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, 2002
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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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(Exact name of registrant as specified 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: $42,796,726
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of December 19, 2002 was approximately $7,361,431. 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, 2002 which was $1.15 per share as reported by
NASDAQ.
As of December 11, 2002, the number of shares of Common Stock outstanding was
8,854,758 (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 our Proxy Statement to be filed within 120
days of September 30, 2002 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 our actual results, performance or achievements,
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 including the terms "believes," "belief,"
"expects," "plans," "anticipates," "feel", 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
All references herein to "us", "we" or "the Company" include Hauppauge Digital,
Inc., our wholly-owned subsidiaries and their subsidiaries, unless otherwise
indicated or the context otherwise requires.
We engineer, develop, subcontract for manufacture, market and sell products for
the personal computer ("PC") market and the Apple(R) Macintosh(R) market. We
have three primary product lines, which are sold under the WinTV(R) name: analog
TV receivers, digital TV receivers and personal video recorders.
Our analog TV receiver product line allows PC users to watch cable TV on their
PC screen in a resizable window. Our WinTV digital TV receivers can receive
digital TV transmissions and display the digital TV show
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in a window on the user's PC screen. Our PC-based personal video recording
("PVR") products allow PC users to watch and record TV shows with instant replay
and program pause functions, and to burn their TV recordings onto CD or DVD
media.
We believe the most compelling reason for using our products is to watch TV
shows while performing other tasks on a PC. For example, stockbrokers may watch
a financial TV program in a small window on their PC monitor while viewing stock
quotes or accessing customer accounts. With a single click of the mouse, the TV
program window may be enlarged for full screen viewing. The home user, while
surfing the Internet, doing school work, composing E-mails, or performing any
multitude of other PC activities, may simultaneously watch music videos with our
WinTV(R) products. In addition, our WinTV(R) products can also receive certain
data that may be transmitted along with the TV signal, called "Data
Broadcasting".
In fiscal 2002, we shipped our 3.5 millionth WinTV(R) product.
We sell our products through computer and electronic retailers, computer
products distributors and original equipment manufacturers ("OEMs"). Computer
and electronics retailers sell our products to end users for use with their PCs
or Apple(R) Macintosh(R) computers. Distributors typically sell our products to
smaller retail chains and retail stores, through catalogs and to value added
resellers ("VAR"). OEMs typically bundle our products in their own products for
sale to end users.
Our Strategy
Since our entry into the PC video market in 1991, management believes that we
have become the world leader in bringing TV content to PCs by focusing on four
primary strategic fronts:
o innovating and diversifying our products
o introducing new and desirable features in our products
o expanding our worldwide sales and distribution channels
o forging strategic relationships with key industry players
As more people are looking to their PCs for a total entertainment experience, we
believe that our products will enhance the capabilities of the multimedia PC to
become a one-stop complete integrated entertainment system. We feel our current
and future products have the potential to be the most ubiquitous feature in the
PC based home entertainment network.
Our current product line includes a wide range of analog, digital and PVR
products covering multiple price points. In addition, different versions of our
products incorporate the unique requirements of various national and regional TV
standards and the various methods of receiving TV transmissions. Many of our
products also allow users to enjoy:
o personal video teleconferencing
o creating and editing video for the internet and videography
o FM radio
o an overall user friendly software architecture
o digital TV programs on an existing analog TV set
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Our engineering group is continually working on updating our current models to
add new and innovative features that the marketplace seeks while remaining
vigilant in keeping our products compatible with new operating systems. This
work is done in addition to our research and development efforts in designing,
planning and building new products.
We believe that strategic relationships with key suppliers, OEMs, broadcasters,
internet and e-commerce solutions providers give us important advantages in
developing new technologies and marketing our products. By jointly working and
sharing our engineering expertise with a variety of other companies, we are able
to leverage our investment in research and development and minimize time to
market.
Our international sales and marketing team cultivates a variety of distribution
channels comprising retail stores, distributors, resellers, OEMs, web stores and
third-party catalogs. We work closely with our retailers to enhance sales
through joint advertising campaigns and promotions. We believe that rapidly
developing and growing our international presence give us an important strategic
position and allows us to benefit many times over from investments in product
development, and more firmly establishes the WinTV(R) brand name in the
international marketplace.
We seek to maintain and improve our profit margins by, among other things,
outsourcing our production to contract manufacturers best suited for the type
and volume of our needs. We also leverage worldwide supplier relationships to
assist us in receiving competitive prices for the component parts we buy. We
believe this two-tiered approach allows us to be the lowest cost / highest
quality producer in our marketplace. Successfully engineering products to have
low production costs, commonality of parts and the use of one platform for
multiple models are other important ways that we believe our technology
leadership contributes to the bottom line.
Products
WinTV(R) Products
Our analog, digital and PVR WinTV(R) products enable a PC user to watch TV in a
resizable window on a PC. Our software 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(R) board, in the external WinTV(R)-USB, or in the
operating software. Our products 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. We also have a line of products that allows you to capture and
edit video.
Our WinTV(R) products fall into the following categories:
o Analog TV Receivers
o Digital TV Receivers
o Personal Video Recording products for PCs
These products are either internally plugged into one of the computer's unused
expansion slots on the motherboard (internal boards) or attached to the computer
externally through the USB port. We further tailor our products to the various
international standards for video transmission including, NTSC, PAL I, PAL B/G
and Secam.
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1. Analog TV Receiver Products
Our analog products include a 125 channel cable ready TV tuner with automatic
channel scan and a video digitizer which allows the user to capture still and
motion video images. Some of our analog products allow the user to listen to FM
radio, video-conference over the internet, enjoy the benefits of stereo surround
sound with Dolby(TM)-Pro Logic and control these functions with a handheld
remote control. In Europe, our WinTV(R) products can be used to receive teletext
data broadcasts, which allows the reception of digital data that is transmitted
along with the "live" TV signal.
The WinTV(R)-GO is our low-cost, single slot internal board. Apart from allowing
users to watch TV on their PC, it enables users to snap still and motion video
images and videoconference over the internet with the addition of a camera or
camcorder. Step up models from the WinTV(R)-GO add features such as FM radio and
a remote control.
Our premium analog product is the WinTV(R)-Theater. In addition to allowing
users to watch TV on their PC, the Theater board allows users to enjoy
Dolby(TM)-Pro Logic surround sound over up to 5 speakers plus Virtual Dolby(TM)
surround sound, listen to FM stereo and snap still and motion video images and
videoconference over the internet. Included with the board is a remote control
for both TV and FM stereo.
Some WinTV(R) analog products are available as external devices which connect to
the PC through the USB port. The board included in the USB models is encased in
an attractive plastic shell making USB models freely portable from PC to PC and
from one laptop or notebook computer to another.
2. Digital TV Receiver Products
Destination Digital TV, a publication of the National Association of
Broadcasters, recently reported in its October 2002 and November 2002 issues
(http://www.nab.org/newsroom/issues/digitaltv/DDTV/) that a survey conducted by
the National Association of Broadcasters amongst stations found that 62% of US
television households are now in markets where local broadcasters are delivering
5 or more digital TV signals with 601 digital TV stations on air in 615 markets
that include 94% of television households. In the past year, 386 stations went
digital. In addition to the digital signal broadcast by the local stations, the
major networks are committed to providing more high-definition TV ("HDTV")
programming in the near future. HDTV programming increased 50% within the last
year and there are 2,000 hours of prime-time shows, sporting events and movies
scheduled to be broadcasted in HDTV in the current 2002 - 2003 season.
We have foreseen this trend and currently offer both digital and High Definition
Digital TV products ("HDTV Receiver Products"), which fully exploit their
super-crisp images, superior sound and several other benefits.
Digital TV Receivers for the U.S. and North America
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Our internal WinTV(R)-D board allows users to watch digital TV or cable TV in a
re-sizeable window on their PC. It receives all 18 U.S. digital TV formats and
includes a super video ("S-Video") output to watch digital TV on a large screen
TV set, a 5-channel Dolby(TM) Digital surround sound (AC3) decoder and a remote
control. The WinTV(R)-D can also receive analog TV from cable TV or a TV
antenna.
Our WinTV(R)-HD has similar features of the WinTV(R)-D except that it provides
the user with video in a high definition format. This product enables users to
experience high definition TV viewing quality without purchasing a costly high
definition TV. The WinTV-HD can display high definition television on a computer
monitor or a plasma or other high definition TV monitor.
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Digital TV Receivers for the International Market
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Our WinTV(R)-DVB-s is designed for receiving, decoding and displaying digital
satellite broadcasts on a PC. Used with a modem, it can facilitate connection to
a satellite ISP (Internet Service Provider) to obtain high speed internet
access. Our WinTV(R)-DVB-s product can receive free channels without the need
for any specialized additional equipment. However, to receive 'subscriber' or
'pay per view' channels, an optional common interface module that we sell is
required together with a decryption card that is available for a fee from the
provider of these channels. By contrast, the WinTV(R)-DVB-t has all the features
of the WinTV(R)-DVB-s except that it receives its signal from a terrestrial
source. These products are very popular in Europe and are available in the form
of external devices or internal boards. In fiscal 2002, we began shipping
internationally our WinTV(R)-Nova-CI, a lower cost European satellite receiver
and the common interface module which enables pay TV channels to be received and
decoded.
3. Personal Video Recorder Products for PCs
Our WinTV(R)-PVR products include all of the features of our analog products and
contain both an internal and external TV receiver which adds the ability to
record TV shows or any video to a PC's hard disk. The recording uses a high
quality hardware MPEG 2 encoding built onto the WinTV(R)-PVR device. This
technology allows a typical desktop computer system, to record tens to hundreds
of hours of video.
The WinTV(R)-PVR user can record a TV show to the hard disk using a TV
scheduler, and then play it back, and also edit and record it onto CD-ROM or
DVD-ROM using a CD or DVD writer for playback on a home DVD player or on a PC.
The user can re-size the window either during viewing, recording or playback.
Our WinTV(R)-PVR products also provides for instant replay and is available in
both an internal and external USB models.
In fiscal 2002, we introduced several new PVR models with new price points and
feature sets. The WinTV(R)-PVR-250 provides better quality video and audio at a
lower price point and the WinTV(R)-PVR-350 adds a video-out feature to allow the
recorded content to be played back directly to a TV or video cassette recorder.
An added feature to the WinTV(R)-PVR-250 is that it supports the Windows(R) XP
Media Center Edition. The Windows(R) XP Media Center Edition integrates digital
entertainment experiences including "live" television, PVR, digital music,
digital video, DVDs and pictures. Users can pause, jump forward or watch their
"live" TV, record a program or a whole series, and manage all their digital
music, home movies, videos, photos and DVDs. Users can also access and control
this new entertainment device from anywhere in the room with a large,
easy-to-use-on-screen menus and the Media Center Remote Control.
The WinTV(R)-PVR-250's high-quality hardware MPEG encoder enables Windows(R) XP
Media Center Edition to record TV shows to the PC's hard disk. At the best
quality setting, about one hour of television can be recorded in 2 Gigabytes of
disk space. Windows(R) XP Media Center Edition includes an Electronic Program
Guide so that users can schedule their TV recording automatically with the
WinTV(R)-PVR-250.
Video Capture Products
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Our primary video capture product, the DV-Wizard Pro, allows users to capture
and edit digital videos on their PC. This product also allows users to connect
their digital camcorder to their PC through a firewire connection, convert
digital movies into compressed form thus saving hard disk space, edit digital
movies, add voice narrations and music, record their digital movies onto a
CD-ROM and play them back on a home DVD player or on a PC and output edited
videos back to their camcorder.
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The DV-Wizard Pro was designed to edit and 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.
Our 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(TM) video for Windows(TM)
compatible motion video capture driver.
Our USB Live is an easy way to watch video, grab images and video conference on
the PC with the addition of a camera. It plugs into the PC's USB port for easy
installation and brings video into users' PCs from their camcorder or VCR. Users
can create video movies, save still and motion video images onto their hard disk
with our software and video conference over the internet with the addition of a
camera.
Eskape(TM) Labs Product Line
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Our Eskape(TM) Labs product line is a leader in delivering high quality video
for the Apple(R) Macintosh(R). The video is sent to the PC through the USB port
and as such, there is no complicated installation process. This line is
available to all Apple(R) Macintosh(R) users from the on-the-go iBooks(TM) to
G4(TM) power users. All our products accept both analog and digital input and
are QuickTime(R) compatible. Our Eskape(TM) products are uniquely identified by
having the word "My" prominently displayed and included in the product name.
MyTV2GO and MyTV2GO-FM are the lower priced models of the "My" line. They allow
users to bring TV into their iMacs(TM), PowerBooks(TM) and G3(TM) and G4(TM)
Macintosh(R) models through USB ports. Our Eskape(TM) products also include a
125-channel cable ready TV tuner and the capability to "grab" picture files and
short movie files from the users' TV, video cassette recorder or camcorder and
save these files. The additional attraction of MyTV2GO-FM over the MyTV2GO is
that it allows users to listen to and record FM radio.
MyTV and MyTV-FM are similar to MyTV2GO and MyTV2Go-FM respectively except that
the MyTV2GO products include full-frame rate Motion JPEG video capture functions
for superior video compression, video quality and lip synchronization.
MyView gives iBook(TM) users the ability to make presentations directly from
their iBooks as MyView uses our new video mirroring concept and does not require
a VGA connection and a video port. MyView outputs video images in overscan or
underscan modes from the hard drive to composite and S-Video devices such as
video projectors, monitors and video cassette recorders.
MyCapture II allows users to capture video on their iMac(TM), iBook(TM),
PowerBook(TM)or G3(TM)/G4(TM) Macintosh(R) without opening their computer.
Unlike many other USB video solutions, MyCapture II delivers smooth, full frame
rate video capture. To achieve the highest quality video capture over USB,
MyCapture II utilizes the same state-of-the-art Motion JPEG hardware compression
of more expensive professional solutions. It supports NTSC and PAL video sources
from S-video and composite video connections. MyCapture II is ideal for
QuickTime(R)-enabled websites and for web publishers.
MyVideo essentially combines the features of MyCapture and MyView in one
convenient package. It allows full frame rate video capture and video playback
over USB. The video playback is compatible with both video cassette recorders
and video monitors.
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Digital Entertainment Center
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Our Digital Entertainment Center ("DEC") products, introduced during fiscal 2002
in Europe, are set top boxes that enable analog TV sets to receive digital
satellite and digital terrestrial broadcasts, thus enhancing a person's viewing
pleasure. An owner of an analog TV set can enjoy the benefits of digital
broadcasts, such as a greater choice of channels, clearer picture quality and
superior audio quality. The multi-purpose DEC set top box displays new digital
channels while continuing to allow a TV to display analog programs. DEC set top
boxes have the ability to receive, decode and display wide screen broadcasts,
and can re-format the wide screen broadcast to fit older analog TV models.
Digital radio, interactive television services and digital teletext are other
features that the DEC set top boxes deliver. We hope to develop future product
generations that could enable a user to connect to a PC or Notebook computer and
record digital TV programs to the computer's hard drive, permitting the user to
record and later playback the recorded video in full digital quality on the
user's TV screen or computer monitor.
Product Distribution
The WinTV(R) products sold through the computer retail market are essentially
the same as those available to the OEM market. The differences are in the
packaging and in the sophistication of the operating software. Our WinTV(R)
boards and DEC set top boxes are primarily sold to the retail market and to
OEMs. DV Wizard Pro is sold primarily in the retail market, and our video
capture boards are primarily sold in the OEM market. Our Eskape(TM) Labs
products are sold primarily through catalogs.
Technology
Hauppauge Digital has developed five generations of WinTV(R) products since
their initial introduction in 1991. The first generation of WinTV(R) products
put the TV image on the PC screen using chroma keying, requiring a dedicated
"feature connector cable" between the WinTV(R) and the VGA (video) board.
Despite issues with screen resolution, a PC user could watch TV in a resizable
window on their PC. Our initial customers were mostly professional PC users,
such as financial market professionals who needed to be able to see stock market
related TV shows while spending many hours on their PCs, who found having TV in
a window on their desktop useful and entertaining. Video clip capture and
teletext capabilities, valued features in today's models, can also trace their
origins to our first WinTV(R) products.
In 1993, we invented a technique called "smartlock", which eliminated the need
for the "feature connector cable." In 1994, we introduced the
"WinTV(R)-Celebrity" generation of TV tuner boards based on this "smartlock"
technology, greatly improving customer satisfaction. At the time, our CinemaPro
series of WinTV(R) boards then used smartlock and other techniques to further
reduce cost and improve performance.
In June of 1996, we introduced the WinTV(R)-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(R)-Celebrity and CinemaPro products. The
WinTV(R)-PCI used a technique called "PCI Push" and was designed to be used in
the then emerging Intel(R) Pentium(R) market. These Pentium(R)-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(R)
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(R)-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(R)-PCI found new uses in video conferencing, video
surveillance and internet streaming video applications.
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The fourth generations of our WinTV(R) boards, introduced in 1999, are digital
TV receivers. Our WinTV(R)-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 PCs to receive, display and record
digital TV signals, in addition to watching conventional analog TV. The software
to control the digital TV reception is based on our "WinTV(R)-2000" software,
which was developed during fiscal 1999. In fiscal 1999, we also introduced the
WinTV(R)-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(R)-D and the WinTV(R)-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. Our proprietary
software can decode and display some of these special data broadcasts. We intend
to work on standardized reception and display software, if such broadcasts
become standardized.
The fifth generations of WinTV(R) products are the PVR models, developed during
fiscal 2000 and introduced to the market in early fiscal 2001. The WinTV(R)-PVRs
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.
Research and Development
Our 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. We are also developing more highly
integrated versions of hardware products to further improve performance and cost
points, and new versions of software to add features, improve ease of use, and
provide support for new operating systems. We are developing additional
capabilities in the data broadcasting field, in the e-commerce area, and
enhancing the capabilities of our products in the Apple(R) Macintosh(R) market.
We currently have two Research and Development operations: one based in our
Hauppauge, New York headquarters and one based in Pleasanton, California. The
Pleasanton, California R&D operation develops the Eskape(TM) Labs products,
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 our products and certain 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 our business. We maintain an ongoing R & D
program. Our future success, of which there can be no assurances, will depend in
part on our 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. We continue
to invest heavily in our research and development. We spent approximately
$1,592,000, $1,510,000 and $1,666,000 for research and development expenses for
the years ended September 30, 2002, 2001, and 2000 respectively. There can be no
assurance that our future research and development will be successful or that we
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 our products or technologies non-competitive or
obsolete. See Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors."
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Product Production and Suppliers
We design the hardware for the WinTV(R) and Eskape(TM) Labs products and also
write the operating software to be used in conjunction with many versions of the
popular Microsoft(R) Windows(TM) and Apple(R) Macintosh(R) operating system,
including Windows(R) XP, Windows(R)98, Windows(R)Me, Windows(R)NT and
Windows(R)2000. We subcontract the manufacturing and assembly of our products to
independent third parties at facilities in various countries. We monitor and
test the quality of the completed products at our facilities in the United
States (Hauppauge, New York), Singapore, and Ireland before packaging the
products and shipping them to our customers.
Certain component parts like TV tuners, video decoder chips and software
compression chips that are essential to our business are available from a single
source or limited sources. Other essential component parts which are generally
available from multiple sources may be obtained by us from only a single source
or limited sources because of pricing concerns.
Components are subject to industry wide availability and pricing pressures. Any
availability limitations, interruption in supplies, or price increases could
have a material adverse effect on our business, operating results and financial
condition. In addition, our new products may initially utilize custom components
obtained from only one source. We typically evaluate and qualify additional
suppliers for these components.
Where a product utilizes a new component, initial capacity constraints of the
supplier of that component may exist until such time as the supplier's yields
have matured.
Components are normally acquired through purchase orders, either issued by us or
by our contract manufacturers, typically covering our requirements for a 60-120
day period from the date of issue.
If the supply of a key component were to be delayed or curtailed or in the event
a key manufacturing vendor delays shipment of completed products to us or our
contract manufacturer, our ability to ship products in desired quantities and in
a timely manner will be adversely affected. Our business and financial
performance will likely 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. We attempt
to mitigate these potential risks by working closely with our key suppliers on
product introduction plans, strategic inventories, coordinated product
introductions, and internal and external manufacturing schedules and levels.
We have, from time to time, experienced significant price increases and limited
availability of certain components that are available from multiple sources.
Similar occurrences in the future could have a material adverse effect on our
business, operating results and financial condition.
Manufacturing is performed by three unrelated contract manufacturers, one in
Europe, which primarily handles European products and two in Asia, which
primarily handle products for our domestic and Asian markets. Product design
specifications are provided to insure proper assembly. Contract manufacturing is
primarily done on a consignment basis, in which we provide all the significant
component parts and we pay for assembly charges and for certain parts for each
board produced. Some boards are purchased on a turnkey basis, in which all
components and labor are provided by the manufacturer, and the manufacturing
price includes parts and assembly costs. We continuously monitor the quality of
the finished product produced by our contract manufacturers. We have qualified
five contract manufacturers who are capable of producing our products to our
standards, but utilize three out of the five contract manufacturers. During
fiscal 2002, these three contract manufacturers handled all
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our worldwide production. If demand were to increase dramatically, we believe
additional production could be absorbed by these and the other qualified
contract manufacturers. We also buy finished products that we have not designed
but that we sell under our name on an OEM basis from others parties who are not
our contract manufacturers.
We produce a majority of our European sales through a contract manufacturer in
Austria. The production is done on a consignment basis with assembly, testing
and reworks being handled there. The packaging and shipping of the product to
customers is done at our Ireland facility. By shifting the production of boards
sold in Europe to a European facility, we save on shipping costs and duties on
boards entering Europe. Our Asian contract manufacturers assemble products we
sell in the U.S., Asia and internationally.
Customers and Markets
We primarily market our products to the consumer market. To reach this market,
we sell to a network of computer retailers in the U.S., Europe and Asia and
through computer products distributors. To attract new users to our products, we
run special promotions and participate in cooperative advertising with computer
retailers. We actively participate in trade shows to educate and train key
computer retail marketing personnel. Most of our sales and marketing budget is
aimed at the consumer market.
Apart from the typical home user, we also target business users. One example of
a business application is in the securities brokerage industry where our product
is primarily used to display financial TV shows in a window on a broker's PC
while continuing to receive financial information. We have sold our WinTV(R)
products on an OEM basis to two large financial services information providers
for incorporation into their workstations, and several independent financial
institutions. This market segment is typically project-based.
We also offer our products to PC OEMs that either embed a WinTV(R) product in a
PC that they sell, or sell the WinTV(R) as an accessory to the PC.
Distribution to the Retail Market
During fiscal 2002, net sales to distributors and retailers totaled
approximately $41,458,000 or 97% of our net sales compared to approximately
$47,365,000 or 93% and $60,214,000 or 91% for the years ended September 30, 2001
and 2000 respectively. We have no exclusive distributor or retailer and sell
through a multitude of retailers and distributors, no one of which accounted for
more than 10% of our net sales.
Sales to Original Equipment Manufacturers
The OEM business is one where a PC manufacturer incorporates our products into
an item sold under the OEM's label. Factors which could impact the expansion of
our OEM business include the ability to successfully negotiate and implement new
agreements with OEMs.
Our sales to OEMs totaled approximately $1,338,000, $3,546,000 and $6,079,000
for the years ended September 30, 2002, 2001 and 2000 respectively. We sold our
products 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 3%, 7% and 9% of our net sales for 2002, 2001 and 2000,
respectively.
11
Marketing and Sales
We market our products both domestically and internationally through our sales
offices in the United States (New York and California), Germany, the United
Kingdom, France and Singapore, plus through independent sales representative
offices in the Netherlands, Spain, and Italy. For the fiscal years ended
September 30, 2002, 2001 and 2000, approximately 27%, 23% and 29% of our net
sales were made within the United States, respectively, while approximately 73%,
77% and 71% were outside the United States (predominately in Germany, the United
Kingdom, France, Italy and Asia), respectively.
More information on our geographic segments can be obtained from "Management's
Discussion and Analysis of Financial Condition and Results of Operations," in
Item 7 and "Notes To Consolidated Financial Statements".
We advertise our products in a number of PC magazines. We also participate in
retailers' market promotion programs, such as store circulars and 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 our product introduced to end users. Our sales in computer
retail stores are closely related to the effectiveness of these programs, along
with the technical capabilities of the products. We also list our products in
catalogs of various mail order companies and attend worldwide trade shows.
We currently have 9 sales persons located in Europe, 1 sales person in the Far
East and 3 sales persons in the United States, located in New York and
California. We also utilize the services of 5 manufacturer representatives
retained by us 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 our
sales.
Foreign Currency Fluctuations
Due to extensive sales to European customers with payment made to us in those
local currencies and limited expenses paid in local currencies, we are a net
receiver of currencies other than the U.S. dollar. As such, we benefit from a
weak dollar and are negatively affected by a strong dollar relative to the major
worldwide currencies, primarily the Euro and British Pound Sterling.
Consequently, changes in exchange rates expose us to market risks resulting from
the fluctuations in the foreign currency exchange rates to the U.S. dollar, and
may positively or negatively affect our revenues, gross margins, operating
income and retained earnings (which are all expressed in U.S. dollars). We
attempt to reduce these risks by engaging in hedging programs. We enter into
foreign exchange forward contracts with financial institutions to protect
against currency exchange risks associated with our foreign denominated sales.
By selling foreign currency futures, we fix the rate of exchange at the time we
enter into the contract. We deliver these currencies to the financial
institutions at a later date when we actually receive the foreign currency.
As of September 30, 2002, we had foreign currency forward contracts outstanding
of approximately $6,072,000 against delivery of the Euro. The contracts expire
through February, 2003.
Although we do not try to hedge against all possible foreign currency exposures
because we can not fully estimate the size of our exposure, the contracts we
procure are specifically entered into to as a hedge against existing or
anticipated exposure. We do not enter into contracts for speculative purposes.
Although we maintain these programs to reduce the short term impact of changes
in currency exchange rates, when the U.S. dollar sustains a long term
strengthening position against the foreign currencies in countries where we sell
our products, our revenues, gross margins, operating income and retained
earnings can be adversely affected. Factors that could impact the effectiveness
of our hedging program include volatility of the currency markets and
availability of
12
hedging instruments.
For the year ended September 30, 2002 and 2001, we recorded approximately
$408,000 as a decrease to net sales and $1,119,000 as an increase to net sales
related to the changes in the fair value of our derivative contracts.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" with reference to the impact of foreign currency exchange
fluctuations.
Competition
Our business is subject to significant competition. Competition exists from
larger and smaller companies that might possess substantially greater technical,
financial, human, sales and marketing resources than we have. The dynamics of
competition in this market involve short product life cycles, declining selling
prices, evolving industry standards and frequent new product introductions. We
compete in this emerging market against companies such as ATI Technologies Inc.
and Pinnacle Systems, Inc. We believe that competition from new entrants will
increase as the market for digital video in a PC expands. There can be no
assurances that we will not experience increased competition in the future. Such
increased competition may have a material adverse effect on us.
Though management believes that the delivery of TV via the internet will become
more popular in the future, we believe that TV delivered to the PC via cable,
broadcast or satellite will continue to dominate. As our products connect
directly to cable, broadcast and satellite receivers, and deliver a higher
quality image, we view our products 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 is
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 our products and development efforts, there are
risks that claims associated with such patents or intellectual property rights
could be asserted by third parties against us. We expect 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 we may have not obtained licenses may take the position that it is
required to obtain a license from them.
If a patent holder refuses to offer such a license or offers such a license on
terms unacceptable to us, there is a risk of incurring substantial litigation or
settlement costs regardless of the merits of the allegations, regardless of
which party eventually prevails. If we do not prevail in a litigation suit, we
may be required to pay significant damages and/or to cease sales and production
of infringing products and accordingly, may incur significant defense costs.
Additionally, we may need to attempt to design around a given technology,
although there can be no assurances that this would be possible or economical.
We currently use technology licensed from third parties in certain products. Our
business, financial condition and operating results could be adversely affected
by a number of factors relating to these third-party technologies, including:
o failure by a licensor to accurately develop, timely introduce, promote
or support the technology
o delays in shipment of products
o excess customer support or product return costs due to problems with
licensed technology and
o termination of our relationship with such licensors.
13
We may not be able to adequately protect our intellectual property through
patent, copyright, trademark and other means of protection. If we fail to
adequately protect our intellectual property, our intellectual property rights
may be misappropriated by others, invalidated or challenged, and our competitors
could duplicate our technology or may otherwise limit any competitive
technological advantage we may have. Due to the rapid pace of technological
change, we believe our success is likely to depend more upon continued
innovation, technical expertise, marketing skills and customer support and
service rather than upon legal protection of our proprietary rights. However, we
shall aggressively assert our intellectual property rights when necessary.
Even though we independently develop most of our products, our success will
depend, in a large part, on our ability to innovate, obtain or license patents,
protect trade secrets and operate without infringing on the proprietary rights
of others. We maintain copyrights on our designs and software programs, but
currently we have no patent on the WinTV(R) board as we believe that such
technology cannot be patented.
On December 27, 1994, our trademark, "WinTV(R)", was registered with the United
States Patent and Trademark Office. Our "Hauppauge(R)" 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, 2002, we had 107 employees worldwide, including our
executive officers, all of which are full-time, none of which are represented by
a union.
Corporate Structure
Hauppauge Digital Inc. was incorporated in the state of Delaware on August 2,
1994 and has the following wholly-owned subsidiaries:
o Hauppauge Computer Works, Inc. (incorporated in New York, USA)
o HCW Distributing Corp. (incorporated in New York, USA)
o Eskape Acquisition Corp. (incorporated in Delaware, USA)
o Hauppauge Digital Europe S.a.r.l. (incorporated in Luxembourg)
Hauppauge Computer Works, Inc. is in turn the holding company of a foreign sales
corporation, Hauppauge Computer Works, Ltd (incorporated in the U.S. Virgin
Islands).
Hauppauge Digital Europe S.a.r.l. has the following wholly-owned subsidiaries:
o Hauppauge Digital Asia Pte Ltd (incorporated in Singapore)
o Hauppauge Computer Works, GmbH (incorporated in Germany)
o Hauppauge Computed Works Limited (incorporated in the United
Kingdom)
o Hauppauge Computer Works S.a.r.l. (incorporated in France)
In addition, Hauppauge Digital Europe S.a.r.l. has a branch office in
Blanchardstown, Ireland.
An internal restructuring of some of our international subsidiaries occurred in
fiscal 2000. The goal of the restructuring was twofold: (i) to subsume some of
our subsidiaries as wholly-owned subsidiaries of Hauppauge Digital Europe
S.a.r.l. and (ii) to set up a distribution center for Hauppauge Digital Europe
S.a.r.l. in Blanchardstown, Ireland. The purpose of the restructuring exercise
was to consolidate our international sales and marketing operations under
Hauppauge Digital Europe S.a.r.l. and provide a more cost-effective and
operationally efficient run distribution center for the European market.
14
Hauppauge Computer Works, GmbH (Germany) is responsible for directing and
overseeing European sales and marketing efforts while Hauppauge Computer Works
S.a.r.l. (France) handles the sales and marketing efforts in France. Hauppauge
Computer Works Limited (United Kingdom) is the English counterpart which directs
our sales and marketing efforts in the United Kingdom.
In 1999, we established a sales, warehousing and packing 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 Asian market.
During fiscal 2000, Hauppauge Digital Europe S.a.r.l. (Luxembourg) established a
branch, which houses our European warehousing and packing facility just outside
of Dublin in Blanchardstown, Ireland. As mentioned above, this initiative was to
reduce our European operating costs and to take advantage of certain tax
benefits available to us.
Our executive offices are located at 91 Cabot Court, Hauppauge, New York 11788,
and our telephone number at that address is (631) 434-1600. Our internet address
is http://www.hauppauge.com.
Item 2 DESCRIPTION OF PROPERTY
-----------------------
We occupy approximately 25,000 square feet at a facility located at 91 Cabot
Court, Hauppauge, New York and use it as our executive offices and for the
testing, storage, and shipping of our products. We consider the premises to be
suitable for our needs at such location. The building is owned by a partnership
comprised of certain of our principal stockholders' and is leased to us under a
lease agreement expiring on January 31, 2006, which may be extended, at our
option, for an additional three years.
Rent is currently at the annual rate of approximately $411,000 per year and will
increase to approximately $432,000 per year on February 1, 2003. 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 us upon
which the outstanding principal amount due as of September 30, 2002 was
$830,852. We pay the taxes and operating costs of maintaining the premises.
Our subsidiary, Hauppauge Computer Works, Inc., occupies approximately 1,642
square feet in Pleasanton, California. We use the Californian office as our
western region sales office and for marketing our Eskape(TM)Labs product line.
The lease expires on June 15, 2004 and requires us to pay an annual rent of
approximately $35,000. Hauppauge Computer Works, Inc. is responsible for a
portion of common area maintenance charges based on the space it occupies.
Our German subsidiary, Hauppauge Computer Works GmbH, occupies approximately
6,000 square feet in Mochengladbach, Germany. It is used as our European sales
office and customer support center. It also has a product demonstration room and
a storage facility. Hauppauge Computer Works GmbH pays an annual rent of
approximately $44,000 for this facility pursuant to a rental agreement which
expires on October 31, 2006.
Our Singapore subsidiary, Hauppauge Digital Asia Pte. Ltd., occupies
approximately 3,400 square feet in Singapore, which it uses as a sales and
administration office and for the testing, storage and shipping of our products.
The lease, which expired on November 30, 2002 and was renewed on December 1,
2002, expires on November 30, 2005 and calls for an annual rent of approximately
$26,600. The rent includes an allocation for common area maintenance charges.
On May 1, 2001, Hauppauge Digital S.a.r.l. commenced a lease of a 15,642 square
foot building in Blanchardstown, Dublin, Ireland. The facility houses our
European warehousing and distribution center. The lease, which is for the
standard twenty-five year term in Ireland with the right to terminate on the
fifth and tenth year of the lease, calls for an annual rent of approximately
$127,200. The rent includes an allocation for common area maintenance charges.
15
Item 3. LEGAL PROCEEDINGS.
-----------------
In January 1998, Advanced Interactive Incorporated ("AII") contacted us and
attempted to induce us into entering a patent license or joint venture agreement
with AII relative to certain of our products. AII alleged that such products
infringe U.S. Patent No. 4,426,698 (the "AII Patent"). At such time, our
engineering staff analyzed the AII Patent and determined that our products did
not infringe any such patent. Accordingly, we rejected AII's offer.
On October 6, 1998, we received notice that AII had commenced an action against
us and multiple other defendants in the United States District Court for the
Northern District of Illinois (the "District Court"), alleging that certain of
our products infringed on certain patent rights allegedly owned by the plaintiff
(the "Complaint"). The Complaint sought unspecified compensatory and statutory
damages with interest. We denied such allegations and vigorously defended this
action.
On December 22, 1998, we filed our answer (the "Answer"). We denied that our
products infringed AII's patent rights and asserted certain affirmative
defenses.
On June 26, 2000, the District Court granted the Defendant's Motion for Partial
Adjudication of Claim Constructions Issues and entered a Final Judgment of
Non-infringement to us.
On July 25, 2000, AII filed a Notice of Appeal with the U.S. Court of Appeals
for the Federal Circuit, appealing the District Court's Order granting the
Motion for Partial Adjudication of Claim Construction Issues and Order entering
Final Judgment of Non infringement.
On July 16, 2001, the Federal Circuit entered a Circuit Rule 36 Judgment of
Affirmance Without Opinion. Accordingly, the Federal Circuit affirmed the
District Court's finding of non-infringement. As of December 13, 2001, the time
limit permitting AII to file a petition with the U.S. Supreme Court for a Writ
of Certiorari to review the Federal Circuit judgment has lapsed. This litigation
is now over without the possibility of further appeals.
We have been informed by counsel for the estate of the late Mr. Kenneth Aupperle
("Estate") that they have filed a Demand for Arbitration with the American
Arbitration Association claiming property rights and interest in the Company,
certain amounts due and owing to the Estate based on various corporate
agreements with Mr. Aupperle and certain insurance policies, such amount to be
no less than $2,500,000. We have recently received a formal acknowledgement from
the American Arbitration Association of the said Demand for Arbitration and have
obtained a temporary restraining order on the said arbitration proceedings.
Based on the preliminary information presented to us, management believes that
the claim and the basis for proceeding with arbitrating such claim is without
merit and will vigorously defend it.
In 1997, we licensed a file conversion library for use in its WinTV(R)
applications from Accusoft Corporation. On June 14, 2001, the Company received
notice that Accusoft Corporation had commenced an action against the Company in
the United States District Court for the District of Massachusetts (the
"District Court"), alleging that the Company:
o had infringed Accusoft's copyright in certain software in violation
of Title 17 of the United States Code
o had violated the terms of its software license by making excess
copies of the software without paying additional royalties
o used the software for unauthorized purposes
On July 31, 2001, the Company and Accusoft reached a settlement and release of
all claims against the Company in exchange for payment of the settlement amount
of $212,500.
16
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 September 6, 2002 at our offices:
Proposal No. 1: Election of Directors
The following directors were elected by the votes indicated:
For Withheld
--- --------
Kenneth Plotkin 8,025,963 1,010,848
Bernard Herman 8,030,773 1,015,658
Clive R. Holmes 8,044,793 996,828
Steven J. Kuperschmid 8,025,443 1,016,178
Proposal No. 2: Amendment of the Certificate of Incorporation to authorize the
classification of the Board of Directors into three classes with staggered terms
and to provide for a supermajority voting requirement to amend any provision in
the Certificate of Incorporation relating to such classified Board of Directors.
The proposed amendment to the Certificate of Incorporation to authorize the
classification of the Board of Directors into three classes with staggered terms
and to provide for a supermajority voting requirement to amend any provision in
the Certificate of Incorporation relating to such classified Board of Directors
was not approved because there were insufficient votes cast:
For Against Abstain
--- -------- -------
2,368,289 1,667,910 57,189
Proposal No. 3: Amendment of the Certificate of Incorporation to authorize a
class of preferred stock.
The proposed amendment to the Certificate of Incorporation to authorize a class
of preferred stock was not approved because there were insufficient votes cast:
For Against Abstain
--- -------- -------
3,341,032 641,253 111,103
Proposal No. 4: Amendment of the Certificate of Incorporation to require
unanimous, rather than majority, written consent of stockholders in lieu of
meeting under certain circumstances.
The proposed amendment to the Certificate of Incorporation to require unanimous,
rather than majority, written consent of stockholders in lieu of a meeting under
certain circumstances was not approved because there were insufficient votes
cast:
For Against Abstain
--- -------- -------
2,178,929 1,888,870 25,589
Proposal No. 5: Amendment to the Company's Employee Stock Purchase Plan to
increase the number of Common Shares available thereunder from 100,000 to
180,000 and provide for a termination date thereunder of December 31, 2004
The proposed amendment to the Company's Employee Stock Purchase Plan was
approved by the shareholders'.
For Against Abstain
--- -------- -------
8,137,203 381,051 19,250
Proposal No. 6: To transact such other business as may properly come before the
meeting.
For Against Abstain
--- -------- -------
8,358,408 644,318 38,445
The proposal to transact such other business as may properly come before the
meeting was approved by the shareholders'.
17
PART II
-------
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
---------------------------------------------------------
(a) The principal market on which our common stock (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 our 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, 2002 High Low
- ------------------- ----- ---
First Quarter 3.02 1.05
Second Quarter 2.40 1.59
Third Quarter 2.29 1.75
Fourth Quarter 2.04 1.24
Fiscal Year Ended
September 30, 2001 High Low
- ------------------- ---- ---
First Quarter 6.13 1.38
Second Quarter 5.03 1.38
Third Quarter 3.18 2.03
Fourth Quarter 2.25 1.05
(b) We have been advised by our transfer agent, North American Transfer Co. that
the approximate number of holders of record of our Common Stock as December 13,
2002 was 165. We believe there are in excess of 8,000 beneficial holders of our
Common Stock.
(c) No cash dividends have been paid during the past two years. We have no
present intention of paying any cash dividends in our foreseeable future and
intend to use our net income, if any, in our operations.
Equity Compensation Plan Information
Set forth in the table below is certain information regarding the number of
shares of common stock that may be issued under options, warrants and rights
under all of the Company's existing equity compensation plans as of September
30, 2002.
Number of Securities
remaining available for future
Number of securities to be Weighted average exercise issuance under equity compensation
issues upon exercise of price of outstanding plans (excluding securities
Plan Category outstanding options options reflected in column (a))
- -----------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved by 1,092,826 $ 2.90 629,500
stockholders
- -----------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not approved by 230,000 $ 3.41 120,000
shareholders
- -----------------------------------------------------------------------------------------------------------------------------
Item 6. SELECTED FINANCIAL DATA
The following selected financial data with respect to our financial position and
our results of operations for each of the five years in the period ended
September 30, 2002 set forth below has been derived from our 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 8 and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Item 7 included in this 10-K.
18
Consolidated Statement of Operations Data 2002 2001 2000 1999 1998
Years ended September 30, ------ ---- ---- ---- ----
(in thousands, except for per share amounts)
--------------------------------------------
Net Sales $ 42,797 $ 50,910 $ 66,292 $ 58,602 $ 38,757
Cost of sales 31,661 42,056 54,425 43,027 28,643
------ ------ ------ ------ ------
Gross Profit 11,136 8,854 11,867 15,575 10,114
Selling, general and administrative expenses 9,069 10,282 12,231 9,865 7,244
Research & development expenses 1,592 1,510 1,666 1,257 808
Write off of goodwill - 702 - - -
Litigation settlement - 213 - - -
----- ---- -- --- -----
Income (loss) from operations 475 (3,853) (2,030) 4,453 2,062
Other Income (Expense):
Interest income 35 42 104 201 236
Interest expense - (31) (15) - -
Life insurance proceeds - 2,000 - - -
Foreign currency 5 7 (243) (61) 184
Non operational USD to Euro re-measurement gain (loss) (98) (16)
Other, net - - 1 - -
---- ----- ----- ---- ------
Income (loss) before taxes 417 (1,851) (2,183) 4,593 2,482
Income tax (benefit) provision (911) (333) (1,184) 1,602 1,027
Increase (reduction) in deferred tax valuation allowance 980 1,083 - (127) (503)
--- ----- ----- ---- ----
Net tax provision (benefit) 69 750 (1,184) 1,475 524
-- --- ------ ----- ---
Income (loss) before cumulative effect of a change in
accounting principle 348 (2,601) (999) 3,118 1,958
Cumulative effect of a change in accounting principle - 319 - - -
--- ------ ------- ----- -----
Net income (loss) $ 348 $ (2,282) $ (999) $ 3,118 $ 1,958
========= ========= ========= ========= =========
Per share results-basic:
Income (loss) before cumulative effect of a change in
accounting principle $ 0.04 $ (0.29) $ (0.11) $ 0.36 $ 0.22
Cumulative effect of a change in accounting principle $ - $ 0.03 $ - $ - $ -
--------- --------- --------- --------- ---------
Net income (loss) per share-basic $ 0.04 $ (0.26) $ (0.11) $ 0.36 $ 0.22
========= ========= ========= ======== =========
Per share results-diluted:
Income (loss) before cumulative effect of a change in
accounting principle $ 0.04 $ (0.29) $ (0.11) $ 0.33 $ 0.21
Cumulative effect of a change in accounting principle $ - $ 0.03 $ - $ - $ -
--------- --------- --------- -------- ---------
Net income (loss) per share-diluted $ 0.04 (0.26) (0.11) 0.33 0.21
========= ========= ========= ========= =========
Weighted average shares outstanding:
Basic 8,887 8,910 8,837 8,632 8,806
Diluted 9,037 8,910 8,837 9,480 9,354
Consolidated Balance Sheet Data (at period end):
Working capital $ 11,266 $ 10,258 $ 11,767 $ 12,533 $ 9,539
Total assets 19,846 18,784 26,315 27,728 22,897
Stockholders' equity 11,967 11,186 13,654 13,322 10,037
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
September 30, 2002 and 2001
Results for the fiscal years ended September 30, 2002 and 2001 are detailed
below:
Twelve Twelve
Months Months
Ended Ended Variance Percentage of sales
9/30/02 9/30/01 $ 2002 2001 Variance
------- ------- - ---- ---- --------
Sales $ 42,796,726 $ 50,910,463 $(8,113,737) 100.00% 100.00% 0.00%
Cost of sales 31,661,073 42,056,859 (10,395,786) 73.98% 82.61% -8.63%
---------- ---------- ----------- ----- ----- ----
Gross Margin 11,135,653 8,853,604 2,282,049 26.02% 17.39% 8.63%
Gross Margin % 26.02% 17.39% 8.63%
Costs:
Sales & Marketing 5,741,510 6,479,351 (737,841) 13.42% 12.73% 0.69%
Technical Support 379,592 380,488 (896) 0.89% 0.75% 0.14%
General & Administrative 2,947,943 3,422,635 (474,692) 6.89% 6.72% 0.17%
--------- --------- -------- ---- ---- ----
Total Selling General and Administrative costs 9,069,045 10,282,474 (1,213,429) 21.20% 20.20% 1.00%
Litigation settlement - 212,500 (212,500) 0.00% 0.42% -0.42%
Write of off Goodwill - 701,919 (701,919) 0.00% 1.37% -1.37%
R&D 1,591,551 1,510,092 81,459 3.72% 2.97% 0.75%
--------- --------- ------ ---- ---- ----
Total Costs 10,660,596 12,706,985 (2,046,389) 24.92% 24.96% -0.04%
---------- ---------- ---------- ----- ----- ----
Net operating income (loss) 475,057 (3,853,381) 4,328,438 1.10% -7.57% 8.67%
Other income (expense)
- ---------------------
Interest income 34,781 42,137 (7,356) 0.08% 0.08% 0.00%
Interest expense - (30,833) 30,833 0.00% -0.06% 0.06%
Foreign currency 4,750 6,740 (1,990) 0.01% 0.01% 0.00%
Non operational USD to Euro re-measurement (loss) (98,066) (15,863) (82,203) -0.23% -0.03% -0.20%
Insurance proceeds - 2,000,000 (2,000,000) 0.00% 3.93% -3.93%
------- --------- ---------- ---- ---- ----
Total other income (expense) (58,535) 2,002,181 (2,060,716) -0.14% 3.93% -4.07%
------- --------- ---------- ---- ---- ----
Income (loss) before taxes 416,522 (1,851,200) 2,267,722 0.96% -3.64% 4.60%
Taxes on income 69,000 749,497 (680,497) 0.16% 1.47% -1.31%
------ ------- -------- ---- ---- ----
Income (loss) before cumulative effect of a change in
accounting principle 347,522 (2,600,697) 2,948,219 0.80% -5.11% 5.91%
Cumulative effect of change in accounting principle - 319,000 (319,000) 0.00% 0.63% -0.63%
------- ------- -------- ---- ---- ----
Net income (loss) $ 347,522 $ (2,281,697) $2,629,219 0.80% -4.48% 5.28%
=========== ============ ========== ==== ==== ====
Sales for the twelve months ended September 30, 2002 decreased $8,113,737 when
compared to last year. Sales declined in all geographic locations as follows:
Increase Percentage of sales by
(decrease) Increase Geographic region
Twelve Months Twelve Months Dollar (decrease) 2002 2001
Location ended 9/30/02 ended 9/30/01 Variance Variance %
- -------- ------------- ------------- -------- ---------- ---- ----
Domestic $ 11,508,358 $ 11,888,839 $ (380,481) (3%) 27% 23%
Europe 30,365,681 35,624,555 (5,258,874) (15%) 71% 70%
Asia 922,687 3,397,069 (2,474,382) (73%) 2% 7%
------- --------- ---------- --- - -
Total $ 42,796,726 $ 50,910,463 $(8,113,737) (16%) 100% 100%
============ ============= =========== ==== === ===
20
Results of operations September 30, 2002 and September 30, 2001
The primary forces causing the sales decrease were:
o Sluggish economic conditions
o Reduction in analog board sales
o Lower OEM sales activity
o Lower Asian sales
Sales to domestic customers were 27% of net sales for the year ended September
30, 2002 compared to 23% for the year ended September 30, 2001. Sales to
European customers were 71% of net sales compared to 70% for the same period of
last year. Sales to Asian customers were 2% compared to 7% for the same period
last year.
Gross margins increased $2,282,049 for the twelve months ended September 30,
2002. Gross margin percentage for the twelve months ended September 30, 2002 was
26.02% compared to 17.39% for the same periods in the prior year.
The increases and (decreases) in the margins are detailed below:
Increase
(decrease)
Due to lower sales $ (2,352,411)
Due to higher margins on assembled boards 2,116,392
Due to decreases in labor related and other costs 655,302
Due to inventory obsolescence reserve booked during the fourth quarter of fiscal 2001 1,862,766
---------
Total increase in margins $ 2,282,049
============
The increase in gross margin percentage of 8.63% for the twelve months ended
September 30, 2002 compared to last year is as follows:
Increase
(decrease)
---------
Increase in margin on assembled boards 4.95%
Labor related and other costs as a larger percent of sales 0.03%
Due to inventory obsolescence reserve booked during the fourth quarter of fiscal 2001 3.65%
----
Net increase 8.63%
====
The improved margin percentage on assembled boards was primarily derived from
unit price reductions from our suppliers and subcontractors coupled with a
larger sales mix of higher gross margin product. The increase in the gross
margin percent of 0.03% due to labor related and other costs was due to the
decrease in labor related and other costs of 16.20% being in excess of the sales
decrease of 15.94%.
During the fourth quarter of fiscal 2001, in recognition of the sales decline
from fiscal 2000, slower sales of older product lines and engineering changes to
products, we reviewed the net realizable value of our inventory as of September
30, 2001. We deemed it necessary to increase our reserve for obsolete and slow
moving inventory. An additional reserve of $1,862,766 was recorded during the
fourth quarter of fiscal 2001 and charged to cost of sales. A similar provision
was not required in fiscal 2002, thus there was an improvement in margins of
3.65% for fiscal 2002.
The chart below illustrates the components of selling, general and
administrative expenses:
Twelve months ended September 30,
Dollar Costs Percentage of Sales
----------------------------------------------------------------------------------------------
Increase Increase
2002 2001 (Decrease) 2002 2001 (Decrease)
---- ---- ---------- ---- ---- ----------
Sales and Promotiona $ 5,741,510 $ 6,479,351 $ (737,841) 13.42% 12.73% 0.69%
Customer Support 379,592 380,488 (896) 0.89% 0.75% 0.14%
General and Administrative 2,947,943 3,422,635 (474,692) 6.89% 6.72% 0.17%
--------- --------- -------- ---- ---- ----
Total $ 9,069,045 $ 10,282,474 $(1,213,429) 21.20% 20.20% 1.00%
21
Results of operations September 30, 2002 and 2001-continued
Selling General and Administrative expenses decreased $1,213,429 from the prior
fiscal year. As a percentage of sales, Selling, General and Administrative
expenses for the twelve months ended September 30, 2002 increased by 1.00% when
compared to the twelve months ended September 30, 2001.
The decrease in sales and promotional expense of $737,841 was mainly due to :
o Lower advertising costs of $502,057 due to lower co-operative
advertising and reduced special promotions
o Lower trade show costs of $146,052 due to smaller size and frequency
of trade show attendance
o Lower commission payments of $31,355 due to lower sales
o Decreased compensation costs of $70,295 due to personnel reductions
for sales and marketing personnel
The decrease in General and Administrative expenses of $474,692 was primarily
due to:
o Decrease in compensation costs of $188,572 due to personnel reductions
for administrative personnel
o Lower legal costs of $80,553 due to less litigation activity during
fiscal 2002
o Decreased amortization costs of $81,637 mainly due to the write off of
goodwill during the fourth quarter of fiscal 2001
o Lower rent costs of $48,301 and lower communication costs of $32,211
due to the consolidation of the Eskape Labs office in California into
the Hauppauge California office
Research and development expenses increased $81,459 or approximately 3.7%. The
increase was mainly due to higher compensation and increased material and
contract services cost.
Litigation settlement
During the third quarter of fiscal 2001, we paid $212,500 to settle a claim
pursuant to a copyright infringement dispute.
Write off of goodwill
During fiscal 2000, we acquired certain assets of Eskape(TM) Labs, Inc. This
acquisition was accounted for using the purchase method. The fair value of the
consideration paid exceeded the fair value of the assets acquired and goodwill
of approximately $810,000 was recorded.
Due to changing conditions during fiscal 2001, the following events and
circumstances indicated to us that our goodwill asset had been impaired and was
not likely to be recovered:
o Eskape(TM)Labs was not profitable during fiscal 2001 and did not
contribute, nor is expected to contribute, any positive cash flow stream
o Eskape(TM) Labs did not fulfill its internal sales forecast for fiscal 2001
o The asset value was greater than the estimated future cash flows
o At the time of the acquisition, we hired approximately 10 of the
Eskape(TM) Labs employees, including three from senior management. Only
four employees remain
o Certain Eskape(TM)Labs products have been deemed by management as slow
moving products
In recognition of the above events, we recognized an impairment loss during the
fourth quarter of fiscal 2001 for the entire remaining goodwill balance of
$701,919. The loss was recorded as a component of other income (loss) from
operations.
22
Results of operations September 30, 2002 and 2001-continued
- ------------------------------------------------------------
Other income (expense)
Net other expense for the twelve months ended September 30, 2002 was $58,535
compared to net other income of $2,002,181 for the twelve months ended September
30, 2001 as detailed below:
Twelve months ended September 30,
2002 2001
---- ----
Interest income $ 34,781 $ 42,137
Interest expense - (30,833)
Foreign currency transaction gains (losses) 4,750 6,740
Non operational USD to Euro currency re-measurement (98,066) (15,863)
- 2,000,000
Life insurance proceeds --------- ---------
Total other income (expense) $ (58,535) $2,002,181
========= ==========
The decrease in total other income (expense) was due to the receipt of insurance
proceeds during fiscal 2001 pursuant to a key man life insurance on the
Company's deceased former President and losses in fiscal 2002 resulting from the
"Non operational USD to Euro currency re-measurements" offset by lower interest
expense during fiscal 2002.
"Non operational USD to Euro currency re-measurement" results from the revaluing
from U.S. dollars to Euros any U.S. dollar denominated assets and liabilities on
the books of our Luxembourg based subsidiary, Hauppauge Digital Europe S.a.r.l..
Since the functional currency of Hauppauge Digital Europe S.a.r.l. is the Euro,
any asset, liability or equity accounts which are invested in or purchased using
U.S. dollars by Hauppauge Digital Europe S.a.r.l. need to be revalued into Euros
at the end of each reporting period. This revaluation of U.S. dollar denominated
accounts into Euros results in a non transactional re-measurement gain or loss,
which we have classified as " Non operational USD to Euro currency
re-measurement."
Tax provision (benefit)
Our net tax provision for the twelve months ended September 30, 2002 and 2001 is
as follows:
Twelve months ended September 30,
2002 2001
------ ------
Tax (benefit) attributable to U.S operations $ (980,000) $ (501,000)
Tax expense Asian operations - 44,200
Tax expense European operations 69,000 123,500
Deferred tax asset valuation allowance 980,000 1,082,797
-------- ---------
Net tax provision $ 69,000 $ 749,497
========== ==========
Effective October 1, 1999, we restructured our foreign operations. The result of
the restructuring eliminated the foreign sales corporation and established a new
Luxembourg corporation, which functions as the entity which services our
European customers. The new structure created separate domestic and foreign tax
entities, with the Luxembourg entity paying a license fee to our domestic
operation for use of the Hauppauge name. For the last three fiscal years, our
domestic operation has incurred losses. We analyzed the future realization of
our deferred tax assets as of September 30, 2002 and we concluded that under the
present circumstances, it would be appropriate for us to record a valuation
allowance against the increase in the deferred tax asset attributable to the
current year's loss from domestic operations.
23
Results of operations September 30, 2002 and 2001-continued
- -----------------------------------------------------------
Accumulated other comprehensive income (loss)
As of September 30, 2002, appearing in the equity section under " Accumulated
other comprehensive income (loss)" was a deferred gain of $187,074. Translation
gains and losses, which are the result of translating Euros to USD at the month
end exchange rate for current assets and liabilities, at historical rates for
fixed assets and paid in capital, and at average exchange rates for revenue and
expense items, resulted in a deferred loss of $3,845 as of September 30, 2002.
Mark to market gains and losses result from the difference between the USD value
of our open foreign currency forward contracts at the average contract rate as
opposed to the same contracts translated at the month end spot rate. Prior to
July 1, 2002, the Company did not qualify for cash flow hedge accounting under
FAS 133, therefore material gains or losses were recorded through operations. As
a result of our qualification for cash flow hedge accounting, effective July 1,
2002, gains aggregating to $190,919 on these contracts are shown in the equity
section under "Accumulated other comprehensive income."
The components of other comprehensive income (loss) as of September 30, 2002 are
shown below:
Fiscal 2002 Other
As of comprehensive As of
9/30/01 income (loss) 9/30/02
------- ------------- -------
Translation gains(loss) on HDE S.a.r.l Euro accounts translated to USD $ (218,987) $ 215,142 $ (3,845)
Mark to market gains (loss) per FAS 133 on open foreign currency contracts (48,217) 239,136 190,919
------- ------- -------
Other comprehensive income $ (267,204) $ 454,278 $ 187,074
========== ========= =========
The adoption of Financial Accounting Standards No. 133 (SFAS 133), "Accounting
for Derivative Instruments and Hedging Activities", on October 1, 2000 resulted
in a $319,000 net gain, due to the cumulative effect of a change in accounting
principle.
As a result of all of the above mentioned MD&A items, we recorded net income of
$347,522 for the twelve months ended September 30, 2002, which resulted in basic
and diluted net income per share of $0.04 on weighted average basic and diluted
shares of 8,887,107 and 9,002,150, respectively, compared to a net loss of
($2,281,697) for the twelve months ended September 30, 2001, which resulted in
basic and diluted net loss per share of ($0.26) on weighted average basic and
diluted shares of 8,910,117. Options to purchase 825,322 and 1,827,326 shares of
common stock at prices ranging from $2.07 to $10.06 and from $1.05 to $10.06,
respectively, were outstanding for the twelve month period ending September 30,
2002 and 2001, respectively, but were not included in the computation of diluted
net income or net loss per share because they were anti-dilutive.
24
Results of operations
September 30, 2001 and 2000
Sales decreased $15,382,028 for the fiscal year ended September 30, 2001
compared to the prior year as detailed geographically in the table below:
Percent Percent of sales by
Year ended September 30, Increase Increase geographic region
2001 2000 (decrease) (decrease) 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Domestic $11,888,839 $ 19,504,372 $ (7,615,533) -39% 23% 30%
Europe 35,624,555 44,667,287 (9,042,732) -20% 70% 67%
Asia 3,397,069 2,120,832 1,276,237 60% 7% 3%
--------- --------- --------- -- - -
Total $50,910,463 $ 66,292,491 $(15,382,028) -23% 100% 100%
=========== ============ ============ == === ===
The primary forces causing the decrease were:
o Reduction in analog board sales
o Sluggish worldwide economic conditions
o Lower average Euro to dollar exchange rates
Unit sales for the fiscal year ended September 30, 2001 decreased about 23% to
approximately 744,000 as compared to approximately 969,000 for the prior year.
Sales to domestic customers were 23% of net sales compared to 29% for the prior
year. Sales to European customers were 70% of net sales compared to 68% for the
same period of the prior year. Sales to Asian customers were 7% compared to 3%
for the prior year.
Gross margins decreased $3,013,889 for the year ended September 30, 2001. Gross
margin as a percent of sales was 17.39% for the year ended September 30, 2001
compared to 17.90% for the year ended September 30, 2000. The components of the
margin decrease are detailed below:
Increase
(decrease)
----------
Decrease due to lower sales $ (3,844,481)
Increase due to improved material margins 2,036,221
Decrease due to labor related and other costs (342,853)
Inventory provision for obsolescence in excess of prior year's provision (862,776)
--------
Net decrease in margins $ (3,013,889)
The decrease of 0.51% in the gross margin percentage for the fiscal year ended
September 30, 2001 is as follows:
Increase
(decrease)
----------
Improved margin on assembled boards 4.00%
Increased labor related and other costs (2.36%)
Inventory reserve (2.15%)
-----
Net decrease (0.51%)
=====
The improved margins on assembled boards was primarily derived from:
o Cost savings obtained from the shifting of product pack out from an outside
third party to our distribution center in Ireland
o Larger sales mix of higher gross margin product
25
Results of operations September 30, 2001 and 2000-continued
- -----------------------------------------------------------
Increases in labor related and other costs was primarily due to the overhead,
labor and pack out material expenses of our Irish distribution center, which
commenced operations during the fourth quarter of fiscal 2000.
In recognition of the sales decline from fiscal 2000, slower sales of older
product lines and engineering changes to products, we reviewed the net
realizable value of our inventory as of September 30, 2001. We deemed it
necessary to increase our reserve for obsolete and slow moving inventory. An
additional reserve of $1,863,000 was recorded during the fourth quarter of
fiscal 2001 and charged to cost of sales. The additional reserve decreased
margins by 3.65% for fiscal 2001.
The chart below illustrates the components of selling, general and
administrative expenses:
Fiscal year ended September 30,
Increase Increase
2001 2000 (Decrease) 2001 2000 (Decrease)
---- ---- ---------- ---- ---- --------
Sales and Promotional $ 6,479,351 $ 8,159,606 $ (1,680,255) 12.8% 12.3% .5%
Customer Support 380,488 464,921 (84,433) .7% .7% -%
General and Administrative 3,422,635 3,607,086 (184,451) 6.7% 5.4 1.3%
--------- --------- -------- --- --- ---
Total $10,282,474 $12,231,613 $ (1,949,139) 20.2% 18.4% 1.8%
Selling General and Administrative expenses decreased $1,949,139 from the prior
year. As a percentage of sales, Selling, General and Administrative expenses for
the fiscal year ended September 30, 2001 increased by 1.8% when compared to the
prior year.
The decrease in sales and promotional expense of $1,680,255 was mainly due to:
o Lower advertising costs of $1,009,768 due to lower co-operative
advertising and reduced special promotions
o Reduced European sales office costs of $314,358
o Lower commission payments of $293,489 due to lower sales
o Decreased compensation costs of $21,513 due to personnel reductions
Customer Support costs decreased $84,433 mainly due to lower compensation costs.
The decrease in General and Administrative expenses of $184,451 was primarily
due to:
o Increase in compensation costs of $68,656 related to the
hiring of an MIS Director, an in house attorney, and the
compensation costs related to the addition of Eskape(TM) Labs
administrative personnel somewhat offset by personnel
reductions
o Increased amortization costs of $120,045 mainly due to the
amortization of goodwill and intangible assets related to the
Eskape(TM)Labs acquisition
o Decreased professional fees of $231,170 related to termination
of outside consulting agreements and lower legal costs
relating to legal fees incurred for a patent infringement suit
and legal costs associated to the start up of our Luxembourg
operation
o Lower rent costs of $25,035 due to the consolidation of the
Eskape(TM)Labs office in California into the Hauppauge office
26
Results of operations September 30, 2001 and 2000-continued
- --------------------------------------------------------------------------------
Research and development expenses decreased $155,508 or approximately 9.0%. The
decrease was due to lower worldwide compensation costs and less material and
contract services consumed.
Litigation settlement
In 1997, we licensed a file conversion library for use in our WinTV(R)
applications from Accusoft Corporation. On June 14, 2001, we received notice
that Accusoft Corporation ("Accusoft") had commenced an action against us in the
United States District Court for the District of Massachusetts (the "District
Court"), alleging that we:
o had infringed Accusoft's copyright in certain software in violation of
Title 17 of the United States Code
o had violated the terms of its software license by making excess copies
of the software without paying additional royalties
o used the software for unauthorized purposes
On July 31, 2001, we and Accusoft reached a settlement and release of all claims
against company in exchange for payment of the settlement amount of $212,500.
Write off of goodwill
During fiscal 2000, we acquired certain assets of Eskape(TM) Labs, Inc. This
acquisition was accounted for using the purchase method. The fair value of the
consideration paid exceeded the fair value of the assets acquired and goodwill
of approximately $810,000 was recorded.
Due to changing conditions during fiscal 2001, the following events and
circumstances indicated to us that our goodwill asset had been impaired and was
not likely to be recovered:
o Eskape(TM)Labs was not profitable during fiscal 2001 and did not
contribute, nor is expected to contribute, any positive cash flow
stream
o Eskape(TM) Labs did not fulfill its internal sales forecast for
fiscal 2001
o The asset value was greater than the estimated future cash flows
o At the time of the acquisition, we hired approximately 10 of the
Eskape(TM) Labs employees, including three from senior management.
Only four employees remain
o Certain Eskape(TM)Labs products have been deemed by management as slow
moving products
In recognition of the above events, we recognized an impairment loss during the
fourth quarter of fiscal 2001 for the entire remaining goodwill balance of
$701,919.
We have recorded the impairment loss as a component of income (loss) from
operations for fiscal 2001.
27
Results of operations September 30, 2001 and 2000-continued
- -----------------------------------------------------------
Other income (expense)
We had net other income for the year ended September 30, 2001 of $2,002,181
compared to net other expense for the prior year of $153,567 as detailed below:
Year Year
Ended 9/30/01 Ended 9/30/00
------------- -------------
Interest income $ 42,137 $ 104,485
Interest expense (30,833) (15,134)
Foreign currency transaction losses (15,863) (242,479)
Officer life insurance proceeds 2,000,000 -
Other 6,740 (439)
----- ----
Total other income $2,002,181 $(153,567)
========== =========
The increase in net other income was due to lower foreign currency transaction
losses and insurance proceeds collected from a key man life insurance policy on
the late Mr. Kenneth Aupperle, offset somewhat by interest expense on borrowings
outstanding. See "Legal Proceedings" for a discussion on certain pending
litigation on the said life insurance policy.
Tax provision (benefit)
Our net tax provision (benefit) for the year ended September 30, 2001 and 2000
is as follows:
2001 2000
---- ----
Tax (benefit) attributable to U.S operations $ (501,000) $(1,311,072)
Tax expense Asian operations 44,200 -
Tax expense European operations 123,500 127,000
Deferred tax asset valuation allowance 1,082,797 -
--------- ---------
Net tax provision (benefit) $ 749,497 $(1,184,072)
========== ===========
Effective October 1, 1999, we restructured our foreign operations. The result of
the restructuring eliminated the foreign sales corporation and established a new
Luxembourg corporation, which functions as the entity which services our
European customers. The new structure created separate domestic and foreign tax
entities, with the new Luxembourg entity paying a 7% license fee to our domestic
operation for use of the Hauppauge name. For the last two fiscal years, our
domestic operation has incurred losses. At September 30, 2000, our domestic
operation had a deferred tax benefit of $1,267,997. We analyzed the future
realization of the deferred tax asset during the fourth quarter of fiscal 2001
and we concluded that under the present circumstances, it would be appropriate
for us to record a valuation allowance against the deferred tax asset and reduce
certain income tax liabilities. The net result was a charge to our tax provision
for $1,082,797.
The adoption of Financial Accounting Standards No. 133 (SFAS 133), "Accounting
for Derivative Instruments and Hedging Activities", on October 1, 2000 resulted
in a $319,000 gain, due to the cumulative effect of a change in accounting
principle.
As a result of all of the above mentioned MD&A items, we recorded a net loss of
($2,281,697) for the year ended September 30, 2001, which resulted in basic and
diluted net loss per share of ($0.26) on weighted average basic and diluted
shares of 8,910,117, compared to a net loss of ($999,215) for the year ended
September 30, 2000, which resulted in basic and diluted net loss per share of
($0.11) on weighted average shares of 8,837,256. Options to purchase 1,827,326
and 1,610,226 shares of common stock at prices ranging $1.05 to $10.06 and $1.35
and $10.06 respectively were outstanding as of September 30, 2001 and 2000,
respectively but were not included in the computation of diluted net loss per
share because they were anti-dilutive.
28
Seasonality
As our sales are primarily to the consumer market, we have experienced certain
seasonal revenue trends. Our peak sales quarter, due to holiday season sales of
computer equipment, is our first fiscal quarter (October to December), followed
by our second fiscal quarter (January to March). In addition, our international
sales, mostly in the European market, were 73%, 77% and 70% of sales for the
years ended September 30, 2002, 2001 and 2000, respectively. Our fiscal fourth
quarter sales (July to September) can be potentially impacted by the reduction
of activity experienced in Europe during the July and August summer holiday
period.
To offset the above cycles, we target a wide range of customer types in order to
moderate the seasonality of retail sales.
Liquidity and Capital Resources
Our cash, working capital and stockholders' equity position is disclosed below:
As of September 30,
2002 2001 2000
----- ---- ----
Cash $ 4,964,522 $ 4,422,239 $ 2,744,855
Working Capital 11,276,942 10,258,143 11,766,900
Stockholders' Equity 11,966,612 11,185,618 13,653,677
We had cash and cash equivalents as of September 30, 2002 of $4,964,522, an
increase of $542,283 over September 30, 2001.
The increase was due to:
Net income adjusted for non cash items $ 344,126
Decrease in inventories 466,481
Decrease in prepaid expenses and other current assets 101,531
Increase in accounts payable other current liabilities 281,025
Proceeds from employee stock purchases 31,206
Less cash used for:
Increase in accounts receivable (504,866)
Purchases of fixed assets (87,208)
Purchase of treasury stock (90,012)
-------
Net increase in cash $ 542,283
========
Net cash of $688,297 provided by operating activities was primarily due to a
decrease in inventories of $466,481, prepaid expenses and other current assets
of $101,531, an increase in accounts payable and other current liabilities of
$281,025 and net income adjusted for non cash items of $344,126, offset somewhat
by cash used to fund increases in accounts receivable of $504,866. The increase
in accounts receivable was the result of an increase in sales of $735,488 for
the three months ended September 30, 2002 over the three months ended September
30, 2001.
Cash of $87,208 and $90,012 was used to purchase fixed assets and purchase
treasury stock. Proceeds from the stock purchased by employees through the
employee stock purchase plan provided additional cash of $31,206.
On April 5, 2001 the Company extended its agreement with Chase Manhattan Bank,
to provide it with a $6,500,000 credit facility. The facility is secured by our
assets, and expired in fiscal 2002. It is the intention of the Company to
procure a new credit facility on terms acceptable to the Company.
29
Liquidity and Capital Resources-continued
- -----------------------------------------
On November 8, 1996, we approved a stock repurchase program. The program, as
amended, authorizes the Company to repurchase up to 850,000 shares of our own
stock. We intend to use the repurchased shares for certain employee benefit
programs. On December 17, 1997, the stock repurchase program was extended by a
resolution of our Board of Directors. As of September 30, 2002, we held 514,317
treasury shares purchased for $1,461,574 at an average purchase price of
approximately $2.84 per share.
On June 1, 2000 we acquired certain assets of Eskape(TM) Labs Inc. ("Eskape"), a
California based company specializing in designing and manufacturing TV and
video products for Apple(R)Macintosh(R) computers. The purchased assets expand
and complement our product line into the Apple(R)Macintosh(R) market. The cash
price for the acquisition, which was accounted for under the purchase method,
was approximately $900,000, which included $100,000 in direct transaction costs
and a restrictive covenant totaling $50,000. In addition to the price paid for
the acquired assets, the purchase agreement also provided for contingent
additional consideration, none of which was earned. See (Note 10) to
"Consolidated Financial Statements."
We believe that our cash and cash equivalents as of September 30, 2002 and our
internally generated cash flow will provide us with sufficient liquidity to meet
our currently foreseeable short-term and long-term capital needs.
Critical Accounting Policies and Estimates
- ------------------------------------------
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements.
We believe the following critical accounting policies affect the significant
judgments and estimates used in the preparation of the our financial statements:
o Revenue Recognition
o Management's estimates
o Hedging program for sales denominated in a foreign currency
o Translation of assets and liabilities denominated in non functional
currencies on our European financial statements
Revenue Recognition
- -------------------
Our revenues are primarily derived from the sale of computer boards which enable
you to view television programs on your personal computer. Sales of computer
boards are commonly classified as computer hardware. Our sales are primarily to
retailers, distributors and original equipment manufacturers. Sales to our
customers are documented by a purchase order which describes the conditions of
sale. Sales are recorded when products are shipped to our customers. The product
price is fixed and determinable, collection of the resulting receivable is
probable and product returns are reasonably estimable. Revenue from freight
charged to customers is recognized when products are shipped. Provisions for
customer returns and other adjustments are provided for in the period the
related sales are recorded based upon historical data.
30
Management's Estimates
- ----------------------
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires management to make
estimates and judgments that affect the reported amounts of assets, liabilities
and related disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts for revenues and
expenses during the reporting period. On an ongoing basis, management evaluates
estimates, including those related to sales provisions, as described above,
income taxes, bad debts, inventory reserves and contingencies. We base our
estimates on historical data, when available, experience, and on various other
assumptions that are believed to be reasonable under the circumstances, the
combined results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates.
Hedging program for sales denominated in a foreign currency
- -------------------------------------------------------------
Our European subsidiary accounts for approximately 70% to 75 % of our net sales.
All of our European sales are denominated in local currencies, primarily the
Euro. As a result of this, we are a net receiver of currencies other than the
U.S dollar. Changes in the exchange rate subject us to market risks resulting
from the fluctuation of the Euro to the U.S. dollar. In an attempt to minimize
these risks, we enter into forward exchange contracts with financial
institutions.
We do not enter into contracts for speculative purposes. We enter into monthly
window contracts covering an average period of six months based on existing or
anticipated future sales. Although we enter into these contracts to reduce the
short term impact of currency rate changes, the following risks are still
inherent in hedging the Euro sales.
o Actual sales may fluctuate from our estimates, resulting in contracts in
excess of collections
o Short term volatility of currency markets has the potential to reduce the
effectiveness of our hedging program
o Historical volatility of the Euro has the potential to impact our revenues,
gross margins and operating income
o The magnitude of the success of our hedging program is dependent upon
movements in the Euro exchange rates. These movements are difficult to predict
over an extended period of time.
Translation of assets and liabilities denominated in non functional currencies
on our European financial statements
- -------------------------------------
The functional currency of our European subsidiary is the Euro. In preparing our
consolidated financial statements, we are required to translate assets and
liabilities denominated in a non functional currency, mainly U.S. dollars, to
Euros on the books of our European subsidiary. This process results in exchange
gains and losses depending on the changes in the Euro to U.S. dollar exchange
rate. Under the relevant accounting guidance, we are obligated to include these
gains and losses on our statement of operations, which we report in other income
or expense under the caption "Non operational USD to Euro currency
re-measurement".
The extent of these gains and losses can fluctuate greatly from month to month
depending on the change in the exchange rate, causing results to vary widely.
Due to the past volatility of the Euro, it is difficult to forecast the long
term trend of these gains and losses.
31
Inflation
While inflation has not had a material effect on our operations in the past,
there can be no assurance that we will be able to continue to offset the effects
of inflation on the costs of our products or services through price increases to
our customers without experiencing a reduction in the demand for our products;
or that inflation will not have an overall effect on the computer equipment
market that would have a material affect on us.
Euro
On January 1, 1999, the Euro was adopted in Europe as the common legal currency
among 11 of the 15 member countries of the European Community. On that date, the
participating countries established fixed Euro conversion rates (i.e. the
conversion exchange rate between their existing currencies and the Euro). The
Euro now trades on currency exchanges and is available for non-cash
transactions. A new European Central Bank was established to direct monetary
policy for the participating countries.
Prior to the adoption of the Euro, we billed our European customers in German
Marks or British Pounds, depending upon which currency the customer preferred to
be billed in. Effective January 1, 1999, we began invoicing our customers who
are located in the eleven member countries in Euros. We continue to bill
customers located in the United Kingdom in British Pounds. The benefits to
billing customers in Euros were twofold:
o Our foreign currency hedging program was streamlined to the Euro and
the British Pound
o The pricing from country to country was harmonized, eliminating price
differences between countries due to the fluctuating local currencies
We handled the conversion to the Euro without any material disruptions to our
operations. See Item 7A- Market Risks.
Derivatives and Hedging Activities
We use derivatives to reduce our exposure to fluctuations in foreign currencies.
Foreign currency forward contracts, are used to hedge the foreign currency
market exposures underlying forecasted sales transactions with customers. As of
September 30, 2002, we had foreign currency contracts outstanding of
approximately $6,072,000 against the delivery of the Euro. The contracts expire
through February 2003. Our accounting policies for these instruments are based
on its designation of such instruments as cash flow hedging transactions. We do
not enter into such contracts for speculative purposes. We record all
derivatives on the balance sheet as a component of stockholders' equity under
the caption "Accumulated other comprehensive income (loss)". As of September 30,
2002, a gain of $190,919 reflecting the net translation gain of our derivatives
was recorded on the balance sheet.
For the years ended September 30, 2002 and 2001, we recorded approximately
$408,000 as a decrease to net sales and $1,119,000 as an increase to net sales
related to the changes in the fair value of our derivative contracts.
Recent Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes
Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of " and amends Accounting Principles Board Opinion No. 30, "Reporting Results
of Operations - Reporting the Effects of Disposal of a Segment of a
32
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS 144 retains the fundamental provisions of SFAS 121 for
recognition and measurement of impairment, but amends the accounting and
reporting standards for segments of a business to be disposed of. SFAS 144 is
effective for fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years. The provisions of SFAS 144 generally are to
be applied prospectively. The Company believes that the adoption of SFAS 144
will not have a material impact on the Company's financial position or results
of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB No. 13, and Technical Corrections" (SFAS NO.
145"). SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires
companies to classify certain gains and losses from debt extinguishments as
extraordinary items, eliminates the provisions of SFAS No. 44 regarding the
Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require
that certain lease modifications be treated as sale leaseback transactions. The
provisions of SFAS No. 145 related to classification of debt extinguishments are
effective for fiscal years beginning after May 15, 2002. Earlier application is
encouraged. The adoption of SFAS No. 145 is not expected to have a material
impact on the financial positions or results of operation of the Company.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. This statement also
established that fair value is the objective for initial measurement of the
liability. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company is currently
evaluating the impact, if any, of SFAS NO. 146 on its consolidated financial
statements.
Risks Factors
If TV technology for the PC or our implementation of this technology is not
accepted, we will not be able to sustain or expand our business.
Our 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 us to further expand our
business. We have invested and continue to invest significant time and resources
in the development of new products for this market.
Our:
o dependence on sales of TV and video products for the PC
o lack of market diversification
o lack of development of the market for our products
o potential inability to remain ahead of the development of
competing technologies
could each have a material adverse effect on our business, operating results and
financial condition.
We rely upon sales of a small number of product lines, and the failure of any
one product line to be successful in the market could substantially reduce our
sales.
33
We currently rely upon sales from our internal and external products, to
generate a majority of our sales. While we continue to develop additional
products within these and other product lines, there can be no assurance that we
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 our business, operating results and financial
condition.
We rely heavily on the success of dealers and OEMs to market, sell and
distribute our products. If these resellers do not succeed in effectively
distributing our products, our sales could be reduced.
These resellers may not effectively promote or market our products or they may
experience financial difficulties and even close operations. These dealers and
retailers are not contractually obligated to sell the our products. Therefore,
they may, at any time:
o refuse to promote our products and
o discontinue the our products in favor of a competitor's product.
Also, with this distribution channel standing between us and the actual end
user, we may not be able to accurately gauge current demand and anticipate
future demand for our 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.
Our 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. They also sell 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 us to the following risks, among others:
o we 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, we may be
faced with product returns or price protection obligations
o the distributors or retailers may not continue to stock and
sell our products and
o retailers and retail distributors often carry competing
products
If these resellers do not succeed in effectively distributing our products, this
could have a material adverse effect on our business, operating results and
financial condition.
We operate in a highly competitive market, and many of our competitors have much
greater resources, which may make it difficult for us to remain competitive.
Our business is subject to significant competition. Competition exists from
larger companies that possess substantially greater technical, financial, human,
sales and marketing resources than we do. The dynamics of competition in this
market involve short product life cycles, declining selling prices, evolving
industry standards and frequent new product introductions. We compete in this
emerging market against companies such as ATI Technologies, Inc. and Pinnacle
Systems, Inc., among others. We believe that competition from new entrants will
increase as the market for digital video in a PC expands. There can be no
assurance that we will not experience increased competition in the future. Such
increased competition may have a material adverse affect on our ability to
successfully market our products. Competition is expected to remain intense and,
as a result, we may lose some of our market share to our competitors. Further,
we believe that the market for our products will continue to be price
competitive and thus we could continue to experience lower selling prices, lower
gross profit margins and reduced profitability levels for such products than in
the past.
34
Rapid technological changes and short product life cycles in our industry could
harm our business.
The technology underlying our 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 our business. We will need to maintain an ongoing
research and development program, and our potential future success, of which
there can be no assurances, will depend in part on our 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. We expended approximately $1,592,000, $1,510,000,
and $1,666,000 for research and development expenses for the years ended
September 30, 2002, 2001 and 2000. There can be no assurance that our research
and development will be successful or that we will be able to foresee and
respond to such advances in technological developments and to successfully
develop additional products. Additionally, there can be no assurances that the
development of technologies and products by competitors will not render our
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 or in operating systems, it
could result in a reduction in the demand for add-on TV and video devices.
Although we believe that our software is a competitive strength, as operating
systems such as Windows move to integrate and standardize software support for
video capabilities, we will be challenged to further differentiate our products.
Our operating results and ability to retain our market share are also dependent
on continued growth in the underlying markets for PC, TV and video products.
We may not be able to timely adopt emerging industry standards, which may make
our products unacceptable to potential customers, delay our product
introductions or increase our costs.
Our 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 our products by
the market. If new standards are adopted in the industry, we will be required to
adopt those standards in our products. It may take a significant amount of time
to develop and design products incorporating these new standards, and we may not
succeed in doing so. We 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.
We are heavily dependent upon foreign markets for sales of our products,
primarily the European and Asian markets, and adverse changes in these markets
could reduce our sales.
Our future performance will likely be dependent, in large part, on our ability
to continue to compete successfully in the European and Asian markets, where a
large portion of our current and potential customers are located. Our ability to
compete in these markets will depend on many factors, including:
o the economic conditions in these regions
o the stability of the political environment in these regions
o adverse changes in the relationships between major countries in
these regions
o the state of trade relations among these regions and the United
States
35
o restrictions on trade in these regions
o the imposition or changing of tariffs by the countries in these
regions on products of the type that we sell
o changes in the regulatory environment in these regions
o export restrictions and export license requirements
o restrictions on the export of critical technology
o our ability to develop PC TV products that meet the varied
technical requirements of customers in each of these regions
o our ability to maintain satisfactory relationships with our
foreign customers and distributors
o changes in freight rates
o our ability to enforce agreements and other rights in the
countries in these regions
o difficulties in staffing and managing international operations
o difficulties assessing new and existing international markets
and credit risks
o potential insolvency of international customers and difficulty
in collecting accounts
If we are unable to address any of these factors, it could have a material
adverse effect on our business, operating results and financial condition.
We are heavily dependent upon foreign manufacturing facilities for our products,
primarily facilities in Europe and Asia, which exposes us to additional risks.
The majority of our products are built at contract manufacturing facilities in
Europe and Asia. Our ability to successfully build products at overseas
locations will depend on several factors, including:
o the economic conditions in these regions
o the stability of the political environment in these regions
o adverse changes in the relationships between major countries in
these regions
o the state of trade relations among these regions and the United
States
o restrictions on trade in these regions
o the imposition or changing of tariffs by the countries in these
regions on products of the type that we sell
o changes in the regulatory environment in these regions
o import restrictions and import license requirements
o our ability to maintain satisfactory relationships with our
foreign manufacturers
o changes in freight rates
o difficulties in staffing and managing international operations
o potential insolvency of vendors and difficulty in obtaining
materials
If we are unable to address any of these factors, it could have a material
adverse effect on our business, operating results and financial condition.
Foreign currency exchange fluctuations could adversely affect our results.
Due to extensive sales to European customers with payment made to us in those
local currencies and limited expenses paid in local currencies, we are a net
receiver of currencies other than the U.S. dollar. As such, we benefit from a
weak dollar and are negatively affected by a strong dollar relative to the major
worldwide currencies, especially the Euro and British Pound Sterling.
Consequently, changes in exchange rates expose us
36
to market risks resulting from the fluctuations in the foreign currency exchange
rates to the U.S. dollar. We attempt to reduce these risks by entering into
foreign exchange forward contracts with financial institutions to protect
against currency exchange risks associated with our foreign denominated sales.
The strength or weakness of the U.S. dollar against the Euro and British Pound
Sterling impacts our financial results. Changes in exchange rates may positively
or negatively affect our revenues, gross margins, operating income and retained
earnings (which are all expressed in U.S. dollars). We engage in hedging
programs aimed at limiting, in part, the impact of currency fluctuations. By
selling foreign currency futures, we fix the rate of exchange at the time we
enter into the contract. We deliver these currencies to the financial
institutions at a later date when we actually receive the foreign currency.
As of September 30, 2002, we had foreign currency forward contracts outstanding
of approximately $6,072,000 against delivery of the Euro. The contracts expire
through February, 2003. For the year ended September 30, 2002, we had realized
losses from foreign currency forward contracts of $408,000.
Although we do not try to hedge against all possible foreign currency exposures
because we can not fully estimate the size of our exposure, the contracts we
procure are specifically entered into to as a hedge against existing or
anticipated exposure. We do not enter into contracts for speculative purposes.
Although we maintain these programs to reduce the short term impact of changes
in currency exchange rates, when the U.S. dollar sustains a long term
strengthening position against the foreign currencies in countries where we sell
our products, our revenues, gross margins, operating income and retained
earnings can be adversely affected. Factors that could impact the effectiveness
of our hedging program include volatility of the currency markets and
availability of hedging instruments.
Additionally, there is the risk that foreign exchange fluctuations will make our
products less competitive in foreign markets, which would substantially reduce
our sales.
We may be unable to develop new products that meet customer requirements in a
timely manner.
Our success is dependent on our ability to continue to introduce new products
with advanced features, functionality and performance that our customers demand.
We 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, we may have difficulty establishing our
products' presence in markets where it does not currently have significant brand
recognition.
We may experience declining margins.
We may experience declining gross margins due to the following factors, among
others:
o changes in foreign currency exchange rates
o larger sales mix of lower margin products
o possible future reserves for excess inventory
o increases in costs charged by contract manufacturers
o increases in duty and tariff rates
o increases in shipping costs
o lower average selling prices
o increases in material acquisition costs and
o different gross margins for like products in different markets
37
Consequently, as margins may decline, our 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."
We have experienced, and expect to continue to experience, intense downward
pricing pressure on our products, which could substantially impair our operating
performance.
We are experiencing, and are likely to continue to experience, downward pricing
pressure on our products. As a result, we have experienced, and we expect to
continue to experience, declining average sales prices for our products.
Increases in the number of units that we are able to sell and reductions in per
unit costs may not be sufficient to offset reductions in per unit sales prices,
in which case our net income would be reduced and we could incur losses. Since
we typically negotiate supply arrangements far in advance of delivery dates, we
may need to commit to price reductions for our products before we are aware of
how, or if, these cost reductions can be obtained. As a result, any current or
future price reduction commitments and our inability to respond to increased
price competition could result in substantially reduced revenues and significant
losses.
We are dependent upon contract manufacturers for our production. If these
manufacturers do not meet our requirements, either in volume or quality, then we
could be materially harmed.
During fiscal 2002, we subcontracted the manufacturing and assembly of our
products to an independent third party at facilities in various countries.
Relying on subcontractors involves a number of significant risks, including:
o loss of control over the manufacturing process
o potential absence of adequate production capacity
o potential delays in production lead times
o unavailability of certain process technologies
o reduced control over delivery schedules, manufacturing yields,
quality and costs and
o unexpected increases in component costs
We may need to hold more inventory than is immediately required to compensate
for potential manufacturing disruptions.
If our significant subcontractor becomes unable or unwilling to continue to
manufacture these products in required volumes, we will have to identify
qualified alternate subcontractors. Additional qualified subcontractors may not
be available, or may not be available on a timely or cost competitive 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 our business, operating results and financial condition.
We are dependent upon single or limited source suppliers for our components. If
these suppliers do not meet the demand, either in volume or quality, then we
could be materially harmed.
If the supply of a key component were to be delayed or curtailed or in the event
a key manufacturing vendor delays shipment of completed products, our ability to
ship products in desired quantities and in a timely manner would be adversely
affected. Our business and financial performance could also be adversely
affected, depending
38
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. We attempt to mitigate these potential risks by working
closely with our key suppliers on product introduction plans, strategic
inventories, coordinated product introductions, and internal and external
manufacturing schedules and levels.
We may need to hold more inventory than is immediately required to compensate
for potential component shortages or discontinuation. This could lead to an
increase in the costs of manufacturing or assembling our products.
If any single or limited source supplier becomes unable or unwilling to continue
to supply these components in required volumes, we will have to identify and
qualify acceptable replacements or redesign our products with different
components. Additional sources may not be available, or product redesign may not
be feasible on a timely basis. Any interruption in the supply of or increase in
the cost of the components provided by single or limited source suppliers could
have a material adverse effect on our business, operating results and financial
condition.
We may incur excessive expenses if we are unable to accurately forecast sales of
our products.
We generally ship products within one to four weeks after receipt of orders.
Therefore, our sales backlog is typically minimal. Accordingly, our expectations
of future net sales and our product manufacturing and materials planning are
based largely on our own estimates of future demand and not on firm customer
orders.
If we obtain orders in excess of our internal forecasts, we may be unable to
timely increase production to meet demand which could have a material adverse
effect on our business, operating results and financial condition. If our net
sales do not meet expectations, profitability would be adversely affected, we
may be burdened with excess inventory, and we may be subject to excess costs or
inventory write-offs.
We may experience a reduction in sales if we are unable to respond quickly to
changes in the market for our products.
Our net sales can be affected by changes in the quantity of products that our
distributor and OEM customers maintain in their inventories. We may be directly
and rapidly affected by changes in the market, including the impact of any
slowdown or rapid increase in end user demand. Despite efforts to reduce
distribution channel inventory exposure, distribution partners and OEM customers
may still choose to alter their inventory levels, which could cause a reduction
in our net sales.
We may accumulate inventory to minimize the impact of shortages from
manufacturers and suppliers, which may result in obsolete inventory that we may
need to write off resulting in losses.
Managing our inventory is complicated by fluctuations in the demand for our
products as well as the issues of using contract manufacturers and procuring
components from suppliers mentioned above. As we must plan to have sufficient
quantities of products available to satisfy our customers' demands, we sometimes
accumulate inventory for a period of time to minimize the impact of possible
insufficient capacity or availability of components from our manufacturers and
suppliers. Although we expect to sell the inventory within a short period of
time, products may remain in inventory for extended periods of time and may
become obsolete because of the passage of time and the introduction of new
products or new components within existing products. In these
39
situations, we would be required to write off obsolete inventory which could
have a material adverse effect on our business, operating results and financial
condition.
We may need additional financing, and may not be able to raise additional
financing on favorable terms or at all, which could limit our ability to grow
and increase our costs.
We anticipate that we may need to raise additional capital in the future to
continue our long term expansion plans, to respond to competitive pressures or
to respond to unanticipated requirements. We cannot be certain that we will be
able to obtain additional financing on commercially reasonable terms or at all.
Our failure to obtain additional financing or inability to obtain financing on
acceptable terms could require us to limit our plans for expansion, incur
indebtedness that has high rates of interest or substantial restrictive
covenants, issue equity securities that will dilute existing stockholders'
holdings or discontinue a portion of our operations.
We may become involved in costly intellectual property disputes.
With the proliferation of new products and rapidly changing technology, there is
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 our products and development efforts, there are
risks that claims associated with such patents or intellectual property rights
could be asserted by third parties against us. We expect 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 we may have not obtained licenses may take the position that it is
required to obtain a license from them.
If a patent holder refuses to offer such a license or offers such a license on
terms unacceptable to us, there is a risk of incurring substantial litigation or
settlement costs regardless of the merits of the allegations, regardless of
which party eventually prevails. If we do not prevail in a litigation suit, we
may be required to pay significant damages and/or to cease sales and production
of infringing products and accordingly, may incur significant defense costs.
Additionally, we may need to attempt to design around a given technology,
although there can be no assurances that this would be possible or economical.
We currently use technology licensed from third parties in certain products. Our
business, financial condition and operating results could be adversely affected
by a number of factors relating to these third-party technologies, including:
o failure by a licensor to accurately develop, timely introduce,
promote or support the technology;
o delays in shipment of products;
o excess customer support or product return costs due to problems
with licensed technology; and
o termination of our relationship with such licensors.
We may be unable to enforce our intellectual property rights.
We may not be able to adequately protect our intellectual property through
patent, copyright, trademark and other means of protection. If we fail to
adequately protect our intellectual property, our intellectual property rights
may be misappropriated by others, invalidated or challenged, and our competitors
could duplicate our technology or may otherwise limit any competitive
technological advantage we may have. Due to the rapid pace of technological
change, we believe our success is likely to depend more upon continued
innovation, technical
40
expertise, marketing skills and customer support and service rather than upon
legal protection of our proprietary rights. However, we shall aggressively
assert our intellectual property rights when necessary.
Even though we typically develop our products independently, our success will
depend, in a large part, on our ability to innovate, obtain or license patents,
protect trade secrets, copyrights and trademarks and draw upon our proprietary
technology without infringing on the proprietary rights of others. We maintain
copyrights on our designs and software programs, but currently we have no patent
on the WinTV(R) board as we believe that such technology cannot be patented.
We have no patents issued or pending that relate to our technology. We are
subject to a number of risks relating to intellectual property rights, including
the following:
o the means by which we seek to protect our proprietary rights
may not be adequate to prevent others from misappropriating
our technology or from independently developing or selling
technology or products with features based on or similar to
our products
o our products may be sold in foreign countries that provide
less protection to intellectual property than is provided
under U.S. laws and
o our intellectual property rights may be challenged,
invalidated, violated or circumvented and may not provide us
with any competitive advantage.
We may not be able to attract and retain qualified managerial and other skilled
personnel.
Our success depends, in part, on our ability to identify, attract, motivate and
retain qualified managerial, technical and sales personnel. Our future success
is dependent on our ability to manage effectively the enhancement and
introduction of existing and new products and the marketing of such products. We
are particularly dependent on our ability to identify, attract, motivate and
retain qualified managers, engineers and salespersons. The loss of the services
of a significant number of engineers or sales people or one or more senior
officers or managers could be disruptive to product development efforts or
business relationships and could seriously harm our business.
We depend on a limited number of key personnel, and the loss of any of their
services could adversely affect our future growth and profitability and could
substantially interfere with our operations.
Our products are complex and our market is evolving. The success of our business
depends in large part upon the continuing contributions of our management and
technical personnel. The loss of the services of any of our key officers or
employees could adversely affect our future growth and profitability and could
substantially interfere with our operations.
Our dependence upon our key officers and employees is increased by the fact that
they are responsible for our sales and marketing efforts, as well as our overall
operations. We do not have key person life insurance policies covering any of
our employees other than Mr. Plotkin, our Chairman of the Board, President and
Chief Executive Officer and the insurance coverage that we have on him may be
insufficient to compensate us for the loss of his services.
We may not be able to effectively integrate businesses or assets that we acquire
We may identify and pursue acquisitions of complementary companies and strategic
assets, such as customer bases, products and technology. However, there can be
no assurance that we will be able to identify suitable acquisition
opportunities.
41
If any such opportunity involves the acquisition of a business, we cannot be
certain that:
o we will successfully integrate the operations of the acquired
business with our own
o all the benefits expected from such integration will be realized
o management's attention will not be diverted or divided, to the
detriment of current operations
o amortization of acquired intangible assets will not have a
negative effect on operating results or other aspects of our
business
o delays or unexpected costs related to the acquisition will not
have a detrimental effect on the combined business, operating
results and financial condition
o customer dissatisfaction with, or performance problems at, an
acquired company will not have an adverse effect on our
reputation and
o respective operations, management and personnel will be
compatible
In most cases, acquisitions will be consummated without seeking and obtaining
stockholder approval, in which case stockholders will not have an opportunity to
consider and vote upon the merits of such an acquisition. Although we will
endeavor to evaluate the risks inherent in a particular acquisition, there can
be no assurance that we will properly ascertain or assess such risks.
Our products could contain defects, which could result in delays in recognition
of sales, loss of sales, loss of market share, or failure to achieve market
acceptance, or claims against us.
We develop complex products for TV and video processing. Despite testing by our
engineers, subcontractors and customers, errors may be found in existing or
future products. This could result in, among other things, a delay in
recognition of sales, loss of sales, loss of market share, failure to achieve
market acceptance or substantial damage to our reputation. We could be subject
to material claims by customers, and may need to incur substantial expenses to
correct any product defects. We do not have product liability insurance to
protect against losses caused by defects in our products, and we also do not
have "errors and omissions" insurance. As a result, any payments that we may
need to make to satisfy our customers may be substantial and may result in a
substantial charge to earnings.
We may experience fluctuations in our future operating results, which will make
predicting our future results difficult.
Historically, our quarterly and annual operating results have varied
significantly from period to period, and we expect that our results will
continue to do so. These fluctuations result from a variety of factors,
including:
o market acceptance of our products
o changes in order flow from our customers, and their inability to
forecast their needs accurately
o the timing of our new product announcements and of announcements
by our competitors
o increased competition, including changes in pricing by us and
our competitors
o delays in deliveries from our limited number of suppliers and
subcontractors and
o difficulty in implementing effective cost management constraints
As our sales are primarily to the consumer market, we have experienced certain
seasonal revenue trends. Our peak sales quarter, due to holiday season sales of
computer equipment, is our first fiscal quarter (October to December), followed
by our second fiscal quarter (January to March). In addition, our international
sales, mostly in the European market, were 73%, 77% and 71% of sales for the
years ended September 30, 2002, 2001 and
42
2000, respectively. Our fiscal fourth quarter sales (July to September) can be
potentially impacted by the reduction of activity experienced in Europe during
the July and August summer holiday period. Accordingly, any sales or net income
in any particular period may be lower than the sales and net income in a
preceding or comparable period. Period-to-period comparisons of our results of
operations may not be meaningful, and should not be relied upon as indications
of our future performance. In addition, our operating results may be below the
expectations of securities analysts and investors in future periods. Failure to
meet such expectations, should such an event occur, will likely cause our share
price to decline.
Our common stock price is highly volatile.
The market price of our common stock has been, and may continue to be, subject
to a high degree of volatility. Numerous factors may have a significant impact
on the market price of our common stock, including:
o general conditions in the PC and TV industries
o product pricing
o new product introductions
o market growth forecasts
o technological innovations
o mergers and acquisitions
o announcements of quarterly operating results
o overall U.S. and worldwide economic health
o stability of the U.S. and worldwide securities markets
o the events of September 11, 2001
In addition, stock markets have experienced extreme price volatility and broad
market fluctuations in recent years. This volatility has had a substantial
effect on the market price of securities issued by many high technology
companies in many cases for reasons unrelated to the operating performance of
the specific companies. The price of our common stock has experienced volatility
not necessarily related to our performance.
Our principal stockholders, executive officers and directors have significant
influence over most matters submitted to a vote of the stockholders, limiting
the ability of outside stockholders to control management, and any premium over
market price that an acquirer might otherwise pay may be reduced and any merger
or takeover may be delayed.
Our principal stockholders beneficially own 20.6% of our common stock not
including presently exercisable stock options. As a result, these stockholders
may have significant influence over the outcome of most matters submitted to a
vote of stockholders, including the election of members of our board, and the
approval of significant corporate transactions. This concentration of ownership
may also impede a merger, consolidation, takeover or other business
consolidation, or discourage a potential acquirer from making a tender offer for
our stock. This concentration of ownership could also negatively affect our
stock price or decrease any premium over market price that an acquirer might
otherwise pay.
No dividends and none anticipated.
We have never paid any cash dividends on our common stock and do not contemplate
or anticipate paying any cash dividends on our common stock in the foreseeable
future. It is currently anticipated that earnings, if any, will be used to
finance the development and expansion of the business.
From time to time, information provided by us, statements made by our employees
or information provided in our Securities and Exchange Commission filings,
including information contained in this Form 10-K, may contain forward looking
information. Our actual future results may differ materially from those
projections or
43
statements made in such forward looking information as a result of various risks
and uncertainties, including but not limited to rapid changes in technology,
lack of funds for research and development, competition, proprietary patents and
rights of others, loss of major customers, loss of sources of supply for our
components, non-availability of management, government regulation, currency
fluctuations and our inability to profitably sell our products. The market price
of our common stock may be volatile at times in response to fluctuation in our
quarterly operating results, changes in analysts' earnings estimates, market
conditions in the computer hardware industry, seasonality of the business cycle,
as well as general conditions and other external factors.
Market Risks
- ------------
Due to extensive sales to European customers with payment made to us in those
local currencies and limited expenses paid in local currencies, we are a net
receiver of currencies other than the U.S. dollar. As such, we benefit from a
weak dollar and are negatively affected by a strong dollar relative to the major
worldwide currencies, especially the Euro and British Pound Sterling.
Consequently, changes in exchange rates expose us to market risks resulting from
the fluctuations in the foreign currency exchange rates to the U.S. dollar. We
attempt to reduce these risks by entering into foreign exchange forward
contracts with financial institutions to protect against currency exchange risks
associated with our foreign denominated sales.
The strength or weakness of the U.S. dollar against the Euro and British Pound
Sterling impacts our financial results. Changes in exchange rates may positively
or negatively affect our revenues, gross margins, operating income and retained
earnings (which are all expressed in U.S. dollars). We engage in hedging
programs aimed at limiting, in part, the impact of currency fluctuations. By
selling foreign currency futures, we fix the rate of exchange at the time we
enter into the contract. We deliver these currencies to the financial
institutions at a later date when we actually receive the foreign currency. For
the years ended September 30, 2002 and 2001, we recorded approximately $408,000
as a decrease to net sales and $1,119,000 as an increase to net sales related to
the changes in the fair value of our derivative contracts.
Although we do not try to hedge against all possible foreign currency exposures
because we can not fully estimate the size of our exposure, the contracts we
procure are specifically entered into to as a hedge against existing or
anticipated exposure. We do not enter into contracts for speculative purposes.
Although we maintain these programs to reduce the short term impact of changes
in currency exchange rates, when the U.S. dollar sustains a long term
strengthening position against the foreign currencies in countries where we sell
our products, our revenues, gross margins, operating income and retained
earnings can be adversely affected. Factors that could impact the effectiveness
of our hedging program include volatility of the currency markets and
availability of hedging instruments.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
See Consolidated Financial Statements annexed hereto.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
----------------------------------------------------------------
None
44
PART III
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 our Proxy Statement to be filed within 120 days of September
30, 2002 and are incorporated herein by reference.
Item 14. Controls and Procedures
-----------------------
The Company's Chief Executive Officer and Chief Financial Officer have
concluded, based on their evaluation as of a date within 90 days prior to the
filing date of this report, that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in the reports filed or submitted by it under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms, and include controls and procedures designed to
ensure that information required to be disclosed by the Company in such reports
is accumulated and communicated to the Company's management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
such evaluation including any corrective actions with regard to significant
deficiencies and material weaknesses.
45
PART IV
-------
Item 15. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit
Number
- ------
3.1 Certificate of Incorporation, as amended to date (1)
3.2 By-laws, as amended to date (3)
4.1 Form of Common Stock Certificate (1)
4.2 1994 Incentive Stock Option Plan (1)
4.3 1996 Non-Qualified Stock Option Plan (5)
4.4 1998 Incentive Stock Option Plan (6)
4.5 2000 Hauppauge Digital Inc. Performance and Equity Incentive Plan(7)
4.6 Hauppauge Digital Inc. Employee Stock Purchase Plan (8)
4.7 Stockholder Rights Plan (9)
10.1 Form of Employment Agreement with Kenneth Plotkin(4)
10.2 Lease dated February 7, 1990 between Ladokk Realty Company and
Hauppauge Computer Works, Inc.(1)
10.2.1 Modification made February 1, 1996 to lease dated 1990 between LADOKK
Realty and Hauppauge Computer Works, Inc. (2)
10.3 Long Island Development Corporation ("LIDC") Mortgage Loan
Agreements(1)
10.4 The Company's Guaranty of LIDC Loan Agreements (1)
10.5 Shawmut Mortgage Loan Agreements (1)
10.6 The Company's Guaranty of the Shawmut Mortgage Loan Agreements (1)
10.7 Master Purchase Agreement between Reuters Ltd. and Hauppauge Computer
Works Inc. (1)
10.8 Security Agreement by and between The Chase Manhattan Bank and
Hauppauge Computer Works, Ltd., dated July 12, 2000 (10)
10.9 Security Agreement by and between The Chase Manhattan Bank and HCW
Distributing Corp., dated July 12, 2000 (10)
10.10 Security Agreement by and between The Chase Manhattan Bank and
Hauppauge Computer Works, Gmbh, dated July 12, 2000 (10)
10.11 Security Agreement by and between The Chase Manhattan Bank and
Hauppauge Digital Europe S.a.r.l., dated July 12, 2000 (10)
10.12 Security Agreement by and between The Chase Manhattan Bank and
Hauppauge Computer Works S.a.r.l , dated July 12, 2000 (10)
10.13 Security Agreement by and between The Chase Manhattan Bank and
Hauppauge Digital Asia Pte. Ltd., dated July 12, 2000 (10)
10.14 Security Agreement by and between The Chase Manhattan Bank and
Hauppauge Digital, Inc., dated July 12, 2000 (10)
10.15 Security Agreement by and between The Chase Manhattan Bank and
Hauppauge Computer Works, Inc., dated July 12, 2000 (10)
10.16 Guaranty by and between Hauppauge Digital, Inc. and Hauppauge Computer
Works, Inc. and The Chase Manhattan Bank, dated July 12, 2000 (10)
10.17 Grid Promissory Note by and between Hauppauge Digital, Inc. and
Hauppauge Computer Works, Inc. and The Chase Manhattan Bank, dated
April 5, 2001 (11)
21 Subsidiaries of the Company
23 Consent of BDO Seidman, LLP
1. Denotes document filed as an Exhibit to the Company's Registration
Statement on Form SB-2 (No. 33-85426), as amended, effective January
10, 1995 and incorporated herein by reference.
2. Denotes document filed as an Exhibit to the Company's Form 10-KSB for
September 30, 1996 and incorporated herein by reference.
3. Denotes document filed as an Exhibit to the Company's Form 8K dated
August 22, 2001 and incorporated herein by reference.
4. Denotes document filed as an Exhibit to the Company's Form 10-KSB for
September 30, 1998 and incorporated herein by reference.
5. Denotes document filed as an Exhibit to the Company's definitive Proxy
Statement pursuant to Section 14 (a) of the Securities Exchange Act of
1934, as filed on January 22, 1997, and incorporated herein by
reference.
6. Denotes document filed as an Exhibit to the Company's definitive Proxy
Statement pursuant to Section 14 (a) of the Securities Exchange Act of
1934, as filed on January 27, 1998 and incorporated herein by
reference.
7. Denotes document filed as an Exhibit to the Company's Registration
Statement on Form S-8 (no. 333-46906), and incorporated herein by
reference.
8. Denotes document filed as an Exhibit to the Company's Registration
Statement on Form S-8 (no. 333-46910), and incorporated herein by
reference.
9. Denotes document filed as an Exhibit to the Company's Form 8-K dated
July 20, 2001 and as an Exhibit to the Company's Registration Statement
on Form 8-A12G and incorporated herein by reference.
10. Denotes documents filed as an Exhibit to the Company's Form 10-K for
September 30, 2000, and incorporated herein by reference.
11. Denotes document filed as an Exhibit to the Company's Form 10-K for
September 30, 2001, and incorporated herein by reference.
(b) Reports on form 8K
The Company filed two Forms 8K during the fourth quarter of the fiscal year
ended September 30, 2001 - on July 20, 2001 and August 22, 2001.
47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HAUPPAUGE DIGITAL INC.
By:/s/ Kenneth Plotkin Date: December 27, 2002
----------------------------- -------------------
KENNETH PLOTKIN
Chief Executive Officer
By:/s/ Gerald Tucciarone Date: December 27, 2002
----------------------------- -------------------
GERALD TUCCIARONE
Treasurer and Chief Financial
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
By:/s/ Clive R. Holmes Date: December 27, 2002
----------------------------- -------------------
CLIVE R. HOLMES
Director
By:/s/ Kenneth Plotkin Date: December 27, 2002
----------------------------- -------------------
KENNETH PLOTKIN
Director
By:/s/ Steven J. Kuperschmid Date: December 27, 2002
----------------------------- -------------------
STEVEN J. KUPERSCHMID
Chief Executive Officer
Director
By:/s/ Bernard Herman Date: December 27, 2002
----------------------------- -------------------
BERNARD HERMAN
Director
48
CERTIFICATIONS
I, KENNETH PLOTKIN, certify that:
1. I have reviewed this annual report on Form 10-K of HAUPPAUGE DIGITAL, INC.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By: /s/ Kenneth Plotkin Date: December 27, 2002
--------------------------- -------------------------
KENNETH PLOTKIN
Chief Executive Officer and Director
49
I, GERALD TUCCIARONE, certify that:
1. I have reviewed this annual report on Form 10-K of HAUPPAUGE DIGITAL, INC.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By:/s/ Gerald Tucciarone Date: December 27, 2002
-------------------------- ---------------------
GERALD TUCCIARONE
Treasurer and Chief Financial Officer
* Provide a separate certification for each principal executive officer and
principal financial officer of the registrant. See Rules 13a-14 and 15d-14. The
required certification must be in the exact form set forth above.
50
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page(s)
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets as of September 30, 2002 and 2001 F-3
Consolidated Statements of Operations
for the years ended September 30, 2002, 2001 and 2000 F-4
Consolidated Statements of Other Comprehensive Income (loss)
for the years ended September 30, 2002, 2001 and 2000 F-5
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 2002, 2001 and 2000 F-6
Consolidated Statements of Cash Flows for the years ended
September 30, 2002, 2001 and 2000 F-7
Notes to Consolidated Financial Statements F-8 to F-24
Report of Independent Certified Public Accountants F-25
Schedule II Valuation and Qualifying Accounts-Allowance for Doubtful Accounts F-26
Schedule II Valuation and Qualifying Accounts-Reserve for Obsolete
and Slow Moving Inventory F-27
Schedule II Valuation and Qualifying Accounts-Reserve for Sales Returns F-28
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
Hauppauge Digital, Inc. and Subsidiaries
Hauppauge, New York
We have audited the accompanying consolidated balance sheets of Hauppauge
Digital, Inc. and Subsidiaries as of September 30, 2002 and 2001 and the related
consolidated statements of operations, other comprehensive income (loss),
stockholders' equity and cash flows for each of the three years in the period
ended September 30, 2002. These financial statements are the responsibility of
the management of Hauppauge Digital, Inc. and Subsidiaries. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hauppauge Digital,
Inc. and Subsidiaries as of September 30, 2002 and 2001 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2002 in conformity with accounting principles generally accepted
in the United States of America.
/s/ BDO Seidman, LLP
- --------------------
BDO Seidman, LLP
Melville, New York
December 6, 2002
F-2
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, September 30,
2002 2001
----------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 4,964,522 $ 4,422,239
Accounts receivable, net of various allowances of $2,887,000 and
$2,867,000 5,182,738 4,243,594
Income taxes receivable 501,000 501,000
Inventories 8,091,495 8,171,567
Prepaid expenses and other current assets 416,734 518,265
-------------------------------------
Total current assets 19,156,489 17,856,665
Property, plant and equipment, net 611,054 825,847
Other intangible assets-net - 16,400
Security deposits and other non current assets 78,616 85,228
-------------------------------------
$ 19,846,159 $ 18,784,140
=====================================
LIABILITIES AND STOCKHOLDERS' EQUITY :
Current Liabilities:
Accounts payable $ 6,105,588 $ 5,732,971
Accrued expenses 1,442,475 1,585,023
Income taxes payable 331,484 280,528
-------------------------------------
Total current liabilities 7,879,547 7,598,522
Stockholders' Equity
Common stock $.01 par value; 25,000,000 shares authorized,
9,392,164 and 9,364,359 issued, respectively 93,923 93,644
Additional paid-in capital 12,233,170 12,164,243
Retained earnings 914,019 566,497
Accumulated other comprehensive income ( loss) 187,074 (267,204)
Treasury Stock, at cost, 514,317, and 465,086 shares, respectively (1,461,574) (1,371,562)
-------------------------------------
Total stockholders' equity 11,966,612 11,185,618
-------------------------------------
$ 19,846,159 $ 18,784,140
=====================================
See accompanying notes to consolidated financial statements
F-3
HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended September 30,
--------------------------------------------
2002 2001 2000
--------------------------------------------
Net sales $42,796,726 $50,910,463 $66,292,491
Cost of sales 31,661,073 42,056,859 54,424,998
--------------------------------------------
Gross Profit 11,135,653 8,853,604 11,867,493
Selling, general and administrative expenses 9,069,045 10,282,474 12,231,613
Research & development expenses 1,591,551 1,510,092 1,665,600
Write off of goodwill - 701,919 -
Litigation settlement - 212,500 -
--------------------------------------------
Income (loss) from operations 475,057 (3,853,381) (2,029,720)
Other Income (expense):
Interest income 34,781 42,137 104,485
Interest expense - (30,833) (15,134)
Life insurance proceeds - 2,000,000 -
Foreign currency 4,750 6,740 (242,479)
Non operational USD to Euro currency re-measurement (98,066) (15,863) -
Other, net - - (439)
--------------------------------------------
Total other (expense) income (58,535) 2,002,181 (153,567)
--------------------------------------------
Income (loss) before taxes on income 416,522 (1,851,200) (2,183,287)
Income tax provision (benefit) 69,000 749,497 (1,184,072)
--------------------------------------------
Income (loss) before cumulative effect of a change in accounting principle 347,522 (2,600,697) (999,215)
Cumulative effect of a change in accounting principle - 319,000 -
--------------------------------------------
Net income (loss) $347,522 ($2,281,697) ($999,215)
============================================
Per share results-basic and diluted:
Income (loss) before cumulative effect of a change in accounting principle $0.04 ($0.29) ($0.11)
Cumulative effect of a change in accounting principle - $0.03 -
--------------------------------------------
Net income (loss) per share-basic and diluted $0.04 ($0.26) ($0.11)
============================================
See accompanying notes to consolidated financial statements
F-4
HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)
Years ended September 30,
2002 2001 2000
---- ---- ----
Other comprehensive income (loss):
Net income (loss) $ 347,522 $ (2,281,697) $ (999,215)
Foreign currency translation gain (loss) 454,278 (267,204) -
--------------------------------------------
Other comprehensive income (loss) $ 801,800 $ (2,548,901) $ (999,215)
============================================
F-5
See accompanying notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
Common Stock
----------------------
Accumulated
Number Additional Other
Of Paid-in Retained Comprehensive Treasury
Shares Amount Capital Earnings Income (loss) Stock Total
----------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1999 9,120,604 $ 91,206 $ 10,650,605 $ 3,847,409 $ - $(1,267,129)$13,322,091
Net( loss) for the year ended September 30, 2000 - - - (999,215) - - (999,215)
Exercise of Stock Options 190,274 1,903 452,830 - - (66,935) 387,798
Tax benefit related to stock options exercised
by employees - - 883,000 - - - 883,000
Compensation in options for consulting services - - 38,004 - - - 38,004
Stock issued to pay bonuses 1,700 17 21,982 - - - 21,999
----------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2000 9,312,578 $ 93,126 $ 12,046,421 $ 2,848,194 - $(1,334,064)$13,653,677
Net (loss) for the year ended September 30,
2001 - - - (2,281,697) - - (2,281,697)
Purchase of treasury stock - - - - - (37,498) (37,498)
Exercise of Stock Options 11,000 110 15,712 - - - 15,822
Foreign currency translation loss - - - - (267,204) - (267,204)
Compensation in options for consulting services - - 38,004 - - - 38,004
Stock issued to pay bonuses 800 8 1,755 - - - 1,763
Stock issued through Employee Stock Purchase plan 39,981 400 62,351 - - - 62,751
----------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2001 9,364,359 $ 93,644 $ 12,164,243 $ 566,497 $(267,204) $(1,371,562)$11,185,618
Net income for the year ended September 30,
2002 - - - 347,522 - - 347,522
Purchase of treasury stock - - - - - (90,012) (90,012)
Foreign currency translation gain - - - - 454,278 - 454,278
Compensation in options for consulting services - - 38,000 - - - 38,000
Stock issued through Employee Stock Purchase plan 27,805 279 30,927 - - - 31,206
----------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2002 9,392,164 $ 93,923 $ 12,233,170 $ 914,019 $187,074 $(1,461,574)$11,966,612
==================================================================================
See accompanying notes to consolidated financial statements
F-6
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30,
2002 2001 2000
---------------------------------------------------------
Cash Flows From Operating Activities:
Net (loss), income $ 347,522 $(2,281,697) $(999,215)
---------------------------------------------------------
Adjustments to reconcile net (loss) income to net cash
Provided by (used in) operating activities:
Depreciation and amortization 318,801 1,102,357 265,904
Provision for uncollectible accounts receivable 20,000 10,000 30,000
Provision for inventory reserve (386,409) 1,862,776 1,000,000
Deferred tax expense (benefit) - 1,082,797 (790,723)
Tax benefit related to options exercised by employees - - 883,000
Other non cash items 44,212 39,768 60,003
Changes in current assets and liabilities:
Accounts receivable (504,866) 1,652,195 770,459
Income taxes receivable - 995,045 (1,496,045)
Inventories 466,481 2,255,632 (332,536)
Prepaid expenses and other current assets 101,531 (61,834) (48,515)
Other assets - - (15,009)
Accounts payable 372,617 (4,748,743) (727,063)
Accrued expenses and income taxes (91,592) 871,068 (2,017,234)
---------------------------------------------------------
Total adjustments 340,775 5,061,061 (2,417,759)
---------------------------------------------------------
Net cash provided by (used in) operating activities 688,297 2,779,364 (3,416,974)
---------------------------------------------------------
Cash Flows From Investing Activities:
Purchases of property, plant and equipment (87,208) (143,055) (449,304)
Business acquisition, net of cash acquired - - (899,587)
---------------------------------------------------------
Net cash used in investing activities (87,208) (143,055) (1,348,891)
---------------------------------------------------------
Cash Flows From Financing Activities:
Loan repayments - (1,000,000) -
Proceeds from loan - - 1,000,000
Proceeds from employee stock purchases 31,206 78,573 387,798
Purchase of treasury stock (90,012) (37,498) -
---------------------------------------------------------
Net cash (used in) provided by financing activities (58,806) (958,925) 1,387,798
---------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 542,283 1,677,384 (3,378,067)
Cash and cash equivalents, beginning of year 4,422,239 2,744,855 6,122,922
---------------------------------------------------------
Cash and cash equivalents, end of year $ 4,964,522 $ 4,422,239 $ 2,744,855
=========================================================
Supplemental disclosures:
Interest paid $ - $ 24,546 $ 8,180
Income taxes paid $ 31,948 $ 4,506 $ 503,217
=========================================================
Supplemental disclosure of non cash financing activities:
Shares exchanged for exercise of stock options - - $ 66,935
=========================================================
F-7
See accompanying notes to consolidated financial statements
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Hauppauge Digital,
Inc. and its wholly-owned subsidiaries, Hauppauge Computer Works, Inc., HCW
Distributing Corp., Eskape Acquisition Corporation and Hauppauge Digital Europe
S.a.r.l. and its wholly-owned subsidiaries, Hauppauge Digital Asia Pte Ltd,
Hauppauge Computer Works, GmbH, Hauppauge Computer Works, Ltd., and Hauppauge
Computer Works S.a.r.l. All inter-company accounts and transactions have been
eliminated.
Nature of Business
The Company is primarily engaged in the design, manufacture and marketing of
WinTV(R) video computer boards and video conferencing boards. The Company relies
primarily upon one subcontractor with locations in Hungary and Malaysia to
manufacture its products. WinTV(R) boards convert moving video images from cable
TV, video cameras or a VCR to a digital format which is displayed in a sizable
window on a PC monitor. These video images can be viewed simultaneously with
normal PC operations such as word processing programs and spreadsheet
applications. The WinTV(R) board is marketed worldwide through retailers,
distributors, original equipment manufacturers and manufacturers'
representatives. Net sales to international and domestic customers were
approximately 73% and 27%, 77% and 23%, and 71% and 29% of total sales for the
years ended September 30, 2002, 2001 and 2000, respectively. The Company
operates in one segment. It maintains sales offices in both Europe and Asia.
Net sales to customers by geographic location consist of:
Years ended September 30,
Sales to: 2002 2001 2000
- ----------- ----- ---- ----
United States 27% 23% 29%
Germany 37% 41% 40%
United Kingdom 14% 12% 11%
France 8% 6% 5%
Asia 2% 7% 4%
Italy 2% 2% -
Netherlands 2% 1% 1%
Other Countries 8% 8% 10%
--- -- --
Total 100% 100% 100%
Net long lived assets located in the United States Europe and Asia locations
were approximately 73%, 22% and 5% of total net long lived assets, respectively,
at September 30, 2002, and 78%, 16% and 6% , respectively , at September 30,
2001.
Use of Estimates
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. The Company
F-8
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
reviews all significant estimates affecting the financial statements on a
recurring basis and records the effect of any adjustments when necessary.
Cash and Cash Equivalents
For the purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with an original maturity date of three
months or less to be cash equivalents.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of cash and accounts receivable. At times such
cash in banks are in excess of the FDIC insurance limit. Concentration of credit
risk with respect to accounts receivable exists because the Company operates in
one industry (also see Note 7). Although the Company operates in one industry
segment, it does not believe that it has a material concentration of credit risk
either from an individual counter party or a group of counter parties, due to
the large and diverse user group for its products. The Company performs ongoing
credit evaluations of its customers and generally does not require collateral.
The Company maintains allowances to cover potential or anticipated losses for
uncollectible amounts.
Shipping and Handling Costs
The Company records all shipping and handling charges in Cost of Sales.
Revenue Recognition
The Company records revenue when its products are shipped (FOB shipping point).
The Company generally has no significant post delivery obligations, the product
price is fixed and determinable, collection of the resulting receivable is
probable and product returns are reasonably estimated. Provisions for estimated
sales allowances and returns are accrued at the time revenues are recognized
based on historical experience. The sales return reserve is evaluated on a
quarterly basis. Adjustments to these estimates are made in the period of the
product return.
Price protection is typically granted to the Company's distributors on their
existing inventory if the Company reduces the sales price on current product
offerings. At the time of a price reduction, the Company accrues a charge
against sales for the difference between the value of the distributor's
inventory at its new price compared to the distributor's inventory at its
original cost.
Warranty Policy
The Company warrants that its products are free from defects in material and
workmanship for a period of one year from the date of initial retail purchase.
The warranty does not cover any losses or damage that occur as a result of
improper installation, misuse or neglect and repair or modification by anyone
other than the Company or its authorized repair agent. The Company accrues
anticipated warranty costs based upon historical percentages of items returned
for repair within one year of the initial sale.
F-9
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventories
Inventories are valued at the lower of cost (principally average cost) or
market. A reserve has been provided to reduce obsolete and/or excess inventory
to its net realizable value.
Property, Plant and Equipment
Depreciation of office equipment and machinery and amortization of leasehold
improvements is provided for using both accelerated and straight line methods
over the estimated useful lives of the related assets as follows:
Office Equipment and Machinery: 5 to 7 years
Leasehold improvements: Asset life or lease term, whichever is shorter
Goodwill and intangibles assets
The net assets of businesses purchased have been recorded at their fair value at
the acquisition date, and the consolidated financial statements include their
operations from that date. Any excess of acquisition costs over the fair value
of identifiable net assets acquired is included in goodwill and is amortized on
a straight line basis over periods not exceeding 10 years. (See Note 10)
Income taxes
The Company follows the liability method of accounting for income taxes.
Deferred income taxes are recorded to reflect the temporary differences in the
tax bases of the assets or liabilities and their reported amounts in the
financial statements.
Long-Lived Assets
Long-lived assets, such as property and equipment and goodwill, are evaluated
for impairment when events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable through the estimated
undiscounted future cash flows from the use of these assets. When any such
impairment exists, the related assets will be written down to fair value. (See
Note 10)
Research and Development
Expenditures for research and development are charged to expense as incurred.
Foreign Currency Translations and Transactions
The Company's Asian subsidiary reports its financial position and results of
operations in the reporting currency of the Company.
The financial position and results of operations of the Company's European
subsidiaries are determined using Euros as the functional currency. Certain
assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each year end. Euro-denominated income statement accounts that
pertain to sales are translated at the average monthly forward exchange contract
rate. Currencies other than Euros (primarily British Pound Sterling) and Euro
accounts other than sales are translated at the average prevailing exchange rate
during the year. Translation adjustments arising from the translation to U.S.
dollars at differing exchange rates are included in the accumulated other
comprehensive income (loss) account in stockholders' equity. Gains and losses
resulting from transactions that are denominated in currencies other than Euros
are included in earnings as a component of other income. During the year ended
September 30, 2002 and 2001, the Company recorded a credit to stockholders'
equity of $215,142 for an other comprehensive gain and a charge to stockholders'
equity for an other comprehensive loss of $218,987, respectively, related to the
translation of foreign financial statements. Prior to September 30, 2000, the
Company maintained its functional currency in U.S. dollars.
F-10
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Derivatives and Hedging Activities
The Company uses derivatives to reduce its exposure to fluctuations in foreign
currencies. Derivative products, such as foreign currency forward contracts, are
used to hedge the foreign currency market exposures underlying forecasted sales
transactions with customers. The Company's accounting policies for these
instruments are based on its designation of such instruments as cash flow
hedging transactions. The Company does not use derivative instruments for
purposes other than hedging. All open derivative contracts are recorded on the
balance sheet under accounts receivable at fair value. Prior to July 1, 2002,
the Company did not qualify for cash flow hedge accounting under FAS 133,
therefore material gains or losses were recroded through operations. As of
September 30, 2002, appearing in the equity section under "Accumulated other
comprehensive income (loss)" was a deferred gain of $190,919 on open foreign
currency contracts. The Company recognizes gains and losses on closed derivative
contracts as an adjustment to net sales.
For derivative instruments that are designated and qualify as a fair value hedge
(i.e., hedging the exposure to changes in the fair value of an asset or a
liability or an identified portion thereof that is attributable to a particular
risk), the gain or loss on the derivative instrument as well as the offsetting
gain or loss on the hedged item attributable to the hedged risk are recognized
in earnings in the current period. For derivative instruments that are
designated and qualify as a cash flow hedge (i.e., hedging the exposure of
variability in expected future cash flows that is attributable to a particular
risk), the effective portion of the gain or loss on the derivative instrument is
reported as a component of Accumulated Other Comprehensive Income (Loss) (a
component of stockholders' equity) and reclassified into earnings in the same
period or periods during which the hedged transaction affects earnings. The
remaining gain or loss on the derivative instrument, if any (i.e. the
ineffective portion and any portion of the derivative excluded from the
assessment of effectiveness) is recognized in earnings in the current period.
For derivative instruments not designated as hedging instruments, changes in
their fair values are recognized in earnings in the current period.
The effect of implementing SFAS No.133, "Accounting for Derivative Instruments
and Hedging Activities", which was adopted on October 1, 2000, is presented in
this annual report on form 10-K as a cumulative effect of a change in accounting
principle.
Fair Value of Financial Instruments
The carrying amounts of certain financial instruments, including cash, accounts
receivable and accounts payable, approximate fair value as of September 30, 2002
and 2001 because of the relatively short term maturity of these instruments.
F-11
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net income (loss) per share
Basic net income (loss) per share includes no dilution and is computed by
dividing net income (loss) by the weighted average number of common shares
outstanding for the period. Diluted net income (loss) per share reflect, in
periods in which they have a dilutive effect, the dilution which would occur
upon the exercise of stock options. A reconciliation of the shares used in
calculating basic and diluted earnings (loss) per share follows:
Years ended September 30,
2002 2001 2000
---- ---- ----
Weighted average shares outstanding-basic 8,887,107 8,910,117 8,837,256
Common stock equivalents-stock options 115,043 - -
---------- --------- ---------
Weighted average shares outstanding-diluted 9,002,150 8,910,117 8,837,256
========== ========= =========
Options to purchase 825,322, 1,827,326 and 1,610,226 shares of common stock at
prices ranging $2.07 to $10.06, $1.05 to $10.06 and $1.35 to $10.06,
respectively, were outstanding as of September 30, 2002, 2001 and 2000, but were
not included in the computation of diluted net income (loss) per share because
they were anti-dilutive.
Stock Based Compensation
The Company accounts for its stock option awards under the intrinsic value based
method of accounting as prescribed by APB Opinion Number 25, "Accounting for
Stock Issued to Employees". Under the intrinsic value based method, compensation
cost is the excess, if any, of the quoted market price of the stock at grant
date or other measurement date over the amount an employee must pay to acquire
the stock. The Company discloses the pro forma impact on net income and earnings
per share as if the fair value based method had been applied as required by SFAS
No. 123, "Accounting for Stock Based Compensation".
Recent Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes
Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" and amends Accounting Principles Board Opinion No. 30, "Reporting Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS
144 retains the fundamental provisions of SFAS 121 for recognition and
measurement of impairment, but amends the accounting and reporting standards for
segments of a business to be disposed of. SFAS 144 is effective for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years. The provisions of SFAS 144 generally are to be applied prospectively. The
Company believes that the adoption of SFAS 144 will not have a material impact
on the Company's financial position or results of operations.
F-12
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB No. 13, and Technical Corrections" (SFAS NO.
145"). SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires
companies to classify certain gains and losses from debt extinguishments as
extraordinary items, eliminates the provisions of SFAS No. 44 regarding the
Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require
that certain lease modifications be treated as sale leaseback transactions. The
provisions of SFAS No. 145 related to classification of debt extinguishments are
effective for fiscal years beginning after May 15, 2002. Earlier application is
encouraged. The adoption of SFAS No. 145 is not expected to have a material
impact on the financial positions or results of operation of the Company.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. This statement also
established that fair value is the objective for initial measurement of the
liability. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company is currently
evaluating the impact, if any, of SFAS NO. 146 on its consolidated financial
statements.
2. Inventories
Inventories consist of the following:
September 30,
2002 2001
---- ----
Component Parts $2,842,460 $2,421,420
Work in Process 42,616 92,070
Finished Goods 5,206,419 5,658,077
--------- ---------
$8,091,495 $8,171,567
========== ==========
In recognition of the sales decline experienced in during fiscal 2001, which
primarily occurred in the third and fourth quarters of fiscal 2001, slower sales
of older product lines and engineering changes to products during the latter
part of fiscal 2001, the Company reviewed the net realizable value of its
inventory. The Company deemed it necessary to increase its reserve for obsolete
and slow moving inventory. An additional reserve of approximately $1,863,000 was
recognized during the fourth quarter of fiscal 2001 and charged to cost of
sales. During fiscal 2002, the Company recorded a net reduction to cost of sales
of $386,000 for adjustments to inventory reserves to operations of $386,000 for
inventory obsolescence.
3. Property, Plant and Equipment
The following is a summary of property, plant and equipment:
September 30,
2002 2001
---- ----
Office Equipment and Machinery $1,885,094 $1,814,859
Leasehold Improvements 76,622 69,413
---------- ----------
1,961,716 1,884,272
Less: Accumulated depreciation and amortization 1,350,662 1,058,425
---------- ---------
$ 611,054 $ 825,847
---------- ----------
Depreciation expense totaled $ 302,401, $ 294,234 and $ 230,421 for the total
years ended September 30, 2002, 2001 and 2000, respectively.
F-13
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Income Taxes
The Company's income tax provision consists of the following:
Years ended September 30,
2002 2001 2000
---- ---- ----
Current tax expense (benefit):
Federal income tax (benefit) $ - $ (439,985) $ (473,452)
State income taxes (benefit) - (61,015) (46,897)
Foreign income taxes 69,000 167,700 127,000
------ ------- -------
Total current 69,000 (333,300) (393,349)
------ -------- --------
Deferred tax expense (benefit)
Federal - 969,103 (707,489)
State - 113,694 (83,234)
------ -------- --------
Total deferred - 1,082,797 (790,723)
------ --------- ---------
Total taxes on income $ 69,000 $ 749,497 $(1,184,072)
======== ========== ===========
Components of deferred taxes are as follows:
Years ended September 30,
2002 2001
---- ----
Deferred tax
assets:
Net operating loss carry forwards $2,217,931 $1,221,034
Tax credit carry forward 150,000 150,000
Inventory reserves 1,019,329 1,254,000
Warranty reserve 9,158 8,132
Allowance for doubtful accounts 76,853 69,253
Deferred rent payments 41,632 41,632
Capitalized inventory costs 259,835 146,710
Sales return reserve 289,826 289,826
Goodwill amortization 277,065 -
Other reserves (44,039) (58,295)
-------- ---------
Total deferred assets 4,297,590 3,122,292
Valuation allowance (4,297,590) (3,122,292)
--------- ----------
Net deferred assets - -
========= ==========
F-14
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2002, the Company had $125,295 of restricted net operating
losses, (which expire in the years through 2010) and $6,131,122 of unrestricted
net operating losses (which expire in 2022 and 2021) available to offset future
taxable income. As of September 30, 2001, the Company utilized $1,294,000 of the
fiscal year's net operating loss as a carry back against 1999 taxable income. As
of September 30, 2002, the Company has an income tax receivable for $501,000,
relating to the anticipated refund of taxes paid for fiscal 1999. In addition,
as of September 30, 2002, the Company has a tax credit carry forward for
research and development expenses totaling $150,000.
As of September 30, 2000, the Company was able to utilize the current year's
loss and the $883,000 benefit received from the exercise of employee stock
options to carry back the net operating loss against prior year taxes paid
totaling $ 1,496,045.
For the last three fiscal years, the Company's domestic operation has incurred
losses. On September 30, 2000, the Company's domestic operation had a deferred
tax benefit of $1,267,997. The Company analyzed the future realization of the
deferred tax asset during the fourth quarter of fiscal 2001 and it concluded
that under the present circumstances, it would be appropriate for the Company to
record a valuation allowance against the deferred tax asset and reduce certain
income tax liabilities. The net result was a charge to the Company's tax
provision for approximately $1,082,000. Due to the prior years losses, as of
September 30, 2002, the Company has recorded a valuation allowance of $4,297,590
against the deferred tax asset.
The difference between the actual income tax provision (benefit) and the tax
provision (benefit) computed by applying the Federal statutory income tax rate
of 34% to the income before income tax is attributable to the following:
Years ended September 30,
2002 2001 2000
---- ---- ----
Income tax (benefit) at federal statutory rate $ (1,040,729) $ (629,408) $ (742,318)
Increase (reduction) in deferred income tax valuation allowance 1,175,298 3,122,292 -
Reduction of prior year tax liability - (300,000) -
Permanent differences-life insurance 884 (680,000) -
Permanent differences-other 3,400 11,590 57,283
Income taxed at lower than statutory rates - (822,579) (387,418)
State income taxes, (benefit) net of federal benefit (108,481) (34,768) (85,886)
Foreign income taxes 69,000 167,700 127,000
Research and Development credit - - (150,000)
Other (30,372) (85,330) (2,733)
------- ------- ------
Taxes (benefit) on income $ 69,000 $ 749,497 $(1,184,072)
============ ========= ===========
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 functions as the entity which
services the Company's European customers. The new structure created separate
domestic and foreign tax entities, with the new Luxembourg entity paying a
license fee to the Company's domestic operation for use of the Hauppauge name.
For the years ended September 30, 2002, 2001 and 2000 the Company's domestic
operation incurred a pretax loss of $2,623,414, $3,951,550 and $3,138,484
respectively, and the Company's international operations had pretax net income
of $3,039,936, $2,419,350 and $1,139,466 respectively.
F-15
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Line of Credit
On April 5, 2001 the Company extended its agreement with Chase Manhattan Bank,
to provide it with a $6,500,000 credit facility. The facility is secured by our
assets, and expired in fiscal 2002. It is the intention of the Company to
procure a new credit facility on terms acceptable to the Company.
6. Stockholders' Equity
a. Treasury Stock
On November 8, 1996, the Company approved a stock repurchase program. The
program, as amended, authorizes the Company to repurchase up to 850,000 for the
shares of its own Common Stock. The repurchased shares will be used by the
Company for certain employee benefit programs. As of September 30, 2002 and
2001, 514,317 and 465,086 treasury shares with an accumulated cost of $1,461,574
and $ 1,371,562 and average prices of $ 2.84 and $2.95 were held by the Company
as treasury shares.
b. Stock Compensation Plans
In August 1994, the Company adopted an Incentive Stock Option Plan ("ISO"), as
defined in section 422(A) of the Internal Revenue Code. Pursuant to the ISO,
400,000 options may be granted for up to ten years with exercise prices at the
fair market value of the common stock at the date of the grant. As of September
30, 2002, 2001 and 2000, 118,500, 151,000 and 168,000 options were outstanding,
respectively, ranging in prices from $1.35 to $2.55.
On December 14, 1995, the Board of Directors authorized the adoption of the 1996
Non-Qualified Stock Option Plan (the "1996 Non-Qualified Plan") which was
approved by the Company's stockholders on March 5, 1996. The 1996 Non-Qualified
Plan authorizes the grant of 500,000 shares. The plan terminates on March 5,
2006. This plan does not qualify for treatment as an incentive stock option plan
under the Internal Revenue Code. There are various tax benefits which could
accrue to the Company upon exercise of non-qualified stock options that may not
be available to the Company upon exercise of qualified incentive stock options.
The purpose of the plan is to provide the Company greater flexibility in
rewarding key employees, consultants, and other entities without burdening the
Company's cash resources. As of September 30, 2002, 2001 and 2000, 235,404,
328,804 and 281,304 options ranging in prices from $1.35 to $10 were outstanding
under the 1996 Non-Qualified Plan.
On December 17, 1997 the Company's Board of Directors adopted and authorized a
new incentive stock option plan ("1997 ISO") pursuant to section 422A of the
Internal Revenue Code. This plan was approved by the Company's stockholders at
its March 12, 1998 annual stockholders' meeting. The 1997 ISO plan as adopted
authorizes the grant of 700,000 shares of common stock, subject to adjustment as
provided in the plan. This plan terminates on December 16, 2007. The options
terms may not exceed ten years. Options cannot be granted at less than 100% of
the market value at the time of grant. Options granted to employees who own more
the 10% of the Company's outstanding common stock cannot be granted at less than
110% of the market value at the time of grant. As of September 30, 2002, 2001
and 2000, 545,822, 603,822 and 611,722 options were outstanding with exercise
prices from $2.25 to $ 10.06.
F-16
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's Board of Directors on May 9, 2000 adopted the 2000 Performance and
Equity Incentive Plan (the "2000 Plan"). This plan was approved by the
stockholders at its July 18, 2000 annual stockholders' meeting. The purpose of
the 2000 Plan is to attract, retain and motivate key employees, directors and
non-employee consultants.
The 2000 Plan as adopted reserves 500,000 shares of common stock to be issued
pursuant to stock options grants or other awards, subject to adjustment for any
merger, reorganization, consolidation, recapitalization, stock dividend, stock
split or any other changes on corporate structure affecting the common stock.
This plan is to be administered by the Board of Directors. Grants of awards to
non-employee directors require the approval of the Board of Directors.
This plan allows the granting of options as either incentive stock options or
non-qualified options. Non-employee directors and non-employee consultants may
only be granted Non-Qualified Stock Options. Incentive stock options are priced
at the market value at the time of grant and shall be exercisable no more than
ten years after the date of the grant. Incentive stock options granted to
employees who own 10% or more of the Company's combined voting power cannot be
granted at less than 110% of the market value at the time of grant.
Non-qualified options shall be granted at a price determined by the Board of
Directors and shall be exercisable no more than 10 years and one month after the
grant. The aggregate fair market value of shares subject to an incentive stock
option granted to an optionee in any calendar year shall not exceed $100,000. As
of September 30, 2002, 2001 and 2000, 243,100, 263,700 and 69,200 shares have
been issued from this plan ranging in prices from $1.05 to $ 5.78.
The Company's Board of Directors on May 9, 2000 adopted the Employee Stock
Purchase Plan. This plan was approved by the stockholders at its July 18, 2000
annual stockholders' meeting. This plan is intended to provide the Company's
full- time employees an opportunity to purchase an ownership interest in the
Company through the purchase of common shares. The Company has reserved 100,000
common shares for issuance under the plan. This plan is to be administered by
the Board of Directors. Employees who have completed six months of employment
and who work more than 20 hours per week for more than five months in the year
are eligible to participate in the plan. The employee may elect to payroll
deductions up to 10% per pay period. The purchase price shall either be the
lower of 85% of the closing price on the offering commencement date or the
offering termination date. No employee will be granted an option to purchase
common shares if such employee would own shares or holds options to purchase
shares which would cause the employee to own more than 5% of the combined voting
power of all classes of stock. Non-employees are not eligible to participate.
This plan terminates on December 31, 2003. The maximum number of shares that may
be issued in any quarterly offering is 10,000, plus unissued shares from prior
offerings whether offered or not. At our September 6, 2002 stockholders'
meeting, our stockholders' approved an increase in shares reserved under this
plan to 180,000, and extended the plan termination date to December 31, 2004. As
of September 30, 2002 and 2001, 67,786 and 39,981 common shares were purchased
under this plan.
The Company accounts for its stock option awards under the intrinsic value based
method, as prescribed by APB Opinion 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations. Under APB 25, because the
exercise price of the employees stock options equals the market price of the
underlying stock at the date of the grant, no compensation is cost is
recognized.
SFAS Statement 123 "Accounting for Stock Based Compensation," ("SFAS 123")
requires the Company to provide pro forma information regarding net income or
(loss) and net income or (loss) per share as if compensation cost for the
Company's stock option plans had been determined in accordance with the fair
value based method prescribed in SFAS123. The fair value for these options was
estimated at the date of grant using a
F-17
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Black-Scholes option pricing model with the following weighted average
assumptions for 2002, 2001 and 2000: risk free interest rates of 3.25%, 4.25%
and 5.25%, volatility factor of the expected market price of the Company's stock
of 35%, 40% and 40% and expected lives of either five or ten years. The weighted
average fair value ranges of options granted in 2002, 2001 and 2000 were $.42,
$.57 to $1.72 and $2.27 to $4.60, respectively.
Under the accounting provisions of FASB Statement 123, the Company's net income
and earnings per share would have been reduced to the pro forma amounts
indicated below:
Years Ended September 30,
2002 2001 2000
---- ---- ----
Net income (loss):
As reported $ 347,522 $(2,281,697) $ (999,215)
Pro forma 268,061 (2,569,893) (1,283,184)
Net income (loss), per share:
As reported
Basic $ 0.04 $ (0.26) $ (0.11)
Diluted $ 0.04 $ (0.26) $ (0.11)
Pro Forma
Basic $ 0.03 $ (0.29) $ (0.15)
Diluted $ 0.03 $ (0.29) $ (0.15)
A summary of the status of the Company's fixed options plans as of September 30,
2002, 2001 and 2000 and changes during the years ending those dates is presented
below:
Weighted Weighted
Average Average
Exercise Non Exercise
ISO Price Qualified Price
--- ----- ---------- ------
Balance at September 30, 1999 891,500 $3.12 678,000 $ 2.53
Granted 111,700 6.08 43,300 5.25
Exercised (110,278) 2.33 (79,996) 2.53
Forfeited ( 44,000) 6.91 - -
--------- ---- -------- ------
Balance at September 30, 2000 848,922 $3.40 641,304 $ 2.71
Granted 194,500 1.38 47,500 3.99
Exercised (11,000) 1.43 - -
Forfeited (13,900) 4.73 - -
--------- ---- ------- -------
Balance at September 30, 2001 1,018,522 $3.02 688,804 $ 2.80
Granted 30,000 1.05 - -
Exercised - - - -
Forfeited (141,100) 3.21 (273,400) 1.81
--------- ---- --------- ----
Balance at September 30, 2002 907,422 $2.92 415,404 $ 3.45
======= ===== ======= =======
Options exercisable at September 30, 2002 493,537 $3.08 362,997 $ 2.86
======= ===== ======= =======
The following table summarizes information about stock options outstanding at
September 30, 2002:
F-18
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Options Outstanding
- ---------------------
Range of Weighted Average Weighted Options Exercisable Weighted
Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------ ----------- ---------------- -------------- ----------- --------------
$1.35 44,204 0.4 years $1.35 42,204 $1.35
1.50 30,000 3.4 1.50 30,000 1.50
1.58 180,000 3.3 1.58 180,000 1.58
1.47 1,600 0.8 1.47 1,600 1.47
1.87 33,200 0.6 1.87 33,200 1.87
2.07 9,000 1.0 2.07 6,000 2.07
2.54 90,000 0.3 2.54 90,000 2.55
2.32 60,000 5.3 2.32 60,000 2.32
2.25 124,500 0.4 2.25 63,900 2.25
3.87 10,000 1.3 3.87 10,000 3.87
10.00 50,000 1.8 10.00 30,000 10.00
3.94 250,322 1.5 3.94 133,822 3.94
2.82 60,000 1.0 2.82 60,000 2.82
8.75 20,000 1.7 8.75 12,000 8.75
10.06 10,000 2.3 10.06 4,000 10.06
5.25 59,400 2.8 5.25 33,660 5.25
5.78 34,600 2.8 5.78 13,840 5.78
3.99 47,500 3.1 3.99 28,333 3.99
1.38 178,500 3.3 1.38 23,975 1.38
1.05 30,000 4.0 - -
------ -------
1,322,826 856,534
========= =======
c. Stockholders' Rights Agreements
On July 19, 2001, the Company's Board of Directors adopted a stockholder rights
plan, as set forth in the Rights Agreement, dated as of July 20, 2001 (the
"Rights Agreement") between the Company and North American Transfer Company as
Rights Agent. Pursuant to the Rights Agreement, one Right will be issued for
each share of common stock, par value $0.01 per share, of the Company ("Common
Stock") outstanding as of August 5, 2001. Each of the Rights will entitle the
registered holder to purchase from the Company one share of Common Stock at a
price of $11.00 per share, subject to adjustment. The Rights generally will not
become exercisable unless and until, among other things, any person acquires 10%
to 12% or more of the outstanding Common Stock or makes a tender offer to
acquire 10% or more of the outstanding Common Stock. The 10% threshold will not
be applicable to institutional investors who stay below a 20% ownership level
and who report their ownership on a Schedule 13G under the Securities Exchange
Act of 1934. In addition, stockholders of more than 10% of the Common Stock as a
of July 19, 2001 will be grandfathered at a their current level plus 1% unless
they later fall below the 10% threshold. The Rights are redeemable under certain
circumstances at $0.001 per Right and will expire, unless earlier redeemed or
extended, on July 19, 2011.
7. Significant Customer Information
For the years ended September 30, 2002 and 2001 the Company had no single
customer who accounted for more than 10% of net sales. As of September 30, 2002
and 2001, the Company had fourteen customers who accounted for 79% and 58% ,
respectively of the net accounts receivable.
8. Related Party Transactions
The Company rents its principal office and warehouse space in Hauppauge, New
York from a real estate partnership owned by certain of the Company's principal
stockholders. The lease term expires on January 31, 2006 and includes an option
to extend for three additional years. The lease provides for rent increases of
5% per year. Rent is currently at the annual rate of $410,909 and will increase
to $431,454 annually as of February 1,
F-19
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2003. On December 17, 1995 in connection with a re-negotiation of the lease
term, the Company granted options to purchase 120,000 shares to a real estate
partnership partially owned by the principal stockholder at an exercise price of
$1.905 per share, which are exercisable through the lease term. The market price
of the option equaled the exercise price at the date of the grant. The effect of
imputing the fair value of the options granted was immaterial. The options were
still outstanding as of September 30, 2002.
The Company had amounts payable to this related party for unpaid rent of
$302,128 and 307,099 as of September 30, 2002 and 2001.
The indebtedness partially incurred by the principal stockholder to purchase the
building is also guaranteed by the Company and totaled $819,318 at September 30,
2002.
Minimum annual lease payments to related parties and third parties are as
follows:
Year September 30,
- -----------------
2003 664,677
2004 679,272
2005 673,673
2006 239,803
-------
Total $2,257,425
==========
Rent expense totaled approximately $442,930, $491,231 and $432,196 for the years
ended September 30, 2002, 2001 and 2000 respectively. The Company pays the real
estate taxes and it is responsible for normal building maintenance.
9. Commitments and Contingencies
a. Litigation
In the normal course of business, the Company is party to various claims and/or
litigation. Management and its legal counsel believe that the settlement of all
such claims and or/litigation, considered in the aggregate, will not have a
material adverse effect on the Company's financial position and results of
operations.
In 1997, the Company licensed a file conversion library for use in its WinTV
applications.
On June 14, 2001, the Company received notice that Accusoft Corporation had
commenced an action against the Company in the United States District Court for
the District of Massachusetts (the "District Court"), alleging that the Company:
o had infringed Accusoft's copyright in certain software in
violation of Title 17 of the United States Code
o had violated the terms of its software license by making excess
copies of the software without paying additional royalties
o used the software for unauthorized purposes
On July 31, 2001, the Company and Accusoft reached a settlement and release of
all claims against the Company in exchange for payment of the settlement amount
of $212,500.
F-20
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company been informed by counsel for the estate of the late Mr. Kenneth
Aupperle ("Estate") that it filed a Demand for Arbitration with the American
Arbitration Association claiming property rights and interest in the Company,
certain amounts due and owing to the Estate based on various corporate
agreements with Mr. Aupperle and certain insurance policies, such amount to be
no less than $2,500,000. The Company recently received a formal acknowledgement
from the American Arbitration Association of the said Demand for Arbitration and
obtained a temporary restraining order on the said arbitration proceedings.
Based on the preliminary information presented to the Company, management
believes that the claim and the basis for proceeding with arbitrating such claim
is without merit and will vigorously defend it.
b. Employment Contract
On January 10, 1998, upon the expiration of a prior employment agreement, the
Company's chief executive officer entered into a new employment agreement with
the Company. The term of the employment agreement was for three years, which is
automatically renewed each year unless otherwise not authorized by the Board of
Directors. The agreement provides the chief executive officer with an annual
base salary of $125,000, $150,000 and $180,000 for the first, second and third
year of the contract. For each annual year thereafter, compensation shall be
mutually determined, but cannot be less that the preceding year. The contract
also provides for a bonus of 2% of operating income (income from operations but
before interest and other income) to be paid if the operating income exceeds the
prior year's operating earnings by 120%. A 1% bonus on operating income will be
paid if the operating income exceeds the prior year's operating by less than
120%. The agreement also obligates the Company to provide certain disability,
medical and life insurance, and other benefits. In the event of a change of
control as defined in the employment agreement, a one-time bonus shall be paid
equal to the executive's average annual compensation, including base
compensation, bonus and benefits, received by him during the thirty-six month
period preceding the change in control.
c. Forward Exchange Contracts
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, benefit from a weak dollar and are 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.
As of September 30, 2002, the Company has foreign currency forward contracts
outstanding of $6,072,000 against delivery of the Euro. The contracts expire
through February, 2003.
For the years ended September 30, 2002 and 2001, the Company recorded
approximately $408,000 as a decrease to net sales and $1,119,000 as an increase
to net sales related to the changes in the fair value of the Company's
derivative contracts.
10. Business Acquisition
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(R) Macintosh(R) computers. The
purchased assets expand and complement the Company's product line into the
Apple(R) Macintosh(R) market. The cash price for the acquisition, which was
accounted for under the purchase method, was approximately $900,000, including
$100,000 for direct transactions costs and a restrictive covenant totaling
$50,000. The excess of the acquisition cost over the fair value of identifiable
assets acquired totaled approximately $810,000 and was amortized on a straight
line basis over 10 years and the restrictive covenant on a straight line basis
over two years.
F-21
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The unaudited supplemental information below summarizes, on a pro forma basis,
the Company's results for the year ended September 30, 2000 had the Companies
combined at October 1, 1999.
Year ended September 30,
2000
----
Net sales $66,410,689
Net income (loss) (1,707,656)
Earnings (loss) per share
Basic $ (0.19)
Diluted $ (0.19)
Pro forma net income (loss) may not be indicative of actual results, primarily
because the pro forma results are historical results of the acquired entity and
do not reflect any cost savings that may be obtained from the integration and
elimination of redundant functions. The results of operations of Eskape for the
year ended September 30, 2002 and 2001 are included in the results of operations
of the Company.
In connection with the acquisition the Company had recorded goodwill of
approximately $810,000. Due to changing conditions that occurred during the
second half of fiscal 2001, such as declining sales, lost market share and the
market changes caused by the introduction of a new Macintosh operating system,
the following events and circumstances indicated to the Company that its
goodwill asset has been impaired and is not likely to be recovered:
o The Eskape(TM)Labs division was not profitable during fiscal
2001 and did not contribute, nor is to expected to contribute,
any positive cash flow stream
o The asset value was greater than the estimated future cash flows
o Eskape(TM) Labs division did not fulfill its internal sales
forecast for fiscal 2001
o At the time of the acquisition, the Company hired approximately
10 of the EsKape(TM) Labs' employees, including three from
senior management. Only four employees remain.
o Certain Eskape(TM)Labs products have been deemed by management
as slow moving products
In recognition of the above events, the Company recognized an impairment loss
during the fourth quarter of fiscal 2001 for the entire remaining goodwill
balance of $701,919.
The Company recorded the impairment loss as a component of income (loss) from
operations for fiscal 2001.
11. Life Insurance Proceeds
On January 29, 2001 the Company's President unexpectedly passed away. Pursuant
to key man life insurance policies the Company had on its President, it
collected life insurance proceeds in the aggregate of $2 million from these
policies, $1 million of which was recorded in the quarter ended June 30, 2001,
while the other $1 million was recorded during the quarter ended September 30,
2001. The proceeds were reported on the Company's statement of operations in
"Other income (expense)" under the caption " Life insurance proceeds".
F-22
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Quarterly Information (Unaudited)
The following presents certain unaudited quarterly financial data:
(In thousands, except per share data)
Quarters ended
December 31, March 31, June 30, September 30,
2001 2002 2002 2002
---- ---- ---- ----
Net Sales $ 12,062 $ 10,748 $ 10,113 $ 9,872
Gross Profit 2,919 2,824 2,669 2,724
Operating income (loss) 393 165 74 (157)
Net income (loss) 284 217 26 (179)
Net income (loss) per share:
Basic and diluted $ .03 $.02 $ 0.00 $ (.02)
===== ======== ======== =======
(In thousands, except per share data)
Quarters ended
December 31, March 31, June 30, September 30,
2000 2001 2001 2001
---- ---- ---- ----
Net Sales $17,896 $ 14,495 $ 9,383 $ 9,136
Gross Profit 3,970 3,204 1,733 (53)
Operating income (loss) 731 238 (1,220) (3,603)
Cumulative effect of a change in
accounting principle 204 - - 115
Net income (loss) 965 300 195 (3,742)
Per share results-basic:
Income (loss) before cumulative effect of a
Change in accounting principle $.09 $.03 $.02 $(.43)
Cumulative effect of a change in
accounting principle $.02 - - $.01
---- -- --- ----
Net income (loss) per share basic $.11 $.03 $.02 $(.42)
==== ==== ==== ======
Per share results-diluted:
Income (loss) before cumulative effect of a
Change in accounting principle $.08 $.03 $.02 $(.43)
Cumulative effect of a change in
accounting principle $.02 - - $ .01
---- -- ---- ----
Net income (loss) per share basic $.10 $.03 $.02 $(.42)
==== ==== ==== =====
F-23
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Since the Company sells primarily to the consumer market, it has experienced
certain revenue trends. The sales of the Company's products, which are primarily
sold through distributors and retailers, have historically been stronger 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 73%, 77%
and 71% of sales for the years ended September 30, 2002, 2001 and 2000,
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.
During the 4th quarter of the fiscal year ended September 30, 2001, the Company
recorded the following adjustments:
o Due to the decline in sales during the third and fourth quarters of the
current fiscal year, the Company deemed it necessary to increase its
reserve for obsolete and slow moving inventory. An additional reserve
of approximately $1,863,000 was recognized during the fourth fiscal
quarter of fiscal 2001 and charged to cost of sales (see Note 2)
o The Company analyzed the future realization of the deferred tax asset
during the fourth quarter of fiscal 2001 as a result of the operating
losses incurred in the third and fourth quarters of 2001, and it
concluded that under the present circumstances, it would be appropriate
for the Company to record a valuation allowance against the deferred
tax asset and reduce certain income tax liabilities. The net result was
a charge to the Company's tax provision for $1,082,000 (see Note 4)
o Due to changing conditions that occurred during the second half of
fiscal 2001, such as declining sales, lost market share and the market
changes caused by the introduction of a new Macintosh operating system,
the Company deemed it necessary to write off approximately $701,000 of
goodwill related to its June 2000 acquisition of Eskape Labs (see Note
10)
F-24
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
Hauppauge Digital, Inc. and Subsidiaries
Hauppauge, New York
The audits referred to in our report dated December 6, 2002, relating to
the consolidated financial statements of Hauppauge Digital, Inc. and
Subsidiaries included the audits of the financial statement schedules for each
of the three years in the period ended September 30, 2002. These financial
statement schedules are the responsibility of management. Our responsibility is
to express an opinion on these schedules based on our audits.
In our opinion, such financial statement schedules presents fairly, in all
material respects, the information set forth therein.
/s/ BDO Seidman, LLP
- ----------------------------
BDO Seidman, LLP
Melville, New York
December 6, 2002
F-25
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts
Balance at Charged to Costs Charged to Bad Debt Balance at
Description Beginning of and Expenses Other Accounts Deductions(1)Recoveries(2)End of Year
----------- ------------ ------------ -------------- ----------- ---------- -----------
YEAR ENDED SEPTEMBER 30, 2002
Reserve and allowances deducted from asset
accounts $ 182,244 $ 20,000 - - - $ 202,244
Allowance for doubtful accounts
YEAR ENDED SEPTEMBER 30, 2001
Reserve and allowances deducted from asset
accounts
Allowance for doubtful accounts $ 165,000 $ 10,000 - $ 77,187 $ 84,431 $ 182,244
YEAR ENDED SEPTEMBER 30, 2000
Reserve and allowances deducted from asset
accounts
Allowance for doubtful accounts $ 135,000 $ 30,000 - - - $ 165,000
(1) Doubtful accounts written off net of collections
(2) Recovery of accounts previously written off
F-26
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Reserve for Obsolete and Slow Moving Inventory
----------------------------------------------
Balance at Charged to Costs Charged to Other Balance at
Description Beginning of Year And Expenses Accounts Disposals(1) End of Year
----------- ----------------- ------------ --------- ----------- -----------
YEAR ENDED SEPTEMBER 30, 2002
Reserve and allowances deducted from asset $ 3,300,000 $ (386,409) - $ 181,146 $2,732,445
accounts
Reserve for obsolete and slow moving inventory
YEAR ENDED SEPTEMBER 30, 2001
Reserve and allowances deducted from asset $ 1,509,325 $ 1,862,786 - $ 72,111 $3,300,000
accounts
Reserve for obsolete and slow moving inventory
YEAR ENDED SEPTEMBER 30, 2000
Reserve and allowances deducted from asset
accounts $ 350,000 $ 1,200,000 - $ 40,675 $1,509,325
Reserve for obsolete and slow moving
inventory
(1) Obsolete inventory disposed of
F-27
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Reserve for sales returns
--------------------------
Balance at Charged to Costs Charged to Other Balance at
Description Beginning of Year and Expenses Accounts Adjustments End of Year
----------- ----------------- ------------- -------- ----------- -----------
YEAR ENDED SEPTEMBER 30, 2002
Sales reserve deducted from sales and
receivables account $ 2,684,940 $ - - $ - $ 2,684,940
Reserve for sales returns
YEAR ENDED SEPTEMBER 30, 2001
Sales reserve deducted from sales and
receivables account $ 2,684,940 $ - - $ - $ 2,684,940
Reserve for sales returns
YEAR ENDED SEPTEMBER 30, 2000
Sales reserve deducted from sales and
receivables account $ 3,984,940 $ - - $1,300,000 $ 2,684,940
Reserve for sales returns
(1) Sales reserve adjusted per historical
evaluation
F-28