect trade secrets and operate without
infringing on the proprietary rights of others. The Company maintains copyrights
on its designs and software programs, but currently has no patent on the
WinTV(R) board and the Company believes that such technology cannot be patented.
On December 27, 1994, the Company's mark, "WinTV(R)", was registered with
the United States Patent and Trademark Office. The Company's "Hauppauge" name
logo is also registered.
See "Legal Proceedings" for a discussion of certain litigation and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Employees
As of September 30, 2000, the Company had 118 employees worldwide,
including its executive officers, all of which are full-time, none of which are
represented by a union.
Corporate Structure
The Company was incorporated in the state of Delaware on August 2, 1994 and
has six wholly owned subsidiaries, Hauppauge Computer Works, Inc., HCW
Distributing Corp., Hauppauge Digital Asia Pte. Ltd., which is incorporated in
Singapore, Hauppauge Digital Europe SARL, which is incorporated in Luxembourg,
Eskape Acquisition Corp, which is incorporated in Delaware and Hauppauge
Computer Works, LTD, a Virgin Islands corporation responsible for handling sales
in Central and South America. Hauppauge Digital Europe SARL is the owner of all
the outstanding shares of Hauppauge Computer Works, GmbH, a German corporation
responsible for directing European marketing efforts, Hauppauge Computer Works
SARL, a French Corporation responsible for sales and marketing efforts in France
and Hauppauge Computer Works LTD, an English corporation which directs the
Company's sales and marketing efforts in the United Kingdom.
13
In 1999, the Company established a new sales, warehousing, packing and R&D
facility in Singapore. This is the headquarters for Hauppauge Digital Asia Pte.
Ltd. The purpose of this facility is to better provide sales and marketing
support for the Asia market, and to expand the Company's Research and
Development capacity.
During fiscal 2000, the Company established a warehousing and packing
facility just outside of Dublin in Blanchardstown, Ireland. This Company, named
Hauppauge Digital SARL Ireland, was established as a branch office of Hauppauge
Digital Europe SARL in Luxembourg. The purpose of this facility is to better
provide a more cost effective and operationally efficient Company run
distribution center for the European market, in addition to reducing the
Company's overall tax rate.
The Company's executive offices are located at 91 Cabot Court, Hauppauge,
New York 11788, its telephone number at that address is (631) 434-1600 and its
Internet address is http://www.hauppauge.com.
Item 2 DESCRIPTION OF PROPERTY
The Company occupies approximately 25,000 square feet at a facility located
at 91 Cabot Court, Hauppauge, New York which it uses as its executive offices
and for the testing, storage, and shipping of its products. The Company
considers the premises to be suitable for its needs at such location. The
building is owned by a partnership consisting of the Company's principal
stockholders and their wives and is leased to the Company under a lease
agreement expiring on January 31, 2006 which may be extended, at the Company's
option, for an additional three years. Rent is currently at the annual rate of
$372,707 and will increase to $391,342 per year on February 1, 2001. The rent is
payable in equal monthly installments and increases at a rate of 5% per year on
February 1 of each year thereafter including during the option period. The
premises are subject to two mortgages which have been guaranteed by the Company
upon which the outstanding principal amount due as of September 30, 2000 was
$961,469. The Company pays the taxes and operating costs of maintaining the
premises.
The Company, through Hauppauge Computer Works, Inc., occupies approximately
3,300 square feet in Fremont, California, which it uses as the Company's western
region sales office for Hauppauge Computer Works, Inc. and Eskape Labs. The
lease expires on May 31, 2004 and requires the Company to pay annual rent of
approximately $67,200, with the rent increasing 3.8 percent annually during the
lease term. The Company is also responsible for a portion of common area
maintenance charges based on the space it occupies.
The Company, through Hauppauge Computer Works GmbH, occupies approximately
6,000 square feet in Germany which it uses as sales office, customer support
area, a demonstration room and a storage facility. The Company pays a annual
rent of approximately $44,400 for this facility pursuant to a rental agreement
which expires on October 31, 2006.
The Company, through Hauppauge Digital Asia Pte. Ltd., occupies
approximately 6,400 square feet in Singapore, which it uses as a sales and
administration office and for the testing, storage and shipping of its products.
The lease, which expires on November 30, 2002, calls for an annual rent of
$56,400. The rent includes an allocation for common area maintenance charges.
In April 2000, the Company, through Hauppauge Digital SARL, leased a 15,000
square foot building in Blanchardstown, Dublin, Ireland, which houses the
European warehousing and distribution functions. The lease,
14
which is for one year, calls for a annual rent of $ 86,400. The rent includes an
allocation for common area maintenance charges.
Item 3. LEGAL PROCEEDINGS.
In January 1998, Advanced Interactive Incorporated ("AII") contacted the
Company and attempted to induce the Company to enter into a patent license or
joint venture agreement with AII relative to certain of the Company's products.
AII alleged that such products infringe U.S. Patent No. 4, 426, 698 (the "AII
Patent"). At such time, the Company's engineering staff analyzed the AII Patent
and determined that the Company's products did not infringe any such patent.
Accordingly, the Company rejected AII's offer.
On October 6, 1998, the Company received notice that AII had commenced an
action against it and multiple other defendants in the United States District
Court for the Northern District of Illinois (the "District Court"), alleging
that the certain of the Company's products infringed on certain patent rights
allegedly owned by the plaintiff (the "Complaint"). The Complaint sought
unspecified compensatory and statutory damages with interest. The Company denied
such allegations and vigorously defended this action. On December 22, 1998, the
Company filed its answer (the "Answer"). Among other things, pursuant to the
Answer, the Company denied that its products infringed AII's patent rights and
asserted certain affirmative defenses. In addition, the Answer included a
counterclaim challenging the validity of AII's alleged patent rights. On March
5, 1999, the Company joined a Motion for Partial Adjudication of Claim
Construction Issues, filed by one of the multiple defendants. The Motion
provided the defendants' interpretation of certain limitations of the claims at
issue. On February 17, 2000, the District Court granted the Motion en toto. On
June 20, 2000, AII and the Company, inter alia, entered into an Agreed Motion to
Entry of Judgment, where AII stipulated that based on the District Court's claim
construction, certain claim elements in the claims at issue were not present in
the Company's accused products. On June 26, 2000, the District Court granted the
Agreed Motion and directed a Final Judgment of Non- infringement as to the
Company.
On July 25, 2000, AII filed a Notice of Appeal with the U.S. Court of
Appeals for the Federal Circuit, appealing the District Court's Order granting
the Motion for Partial Adjudication of Claim Construction Issues and Order
entering Final Judgment of Non infringement. AII filed its Brief for
Plaintiff-Appellant on October 13, 2000, while the Company joined the Brief for
Defendents-Appellees, filed on December 22, 2000. As with the prior action in
the District Court, the Company intends to defend this action vigorously.
Notwithstanding the foregoing, because of the uncertainties of litigation,
no assurances can be given as to the outcome of AII's appeal. It is possible
that the U.S. Court of Appeals for the Federal Circuit may reverse the
District's Court's rulings and remand the case back to the District Court. In
such an event, and if the Company were not to prevail in the remanded
litigation, the Company could be required to pay significant damages to AII and
could be enjoined from further use of such technology as it presently exists.
Although a negative outcome in the AII litigation would have a material adverse
affect on the Company, including, but not limited to, its operations and
financial condition, the Company believes that, if it is held that the Company's
products infringe AII's patent rights, the Company would attempt to design
components to replace the infringing components or would attempt to negotiate
with AII to utilize its system, although no assurances can be given that the
Company would be successful in these attempts. At the present time, the Company
can not assess the possible cost of designing and implementing a new system or
obtaining rights from AII.
15
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 July 18,2000 at the offices of the
Company and were approved by the votes as indicated:
Proposal No. 1: Election of Directors
The following directors were elected by the votes indicated:
For Withheld
Kenneth A. Aupperle 8,803,608 56,565
Kenneth Plotkin 8,803,278 56,895
Steven J. Kuperschmid 8,799,079 70,094
Bernard Herman 8,790,079 60,383
Proposal No. 2: Amendment to Certificate of Incorporation to increase number
of authorized shares of common stock from 10,000,000 to 25,000,000
The Amendment to Certificate of Incorporation to increase the number of
authorized shares of common stock was approved by the votes indicated:
For Against Abstain
8,625,385 214,989 495,632
Proposal No. 3: Adoption of the 2000 Performance and Equity Incentive Plan
The adoption of the 2000 Performance Equity Incentive Plan was approved by
the votes indicated:
For Against Abstain
3,711,660 278,589 5,300,834
Proposal No. 4: Adoption of the Employee Stock Purchase Plan
The adoption of the Employee Stock Purchase Plan was approved by the votes
indicated:
For Against Abstain
3,856,546 138,682 5,300,834
16
Proposal No. 5: Appointment of BDO Seidman LLP as independent auditors
The appointment of BDO Seidman LLP as independent auditors for the fiscal
year ended September 30, 2000 was approved by the vote indicated:
For Against Abstain
8,775,021 159,187 375,740
17
PART II
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDE MATTERS.
(a) The principal market on which the common stock of the Company (the
"Common Stock") is traded is the over-the counter market. The Common Stock is
quoted on the NASDAQ National Market and its symbol is HAUP. The table below
sets forth the high and low bid prices of the Company's Common Stock as
furnished by NASDAQ. Quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
Fiscal Year Ended
September 30, 2000 High* Low*
- ------------------- ------ ----
First Quarter 14 5/8 10 1/16
Second Quarter 48 11 3/16
Third Quarter 16 8 7/16
Fourth Quarter 10 1/4 5 1/4
Fiscal Year Ended
September 30, 1999 High* Low*
- ------------------- ------ ----
First Quarter 5 1/16 2 13/16
Second Quarter 5 3/43 3 7/8
Third Quarter 15 3/16 4 29/32
Fourth Quarter 16 1/16 10 11/16
- ----------------------
* On February 7, 2000, the Company's Board of Directors approved a 2 for 1 stock
split effective March 27, 2000. The per share prices reflect the stock split for
the periods presented.
(b) The Company has been advised by its transfer agent, North American Transfer
Co., that the approximate number of holders of record of the Common Stock as of
December 9, 2000 was 125. The Company believes there are in excess of 12,000
beneficial holders of the Common Stock.
(c) No cash dividends have been paid during the past two years. The Company has
no present intention of paying any cash dividends in its foreseeable future and
intends to use its net income, if any, in its operations.
Item 6. SELECTED FINANCIAL DATA
The following selected financial data with respect to the Company's
financial position and its results of operations for each of the five years in
the period ended September 30, 2000 set forth below has been derived from the
Company's audited consolidated financial statements. The selected financial
information presented below should be read in conjunction with the Consolidated
Financial Statements and related notes thereto in Item
18
8 and "Management's Discussion and Analysis of Financial Condition and Results
of Operations" in Item 7 included in this 10-K.
Consolidated Statement of Operations Data 2000 1999 1998 1997 1996
Years ended September 30, ---- ---- ---- ---- ----
(in thousands, except for per share amounts)
--------------------------------------------
Net Sales $ 66,292 $ 58,602 $ 38,757 $ 25,613 $ 14,695
Cost of sales 53,535 42,435 28,643 19,962 11,014
------ ------ ------ ------ ------
Gross Profit 12,757 16,167 10,114 5,651 3,681
Selling, General and Administrative
Expenses 13,121 10,458 7,244 4,283 3,022
Research & Development Expenses 1,666 1,256 808 560 448
----- ----- --- --- ---
Income (loss) from operations (2,030) 4,453 2,062 808 211
Other Income (Expense):
Interest Income 109 201 236 243 82
Interest Expense ( 15) - - - -
Other, net (247) (61) 184 (9) 16
---- --- --- -- --
Income (loss) before taxes on income ( 2,183) 4,593 2,482 1,042 309
Income tax (benefit) provision ( 1,184) 1,602 1,027 150 30
Reduction in deferred tax valuation allowance - (127) (503) (94) -
------- ---- ---- ---
Net tax (benefit) provision ( 1,184) 1,475 524 56 30
------- ----- --- -- --
Net income (loss) $ ( 999) $ 3,118 $ 1,958 $ 986 $ 279
============ ========= ======= ====== ======
Net income (loss) per share:
Basic $ ( 0.11) $ 0.36 $ 0.22 $ 0.11 $ 0.04
============== ========= ======= ====== ======
Diluted $ ( 0.11) $ 0.33 $ 0.21 $ 0.11 $ 0.04
============== ========= ======= ====== ======
Weighted average shares outstanding:
Basic 8,837 8,632 8,806 8,854 6,522
Diluted 8,837 9,480 9,354 8,870 6,522
Consolidated Balance Sheet Data (at period end):
Working capital $ 11,767 $ 12,533 $9,536 $8,689 $ 7,969
Total assets 26,315 27,728 22,897 14,471 11,931
Stockholders' equity 13,654 13,322 10,037 8,966 8,174
Note: All per share amounts and weighted average shares have been retroactively
restated to reflect a two for one stock split effective March 27, 2000
19
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Results of Operations
Years ended September 30, 2000 and 1999
Sales for the year ended September 30, 2000 were $66,292,491 compared to
$58,601,611 for year ended September 30, 1999, an increase of $7,690,880 or 13%,
comprised of a 22% increase in domestic sales and a 10% increase in European
sales. The forces driving the sales growth were:
- Sales of new products introduced during the latter part of fiscal
1999, including the WinTV-USB, the WinTV-DVB and the WinTV-Go.
- Sales contribution from the Company's Singapore office, which was
opened during the fourth quarter of fiscal 1999.
- Sales contribution of Eskape Labs line of products for the Macintosh
market.
Unit sales of the WinTV and ImpactVCB products for the year ended September
30, 2000 increased 45% to approximately 969,000 as compared to approximately
670,000 for the prior year. Sales to domestic customers for the fiscal 2000 were
29% of net sales compared to 27% for fiscal 1999. Sales to international
customers were 71% of net sales for fiscal 2000 compared to 73% for the prior
fiscal year.
Gross profit for the year was $12,757,030 compared to $16,166,999 for the
prior fiscal year, a decrease of $3,409,969. The gross profit percentage was 19%
for the current period compared to 28% for the prior comparable period. Factors
contributing to the decrease in gross profit margins include:
- Decline in the Euro to U.S. dollar exchange rate.
- Larger sales mix of lower margin product.
- A $1,000,000 reserve for certain excess inventory related to the
Company's digital TV receiver products recorded during the quarter
ended June 30, 2000 to reflect tepid sales of digital products.
The chart below illustrates the components of selling, general and
administrative expenses:
Years ended September 30,
Dollar Costs Percentage of Sales
Increase/
2000 1999 Increase 2000 1999 (Decrease)
---- ---- -------- ---- ---- ----------
Sales & Promotional $ 8,159,606 $ 6,073,732 $2,085,874 12.4% 10.4% 2.0%
Customer Support 464,921 447,860 17,061 .7% .7% -
Product Handling 890,145 592,494 297,651 1.3% 1.0% .3%
General & Admin 3,606,480 3,343,627 262,853 5.4% 5.7% (.3%)
--------- --------- ------- --- --- ---
Total $13,121,152 $10,457,713 $2,663,439 19.8% 17.8% 2.0%
As a percentage of sales, selling, general and administrative expenses for the
year ended September 30, 2000 increased by 2.0% when compared to the prior
comparable period. Represented in dollars, selling, general and
20
administrative expenses increased $2,663,439 over the comparable prior fiscal
year.
The increase in sales and promotional expense of $2,085,874 was mainly due to :
- Full year compensation costs for Singapore office.
- Compensation costs for Eskape Labs' personnel.
- Increased marketing department staff.
- Higher commission attributable to increased
sales and higher effective commission rate.
- Higher coop advertising costs due to increased
sales.
- Increased cost of European sales offices due
to expanded marketing and customer support activities.
- Increased Trade show costs due to attendance at
shows geared to the Macintosh market.
Customer support and product handling expenses increased $17,061 and
$297,651 respectively. Customer support costs increases were mainly due to
customer support service required to handle Asian customers. Increased product
handling costs was a function of the 45% increase in unit shipment volume.
The increase in general and administrative expenses of $262,853 was primarily
due to:
- Higher professional fees for worldwide investment, tax and
litigation advice and the cost of defending a patent litigation
lawsuit.
- Hiring of in house staff counsel.
- Contractual salary increases for senior
executives.
- Compensation of Eskape Labs' administrative
staff.
- Compensation of Singapore office's administrative staff.
- Increased rent of the California office due to additional space
required to house Eskape Lab personnel.
- Full year of rent for the Singapore office.
- Direct building overhead costs of the Singapore and Eskape
Lab offices.
- Increased communication costs due to Singapore
and Eskape Lab offices.
- Amortization of Goodwill and other intangible
assets acquired in the Eskape acquisition.
- Depreciation for fixed assets located at the Singapore and
Eskape Lab offices.
Research and development expenses increased $409,064 or approximately 33%.
The increase was due to the engineering compensation costs at the Company's
Singapore and Eskape Labs offices.
The Company had net other expenses for the year ended September 30, 2000 of
$153,565 compared to net other income for the prior year of $139,878. The
decrease in net other income was primarily due to lower returns on monies
invested and foreign currency losses due to the decline of the Euro and British
Pound Sterling.
The Company recorded an income tax benefit of $1,184,072 for the year ended
September 30, 2000 compared to a tax provision of $1,475,000 for the year ended
September 30, 1999. Effective October 1, 1999, the Company restructured its
foreign operations. The result of the restructuring eliminated the foreign sales
corporation and established a new Luxembourg corporation, which will function as
the entity which services the Company's European customers. The Company's tax
provision for the year ended September 30, 2000 was based on this new structure.
As a result of losses attributed to domestic operations, the tax benefit derived
from
21
domestic losses offset the taxes due on income attributable to the European
operation.
As a result of the above, the Company incurred a net loss after taxes for
the year ended September 30, 2000 of $999,215, which resulted in a basic and
diluted loss per share of $0.11, on weighted average basic and diluted shares of
8,837,256, compared to net income after taxes of $3,117,628 for the year ended
September 30, 1999, which resulted in basic and diluted earnings per share of
$0.36 and $0.33 on weighted average shares, adjusted for the stock split, of
8,632,432 and 9,479,748, respectively. Options to purchase 1,610,226 and 95,000
shares of common stock were outstanding as of September 30, 2000 and 1999, but
were not included in the computation of diluted earnings per share because they
were anti-dilutive .
On February 10, 2000 the Company's Board of Directors authorized a two for
one stock split effected as a 100% common stock dividend. The stock split has
been reflected retroactively for all issued common stock.
Results of Operations
Years ended September 30, 1999 and 1998
Sales for the year ended September 30, 1999 were $58,601,611 compared to
$38,757,443 for the year ended September 30, 1998, resulting in an increase of
$19,844,168 or 51%, comprised of an increase in domestic sales of 44% and an
increase in international sales of 54%. The primary forces driving the sales
growth were:
- The full year effect of the increase in the
Company's domestic distribution and retail channel to
approximately 3,000 locations.
- Increased European sales due to the Company's
expansion into new geographic markets combined with increased
sales to the Company's existing European customers.
- Growth in sales to direct corporate customers.
Unit sales for the year ended September 30, 1999 increased 62% to
approximately 670,000 as compared to approximately 413,000 for the prior year.
Domestic sales were 27% of net sales for the current year compared to 28% for
the prior year. International sales were 73% of net sales for the current year
compared to 72% for the prior year.
Gross profit increased to $16,166,999 from $10,113,600, an increase of
$6,053,399 or 60% over the prior year. The gross profit percentage was 27.6% for
the year ended September 30, 1999 compared to 26.1% for the year ended September
30, 1998.
The increase in gross profit was primarily due to:
- Shifting the majority of the Company's production to
subcontractors in Scotland and Malaysia, resulting in a
reduction of import duties and lower unit manufacturing costs.
- A reduction in material, labor and other subcontractor
production costs due to the benefits of increased production
volume, which resulted in improved material prices and
allocation of fixed production overhead spread over a larger
volume of boards.
22
The chart below illustrates the components of selling, general and
administrative expenses:
Twelve months ended September 30,
Dollar Costs Percentage of Sales
Increase/
1999 1998 Increase 1999 1998 (Decrease)
---- ---- -------- ---- ---- ----------
Sales & Promotional $ 6,073,732 $4,603,989 $1,469,743 10.4% 11.9% (1.5%)
Customer Support 447,860 301,860 146,000 .8% .8% -
Product Handling 592,494 449,999 142,495 1.0% 1.2% (.2%)
General & Admin 3,343,627 1,887,970 1,455,657 5.7% 4.9% .8%
--------- --------- --------- --- --- --
Total $10,457,713 $7,243,818 $3,213,895 17.9% 18.8% (.9%)
As a percentage of sales, selling, general and administrative expenses for
the year ended September 30, 1999 declined by .9% when compared to the prior
year. Sales and promotional expenses and product handling expenses declined 1.5%
and .2% respectively. General and Administrative expenses increased by .8%.
Represented in dollars, selling, general and administrative expenses increased
$3,213,895 compared to the prior year.
The increase in sales and promotional expenses of $1,469,743 was primarily due
to:
- Increase in marketing and promotional programs to support
product visibility at a greater number of retail locations.
- Higher commissions resulting from the 51% net sales increase.
- The opening of sales offices in the United Kingdom and France.
- Additional marketing personnel required to handle expanded
market locations.
Customer support and product handling expenses increased $146,000 and
$142,495 respectively. Customer support costs increased due to the additional
staff required to maintain a high level of customer service to support the
Company's expanding domestic and international customer base. Increased product
handling costs was a function of greater shipment volume to customers.
The increase in general and administrative costs of $1,455,657 was primarily due
to:
- Contractual wage increases for senior executives.
- Retaining professional services for public relations and
investment banking advice.
- Fees for legal and accounting services, primarily for tax
consultation, patent issues and acquisition advice.
- Larger incentive bonus accruals based on increased
profitability.
- Increased bad debt expense, due primarily to a
customer filing for bankruptcy.
Research and development expenses increased $448,448 or approximately 56%.
The increase was due to the initiation and completion of several projects in
fiscal 1999 which led to the introduction of several new products in the USB and
digital video areas.
23
The Company had net other income for the twelve months ended September 30,
1999 of $139,878 compared to net other income for the prior year of $420,796.
The decrease in net other income was primarily due to lower returns on monies
invested throughout the year and foreign currency exchange losses due to the
decline of the Euro.
Provision for income taxes was $1,475,000, or an effective tax rate of 32%
for the year ended September 30, 1999 compared to $523,937 or an effective tax
rate of 21% for the year ended September 30, 1998. The net effective rate for
fiscal 1999 and 1998 was reduced by a reduction in the deferred tax valuation
allowance of $127,000 and $503,131, recorded during the fourth quarters of
fiscal 1999 and 1998, respectively. The reduction lowered the effective rate tax
rate from 35% to 32% in fiscal 1999 and 41% to 21% in fiscal 1998, respectively.
The reduction in the effective tax rate, before the reduction of the
deferred tax valuation allowance, for 1999 to 35% from 41% for 1998, was due to
the tax benefits derived primarily from the allocation of income to a foreign
sales corporation.
As a result of the above, the Company recorded net income after taxes for
the year ended September 30, 1999 of $3,117,628, or an increase of 59%, when
compared to $1,958,553 for the year ended September 30, 1998. Earnings per
share, on a basic and diluted basis were, $0.36 and $0.33, respectively, for
1999, on weighted average basic and diluted shares outstanding adjusted for the
March 27, 2000 stock split of 8,632,432 and 9,479,748, respectively. Earnings
per share, on a basic and diluted basis for 1998 were $0.22 and $0.21,
respectively for 1998 on weighed average basic and diluted shares outstanding
adjusted for the stock split of 8,806,711 and 9,353,494, respectively.
Seasonality
Since the Company sells primarily to the consumer market, the Company has
experienced certain revenue trends. The sales of the Company's products, which
are primarily sold through distributors and retailers, have historically
recorded stronger sales results during the Company's first fiscal quarter
(October to December), which due to the holiday season, is a strong quarter for
computer equipment sales. In addition, the Company's international sales, mostly
in the European market, were 71%, 73 % and 72% of sales for the years ended
September 30, 2000, 1999 and 1998, respectively. Due to this, the Company's
sales for its fourth fiscal quarter (July to September) can be potentially
impacted by the reduction of activity experienced with Europe during the July
and August summer holiday period.
To offset the above cycles, the Company continues to target a wide a range
of customer types in order to moderate the seasonality of retail sales.
24
Liquidity and Capital Resources
The Company's cash, working capital and stockholders' equity position is
disclosed below:
As of September 30,
2000 1999 1998
------- ---- ----
Cash $ 2,744,855 $ 6,122,922 $ 6,281,852
Working Capital 11,766,900 12,533,310 9,536,450
Stockholders' Equity 13,653,677 13,322,091 10,036,898
The significant items of cash provided by and cash (consumed ) for the fiscal
year ended September 30, 2000 are detailed below:
Net income (loss) (adjusted for non cash items) $ (643,308)
Changes to deferred tax assets (790,723)
Tax benefit related to options exercised by employees 883,000
Changes in investment for current assets 1,389,408
Income taxes receivable (1,496,045)
Decrease in current liabilities-net (2,744,297)
Acquisition of Eskape Labs (899,587)
Purchase of Property, Plant & Equipment (449,304)
Proceeds from exercise of options 387,798
Proceeds from loan 1,000,000
Other (15,009)
------------
Net Cash Consumed $(3,378,067)
Net cash of $ 3,416,974 consumed by operating activities was primarily due
to net cash required to fund the net loss (adjusted for non cash items) of $
643,308, a net increase in the deferred tax asset of $790,723, cash required to
funded the net decrease in current liabilities of $ 2,744,297, an increase in
other assets of $15,009 and an increase in income taxes receivable of $
1,496,045 offset partially by a net decrease in current assets of $ 1,389,408
and the tax benefit derived from the exercise of options by employees.
Cash of $449,304 was used to purchase fixed assets. The exercise of
employee options provided additional cash of $387,798.
On June 1, 2000 the Company acquired certain assets of Eskape Labs Inc.
("Eskape"), a California based company specializing in designing and
manufacturing TV and video products for Apple Macintosh computers. The purchased
assets expand and complement the Company's product line into the Macintosh
market. The cash price for the acquisition, which was accounted for under the
purchase method, was approximately $899,587, which includes legal and accounting
acquisition costs. In addition to the price paid for the acquired assets, the
purchase agreement also calls for contingent additional consideration. See "Note
10" to "Consolidated Financial Statements."
25
On July 12, 2000 the Company signed an agreement with Chase Manhattan Bank,
who will provide the Company with a $6,500,000 credit facility. The facility
allows the Company, at its option, to borrow at prime rate, which was 9.50% at
September 30, 2000 or 1.25% above the London Interbank Offered Rate. The
facility is secured by the assets of the Company, and expires on March 31, 2001.
As of September 30, 2000, the Company had $1 million in borrowings from this
line of credit outstanding.
On November 8, 1996, the Company approved a stock repurchase program for
the repurchase of up to 600,000 shares of its own stock. The Company will use
the repurchased shares for certain employee benefit programs. On December 17,
1997, the stock repurchase program was extended by a resolution of the Board of
Directors. As of September 30, 2000, the Company held 429,602 treasury shares
for $1,334,064 at an average purchase price of approximately $3.11 per share.
The Company believes that its current cash position, its bank line of credit and
its internally generated cash flow will be sufficient to satisfy the Company's
anticipated operating needs for at least the ensuing twelve months.
Inflation
While inflation has not had a material effect on the Company's operations
in the past, there can be no assurance that the Company will be able to continue
to offset the effects of inflation on the costs of its products or services
through price increases to its customers without experiencing a reduction in the
demand for its products; or that inflation will not have an overall effect on
the computer equipment market that would have a material affect on the Company.
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.
Prior to the adoption of the Euro, the Company billed its European
customers in German Marks or British Pounds, depending upon which currency the
customer preferred to be billed in. Effective January 1, 1999, the Company began
invoicing its customers, located in the eleven member countries, in Euros. The
Company continued to bill customers location in the United Kingdom in British
Pounds. The benefits to the Company were twofold:
- The Company's 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.
The conversion to the Euro was handled by the Company without any material
disruptions to the Company's operations. See Item 7A -- Market Risks .
26
Effect of New Accounting Pronouncements
Investment Derivatives and Hedging Activities
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
("SFAS 133"), Accounting for Derivative Investments and Hedging Activities
Income. SFAS 133 is effective for transactions entered into by the Company after
October 15, 2000. SFAS 133 requires that all derivative instruments be recorded
on the balance sheet at fair value. Changes in the fair value of the derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designed as part of the hedge transaction
and the type of hedge transaction. The ineffective portion of all hedges will be
recognized in earnings. The effect of implementing SFAS 133 will be presented in
the Company's 10Q for the quarter ended December 31, 2000 as a cumulative effect
of a change in accounting principle. At September 30, 2000, the Company's
unrecognized gain or ineffective portion of $319,000 will be reported in income,
the effective portion will be reported as a component of accumulated
comprehensive income and the fair value of the $11,310,000 in Euro forward
contracts in current assets and current liabilities, respectively.
Revenue Recognition
During December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB No. 101), "Revenue Recognition in Financial
Statements." SAB No. 101 is effective for fiscal years beginning after December
15, 1999. The adoption of this bulletin is not expected to have an effect on the
consolidated financial statements.
Risks Factors
If TV technology for the PC or the Company's implementation of this technology
is not accepted, the Company will not be able to sustain or expand its business.
The Company's future success depends on the growing use and acceptance of
TV and video applications for PCs. The market for these applications is still
evolving, and may not develop to the extent necessary to enable the Company to
expand its business. The Company has invested and expects to continue to invest
significant time and resources in the development of new products for this
market. The Company's dependence on sales of TV and video products for the PC,
its lack of market diversification, the lack of development of the market for
the Company's products, and the development of competing technology could each
have a material adverse effect on the Company's business, operating results and
financial condition .
The Company relies upon sales of a small number of product lines, and the
failure of any one product lines to be successful in the market could
substantially reduce its sales.
The Company currently relies upon sales from two product lines, its
Internal PCI-based WinTV Boards and External WinTV Products, to generate a
majority of its sales. The Company is developing additional products within
these and its other product lines, but there can be no assurance that it will be
successful in doing so. Consequently, if the existing or future products are not
successful, sales could decline substantially, which would have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company relies heavily on dealers and OEMs to market, sell and distribute
its products. In turn, it depends heavily on the success of these resellers. If
these resellers do not succeed in effectively distributing the Company's
products, its sales could be reduced.
27
These resellers may not effectively promote or market the Company's
products or they may experience financial difficulties and even close
operations. These dealers and retailers are not contractually obligated to sell
the products. Therefore, they may, at any time:
- Refuse to promote the products; and
- Discontinue the products in favor of a competitor's product.
Also, with this distribution channel standing between the Company and the
actual market, the Company may not be able to accurately gauge current demand
for products and anticipate demand for its products. For example, dealers may
place large initial orders for a new product just to keep their stores stocked
with the newest products and not because there is a significant demand for them.
The Company's distribution network includes several consumer channels,
including large distributors of products to computer software and hardware
retailers, which in turn sell products to end users. It also sells its consumer
products directly to certain retailers. Rapid change and financial difficulties
of distributors have characterized distribution channels for consumer retail
products. These arrangements have exposed the Company to the following risks,
among others:
- The Company may be obligated to provide price protection to
certain retailers and distributors and, while certain
agreements limit the conditions under which product can be
returned, the Company may be faced with product returns or
price protection obligations;
- The distributors or retailers may not continue to stock and
sell the Company's products; and
- Retailers and retail distributors often carry competing
products.
If these resellers do not succeed in effectively distributing the Company's
products, it could have a material adverse effect on the Company's business,
operating results and financial condition.
The Company operates in a highly competitive market, and many of its competitors
have much greater resources, which may make it unable to remain competitive.
The Company's business is subject to significant competition. Competition
exists from larger companies that possess substantially greater technical,
financial, sales and marketing resources than that which the Company has. The
dynamics of competition in this market involve short product life cycles,
declining selling prices, evolving industry standards and frequent new product
introductions. The Company competes in this emerging market against companies
such as ATI Technologies, Inc., 3dfx Interactive Inc. and Pinnacle Systems,
Inc., among others. The Company believes that competition from new entrants will
increase as the market for digital video in a PC expands. There can be no
assurances that the Company will not experience increased competition in the
future. Such increased competition may have a material adverse affect on the
Company's ability to successfully market its products. Competition is expected
to remain intense and, as a result, the Company may lose some of its business to
its competitors. Further, the Company believes that the market for its products
will continue to be price competitive and thus it could continue to experience
lower selling prices, lower gross profit margins and reduced profitability
levels for such products than in the past.
28
Rapid technological changes and short product life cycles in the Company's
industry could harm its business.
The technology underlying the Company's products and other products in the
computer industry, in general, is subject to rapid change, including the
potential introduction of new types of products and technologies, which may have
a material adverse impact upon the Company's business. The Company will need to
maintain an ongoing research and development program, and the Company's success,
of which there can be no assurances, will depend in part on its ability to
respond quickly to technological advances by developing and introducing new
products, successfully incorporating such advances in existing products, and
obtaining licenses, patents, or other proprietary technologies to be used in
connection with new or existing products. The Company continues to increase it
research and development expenditures. The Company expended approximately
$1,666,000, $1,257,000 and $808,000 for research and development expenses for
the years ended September 30, 2000, 1999 and 1998. There can be no assurance
that the Company's research and development will be successful or that the
Company will be able to foresee and respond to such advances in technological
developments and to successfully develop other products. Additionally, there can
be no assurances that the development of technologies and products by
competitors will not render the Company's products or technologies
non-competitive or obsolete. See Item 7 Management's Discussion and Analysis-
Risks and Forward Looking Statements.
If TV or video capabilities are included in PCs, it could result in a
reduction in the demand for add-on TV and video devices. In addition, the
Company believes its WinTV software is a competitive strength. However, as
operating systems such as Windows move to integrate and standardize software
support for video capabilities, the Company will be challenged to further
differentiate its products. The Company's operating results and ability to
retain its market share are also dependent on continued growth in the underlying
markets for PC TV and video products.
The Company may not be able to timely adopt emerging industry standards, which
may make its products unacceptable to potential customers, delay its product
introductions or increase its costs.
The Company's products must comply with a number of current industry
standards and practices established by various international bodies. Failure to
comply with evolving standards, including video compression standards, TV
transmission standards, and PC interface standards, will limit acceptance of its
products by the market. If new standards are adopted in the industry, the
Company may be required to adopt those standards in its products. It may take a
significant amount of time to develop and design products incorporating these
new standards, and the Company may not succeed in doing so. It may also become
dependent upon products developed by third parties and have to pay royalty fees,
which may be substantial, to the developers of the technology that constitutes
the newly adopted standards.
The Company is heavily dependent upon foreign markets for sales of its products,
primarily the European and Asian markets, and adverse changes in these markets
could reduce its sales.
The Company's future performance will likely be dependent, in large part,
on its ability to continue to compete successfully in the European and Asian
markets, where a large portion of its current and potential customers are
located. Its ability to compete in these markets will depend on many factors,
including:
29
- the economic conditions in these regions;
- the stability of the political environment in these regions;
- adverse changes in the relationships between major countries in
these regions;
- the state of trade relations among these regions and the
United States;
- restrictions on trade in these regions;
- the imposition or changing of tariffs by the countries in these
regions on products of the type that the Company sells;
- changes in the regulatory environment in these regions;
- export restrictions and export license requirements;
- restrictions on the export of critical technology;
- the Company's ability to develop PC TV products that meet the varied
technical requirements of customers in each of these regions;
- its ability to maintain satisfactory relationships with its foreign
customers and distributors; o changes in freight rates;
- its ability to enforce agreements and other rights in the countries
in these regions;
- difficulties in staffing and managing international operations;
- difficulties assessing new and existing international markets and
credit risks; and
- potential insolvency of international customers and difficulty in
collecting accounts.
If the Company is unable to address any of these factors, it could have a
material adverse effect on the Company's business, financial operating results
and financial condition.
The Company is heavily dependent upon foreign manufacturing facilities for its
products, primarily facilities in Europe and Asia, which exposes it to
additional risks.
The Company has a majority of its product built at contract manufacturing
facilities in Europe and Asia. Its ability to do this successfully will depend
on several factors, including:
- the economic conditions in these regions;
- the stability of the political environment in these regions;
- adverse changes in the relationships between major countries in
these regions;
- the state of trade relations among these regions and the
United States;
- restrictions on trade in these regions;
- the imposition or changing of tariffs by the countries in these
regions on products of the type that the Company sells;
- changes in the regulatory environment in these regions;
- import restrictions and import license requirements;
- its ability to maintain satisfactory relationships with its foreign
manufacturers;
- changes in freight rates;
- difficulties in staffing and managing international operations; and
- potential insolvency of vendors and difficulty in obtaining
materials.
If the Company is unable to address any of these factors, it could have a
material adverse effect on the Company's business, financial operating results
and financial condition.
30
Foreign currency exchange fluctuations could adversely affect the Company's
results.
Due to extensive sales to European customers denominated in local
currencies, the Company is a net receiver of currencies other than the U.S.
dollar and as such benefits from a weak dollar and is adversely affected by a
strong dollar relative to the major worldwide currencies, especially the Euro
and British Pound Sterling. Consequently, changes in exchange rates expose the
Company to market risks resulting from the fluctuations in the foreign currency
exchange rates to the U.S. dollar. The Company attempts to reduce these risks by
entering into foreign exchange forward contracts with financial institutions to
protect against currency exchange risks associated with its foreign denominated
accounts receivable.
The strength or weakness of the U.S. dollar against the value of the Euro
and British Pound Sterling impact the Company's financial results. Changes in
exchange rates may positively or negatively affect the Company's revenues, gross
margins, operating income and retained earnings (which are expressed in U.S.
dollars). Where it deems prudent, the Company engages in hedging programs aimed
at limiting, in part, the impact of currency fluctuations. Primarily selling
foreign currencies through forward window contracts, the Company attempts to
hedge its foreign sales against currency fluctuations.
As of September 30, 2000, the Company has foreign currency forward
contracts outstanding of approximately $11.3 million for the Euro. The contracts
expire through December 2000. As of September 30, 2000, the Company had
unrecognized gains from foreign currency forward contracts of $319,000.
These hedging activities provide only limited protection against currency
exchange risks. Factors that could impact the effectiveness of the Company's
programs include volatility of the currency markets and availability of hedging
instruments. The contracts the Company procures are specifically entered into to
as a hedge against existing or anticipated exposure. The Company does not enter
into contracts for speculative purposes. Although the Company maintains these
programs to reduce the impact of changes in currency exchange rates, when the
U.S. dollar sustains a strengthening position against the currencies in which
the Company sells it products, the Company's revenues can be adversely affected.
However, it is not possible to completely protect the Company from the
risks of foreign currency exchange fluctuations, and there can be no assurances
that the measures it takes will be successful nor sufficient.
Additionally, there is the risk that foreign exchange fluctuations will
make the Company's products less competitive in foreign markets, which would
substantially reduce its sales.
The Company may be unable to develop new products that meet customer
requirements in a timely manner.
The Company's success is dependent on its ability to continue to introduce
new products with advanced features, functionality and performance that its
customers demand. The Company may not be able to introduce new products on a
timely basis, that are accepted by the market, and that sell in quantities
sufficient to make the products viable for the long-term. Sales of new products
may negatively impact sales of existing products. In addition, the Company may
have difficulty establishing its products' presence in markets where it does not
currently have significant brand recognition.
31
The Company may experience declining margins.
The Company may experience declining gross margins due to the following
factors, among others:
- Changes in foreign currency exchange rates;
- Larger sales mix of lower margin products;
- Possible future reserves for excess inventory;
- Increases in material acquisition costs; and
- Differing gross margins in different markets.
Consequently, as margins may decline, the Company's profitability will be more
dependent upon effective cost and management controls. There can be no
assurances that such cost and management controls can be implemented and
maintained, and if implemented, that they will be successful. See "Item 7.
Managements' Discussion and Analysis of Financial Condition and Results of
Operations."
The Company has experienced, and expects to continue to experience, intense
downward pricing pressure on its products, which could substantially impair its
operating performance.
The Company is experiencing, and is likely to continue to experience,
downward pricing pressure on its products. As a result, it has experienced, and
expects to continue to experience, declining average sales prices for its
products. Increases in the number of units that the Company is able to sell or
reductions in per unit costs may not be sufficient to offset reductions in per
unit sales prices, in which case its net income could be reduced or it could
incur losses. Since the Company must typically negotiate supply arrangements far
in advance of delivery dates, it may need to commit to price reductions for its
products before it is aware of how, or if, these cost reductions can be
obtained. As a result, any current or future price reduction commitments and any
inability of the Company to respond to increased price competition could result
in substantially reduced revenues and significant losses.
The Company is dependent upon contract manufacturers for its production. If
these manufacturers do not meet the Company's demand, either in volume or
quality, then it could be materially harmed.
The Company designs the WinTV products and also writes the operating
software to be used in conjunction with many versions of the popular
Microsoft(R) Windows(R) operating system, including Windows98, WindowsMe,
WindowsNT and Windows 2000. The Company subcontracts the manufacturing and
assembly of the WinTV Boards to independent third parties at facilities in
various countries. The Company monitors the quality of the completed product at
its facilities in New York, Singapore, and Ireland before packaging the product
and shipping it to customers.
Manufacturing is performed by a select group of contract manufacturers.
Product design specifications are provided to insure proper assembly. Contract
manufacturing is either done on a consignment basis, in which the Company
provides all the component parts and pays an assembly charge for each board
produced, or on a turnkey basis, in which components and labor are provided by
the contract manufacturer, and the manufacturing price the Company is charged
includes parts and assembly costs. The Company continuously monitors the quality
of its selected manufacturers. The Company has qualified five contract
manufacturers and utilizes three. These three contract manufacturers are
presently being utilized to handle the majority of production. If demand were
32
to increase dramatically, the Company believes additional production could be
absorbed by these and other contract manufacturers.
The Company produces product for the majority of its European sales through
a subcontractor in Hungary. The packaging and shipping of the product to
customers is being performed at the Company's Ireland location. By shifting its
European production to Europe, the Company anticipates savings on production
costs and shipping costs of the Boards, in addition to the elimination of duties
charged on Boards entering Europe from the United States, however, no such
assurances can be given. A subcontractor in Malaysia produces product for
domestic, European and Asian markets.
Relying on subcontractors involves a number of significant risks,
including:
- loss of control over the manufacturing process;
- potential absence of adequate production capacity;
- potential delays in production lead times;
- unavailability of certain process technologies;
- reduced control over delivery schedules, manufacturing
yields, quality and costs; and
- unexpected increases in component costs.
The Company may need to hold more inventory than is immediately required to
compensate for potential manufacturing disruptions. This could lead to an
increase in the costs of manufacturing or assembling its products.
If any significant subcontractor becomes unable or unwilling to continue to
manufacture these products in required volumes, the Company will have to
identify qualified alternate subcontractors. Additional qualified subcontractors
may not be available, or may not be available on a timely basis. Any
interruption in the supply of or increase in the cost of the products
manufactured by third party subcontractors could have a material adverse effect
on the Company's business, operating results and financial condition.
The Company is dependent upon single or limited source suppliers for its
components. If these suppliers do not meet the Company's demand, either in
volume or quality, then it could be materially harmed.
Although certain components essential to the Company's business are
generally available from multiple sources, other key components (including, but
not limited to, TV tuners, video decoder chips and application-specific
integrated circuits (ASICs)) are currently obtained by the Company from single
or limited sources; in addition, these and other key components (including,
without limitation, DRAM), while currently available to the Company from
multiple sources, are at times subject to industry wide availability and pricing
pressures. Any availability limitations, interruption in supplies, or price
increases relative to these and other components could have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, new products introduced by the Company often initially utilize custom
components obtained from only one source until the Company has evaluated whether
there is a need for and subsequently qualifies additional suppliers. In
situations where a component or product utilizes new technologies, initial
capacity constraints may exist until such time as the suppliers' yields have
matured. Components are normally acquired through purchase orders, as is common
in the industry, typically covering the Company's requirements for periods from
60 to 120 days. However, the Company continues to evaluate the need for a supply
contract in each situation.
33
If the supply of a key component to the Company were to be delayed or
curtailed or in the event a key manufacturing vendor delays shipment of
completed products to the Company, the Company's ability to ship products in
desired quantities and in a timely manner could be adversely affected. The
Company's business and financial performance could also be adversely affected,
depending on the time required to obtain s