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, 2003
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OR
( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
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
(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, including area code (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
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding twelve (12) months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past ninety (90) days.
YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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: [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Rule 12b-2).
YES NO X
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of the close of business on March 31, 2003 was approximately
$8,958,177. 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 March 31, 2003 which
was $1.39 per share as reported by NASDAQ.
As of March 31, 2003, the number of shares of Common Stock outstanding was
8,880,682 (exclusive of treasury shares).
PART I
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Special Note Regarding Forward Looking Statements
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Certain statements in this Annual Report on Form 10-K 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 their opposite and derivations thereof and similar words to be uncertain and
forward-looking. All cautionary statements made in this Annual Report on 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
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("PC") market and the Apple(R) Macintosh(R) market. We also offer products for
the home entertainment market.
We have two primary product categories: analog TV products and digital TV
products.
We offer several types of analog products. Our WinTV(R) analog TV receivers
allow PC users to watch television on their PC screen in a resizable window, and
also enable recording of TV shows to a hard disk. Our WinTV(R)-PVR TV personal
video recorder products include hardware MPEG encoders, which improve the
performance of TV recording and add instant replay and program pause functions,
plus also enable the `burning' of TV recordings onto DVD or CD media. Our
Eskape(TM) Labs products allow users of Apple(R)Macintosh(R) computers to watch
television on their computer screen.
We offer three types of digital TV receivers. Our WinTV(R) digital receivers can
receive digital TV transmissions and display the digital TV show in a
re-sizeable window on a user's PC screen. Our Digital Entertainment Center
products ("DEC") allow users to receive digital TV broadcasts and display the
digital TV on either a TV set or a PC screen. Our MediaMVP(TM) product was
designed to allow PC users to play digital media such as digital music, digital
pictures and digital videos on a TV set via a home network.
We sell our products through computer and electronic retailers, computer
products distributors and original equipment manufacturers ("OEMs").
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 international 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 are able to enhance the capabilities of the multimedia
PC to enable it to become a one-stop integrated entertainment system. We feel
our current and future products have the potential to be ubiquitous in PC-based
home entertainment systems.
Our engineering group works on updating our current products to add new and
innovative features that the marketplace seeks, while remaining vigilant in
trying to ensure that our products are 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, technology
providers, and internet and e-commerce solutions providers give us important
advantages in developing new technologies and marketing our products. By jointly
working with and sharing our engineering expertise with a variety of other
companies, we seek 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 comprised of computer and electronic retailers, computer products
distributors and OEMs. Electronic retailers include retail stores, web stores
and third-party catalogs, both print and on-line among others. We work closely
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with our retailers to enhance sales through joint advertising campaigns and
promotions. We believe that developing our international presence contributes to
our strategic position, allowing us to benefit from investments in product
development, and more firmly establishing our Hauppauge(R), WinTV(R),
MediaMVP(TM) and DEC brand names in the international marketplace.
We seek to maintain and improve our profit margins by, among other things,
outsourcing our production to contract manufacturers suited to accommodate the
type and volume of our needs. We also leverage international 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 and commonality of parts along with the
use of single platforms for multiple models are other important ways that we
believe our design and build strategy contribute to our financial performance.
Products
We have two primary product categories: analog TV and digital TV products.
See "Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the Consolidated Financial Statements comprising part
of this Annual Report on Form 10-K for additional information relating to our
operating segments.
Analog TV Products
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Our analog TV receiver products enable a PC user to watch TV in a resizable
window on a PC. Our software controls functions such as channel change, volume
adjustment, freeze frame, and channel scan. Our analog receiver products include
audio functions that allow sound to be heard while watching TV or video. The
audio can be connected to speakers or to a PC's sound card.
(i) WinTV(R) TV Receiver Products
The WinTV(R) analog TV receiver products include 125-channel cable-ready TV
tuners 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 (with the
addition of a camera or camcorder), 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) analog TV receiver products can be used to
receive teletext data broadcasts, which allow 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 video-conference 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
video-conference over the internet with the addition of a camera and camcorder.
Included with the board is a remote control for both TV and FM stereo.
Some WinTV(R) analog TV receiver 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
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making USB models freely portable from PC to PC and from one desktop, laptop or
notebook computer to another.
Over the fiscal 2003, we upgraded nearly all our European analog TV receiver
products to offer improved video quality at lower prices to the customer.
Additionally we also introduced the PCI Express, an entry level version of the
WinTV(R)-GO in Europe.
Over fiscal 2003, we also added a software-based TV recording feature to all
analog WinTV(R) products. Marketed under the SoftPVR(TM) name, this feature
allows consumers to record their TV shows to their hard disk. SoftPVR(TM) is not
as powerful as our hardware MPEG encoder-based WinTV(R)-PVR products, but does
allow rudimentary television recording capabilities. SoftPVR(TM) is available on
both the internal WinTV(R)-PCI boards and the external WinTV(R)-USB products.
(ii) WinTV(R)-PVR TV Recording Products
Our WinTV(R)-PVR TV recording products include all of the basic features of our
analog TV receiver products, such as TV on the PC screen, channel changing and
volume adjustment. They also add the ability to record TV shows to disk using a
built-in high quality hardware MPEG 2 encoder. This technology allows a typical
desktop computer system to record up to hundreds of hours of video to disk,
limited only by the size of the disk (or storage medium). In addition, the
WinTV(R)-PVR user can pause a live TV show, and then resume watching the TV show
at a later time. The maximum amount of recording time and the maximum amount of
paused TV is dependent upon the hard disk space available on the PC.
The WinTV(R)-PVR user can record a TV show to the hard disk using a TV scheduler
and then play the recording back, edit it, and record the show onto a 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 during viewing, recording or playback. Our
WinTV(R)-PVR products also provide for instant replay and are available in both
internal and external USB models.
In fiscal 2003, we introduced several new models with new price points and
feature sets. The WinTV(R)-PVR-250 was introduced, replacing the
WinTV(R)-PVR-pci model. The WinTV(R)-PVR-250 provides better quality video and
audio at a lower price point than prior models. The WinTV(R)-PVR-350 is similar
to the WinTV(R)-PVR-350, but adds a hardware MPEG video decoder which allows
recorded TV shows to be played back on a TV set. The WinTV(R)-PVR-usb2 has
similar hardware and software capabilities to the WinTV(R)-PVR-250, but it is an
external device which connects to a PC or laptop via a USB port.
An added feature to the WinTV(R)-PVR-250 is that it supports Microsoft(R)'s
Windows(R) XP Media Center Edition. Microsoft(R)'s 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 "live" TV, record a program or a whole series, and
manage all their digital music, home movies, videos, photos and DVDs on the PC.
Users can also access and control this new entertainment device 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, approximately one hour of television can be recorded on two
gigabytes of disk space. Microsoft(R)'s Windows(R) XP Media Center Edition
includes an Electronic Program Guide so that users can schedule their TV
recording automatically
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with the WinTV(R)-PVR-250.
(iii) Eskape(TM) Labs Products
Our Eskape(TM) Labs product line delivers TV for Apple(R) Macintosh(R)
computers. The video is sent to the Apple(R)Macintosh(R) computer through the
USB port and as a result, there is no complicated installation process. Eskape
products are available for all Apple(R) Macintosh(R) users from the on-the-go
iBooks(TM) to G5(TM) power users. All our Eskape(TM) Labs products are
QuickTime(R) compatible.
MyTV2GO and MyTV2GO-FM are the lower priced models of the "My" line. They enable
users to bring TV to their iMacs(TM), PowerBooks(TM) and G3(TM), G4(TM) and
G5(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 to disk. 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.
MyCapture II allows users to capture video on their iMac(TM), iBook(TM),
PowerBook(TM)or G3(TM)/G4(TM)/G5(TM) Macintosh(R) without opening their
computer. 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 used in 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.
Digital TV Products
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(i) Digital TV Receivers for the U.S. and North America
Destination Digital TV, a publication of the National Association of
Broadcasters, reported, in its October 2003
issue(http://www.nab.org/newsroom/issues/digitaltv/DDTV/), that a survey
conducted, by the National Association of Broadcasters, amongst stations found
that the number of DTV stations on air in the United States had increased to
1,060 - in 202 markets which serve nearly 100% of TV households. It also
reported that 82% of U.S. TV households are in markets with five or more
broadcasters airing DTV, and 56% are in markets with eight or more broadcasters
sending digital signals.
We offer both digital TV and High Definition Digital TV products ("HDTV Receiver
Products"), which exploit the superior images and sound of the U.S. digital TV
standard.
Our internal WinTV(R)-D board allows users to watch digital TV and conventional
analog 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 enabling users to watch
digital TV on a TV set, a 5-channel Dolby(TM) Digital surround sound (AC3)
decoder and a remote control.
Our WinTV(R)-HD board allows users to watch terrestrial digital and conventional
analog TV. It supports
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the viewing of High Definition video in any of the ATSC HDTV formats. 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.
(ii) Digital TV Receivers for the International Market
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, which we sell, is
required together with a decryption card that is available for a fee from the
provider of these channels. In 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.
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
subscription pay TV channels to be received and decoded, for a fee payable to
the subscription service.
(iii) Digital Entertainment Center ("DEC")
Our DEC products, introduced in Europe during fiscal 2002, are set top boxes
that enable analog TV sets to receive digital satellite and digital terrestrial
broadcasts. DEC products enable an owner of an analog TV set to 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 without the need to purchase a costly digital ready TV. 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.
(iv) Media MVP(TM)
The MediaMVP(TM) is a Linux-based digital media, and is one of a new class of PC
products which link TV sets and PCs. Media, such as music, digital pictures, and
digital videos, are transmitted from the PC, where they are stored, to the
MediaMVP(TM), where they are converted from a digital format into an analog
format, enabling playback on a TV connected to the MediaMVP(TM). MediaMVP(TM)
was introduced to the market in fiscal 2003, but first customer shipments were
not made until the beginning of fiscal 2004.
The MediaMVP(TM) enables users to watch and listen to PC-based videos, music and
pictures on their TV sets through a home network. The MediaMVP(TM) connects to
TV sets or home theater systems and, via an Ethernet network, plays back MP3
music, MPEG-1 and MPEG-2 videos, JPEG and GIF digital pictures that have been
recorded and stored on a PC. The MediaMVP(TM) decodes this media and then
outputs video through composite and S-Video connections for the best video
quality on TV sets, and audio through stereo
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audio output connectors to TV sets or home theater systems.
The MediaMVP(TM) also provides an on-TV-screen display of media directory
listings. It receives commands from the supplied remote control, and sends these
commands to the PC server. The TV menus are created on the PC server, sent over
the Ethernet LAN and displayed by the MediaMVP(TM)'s browser. The MediaMVP(TM)'s
remote control allows a user to pause, fast forward and rewind through videos,
plus pause music and picture shows. A user can adjust the audio volume from
MediaMVP(TM)'s remote control, avoiding the need to use the TV's remote control.
Other Products
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(i) Video Editing Products
Our primary video capture product, the DV-Wizard Pro, allows users to record and
edit videos from a digital video camcorder on their PC. This product also allows
users to connect their digital video camcorder to their PC through a firewire
connection, convert digital movies into a compressed format, thus saving hard
disk space, edit the digital movies, add voice narrations and music, and then
record the edited digital movies onto a DVD or CD-ROM.
The DV-Wizard Pro was designed to enable the user 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,
DVD title producers and creators of corporate product literature on CD-ROM.
(ii) Video Capture Products
Our ImpactVCB 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 capture in industrial applications, the ImpactVCB features "live"
video-in-a-window, still image capture and drivers for Windows(R) 2000,
Windows(R) XP, Windows(R) NT and Windows(R) 98. There are third party drivers
and applications for use with the Linux operating system.
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 or camcorder.
Technology
Analog TV Technology
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We have developed five generations of products which convert analog video into
digital video since our first such product was introduced 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. Our
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initial customers were mostly professional PC users, such as financial market
professionals who needed to be able to view 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.
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 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 per 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.
The fourth generation analog TV receivers are the WinTV(R)-PVR models which were
first developed during fiscal 2000 and introduced to the market in early fiscal
2001. The WinTV(R)-PVRs include both internal PCI and external USB TV receivers
which are designed to add the ability to record TV shows to a PC's hard disk.
The core technology in the WinTV(R)-PVR products is a hardware MPEG encoder,
which compresses analog video from a TV tuner or external video source into an
MPEG format in real time. MPEG is the compression format used on DVDs. This MPEG
encoder is a purchased chip, to which we add our driver and application software
to create the recording and program pause functions. Our WinTV(R)2000
application was enhanced to add the functions needed to record, pause and play
back TV on a PC screen.
Digital TV Technology
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Our WinTV(R)-D board, developed during the 1999 fiscal year and delivered to the
market in the beginning of fiscal 2000, was the first digital TV receiver for
the U.S. market which allowed 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.
Our MediaMVP(TM) contains our newest technology. Based on the Linux operating
system, the MediaMVP(TM) works in a client/server system with a PC,
communicating with the PC `server' and
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receiving digital media from the PC and displaying the media on a TV set. The
core technology to the MediaMVP(TM) comprises the configuration and enhancements
to the Linux operating system, the user interface displayed on the TV set, and
the technology to transmit digital media reliably over the local area network.
Research and Development
Our development efforts are currently focused on extending the range and
features of the WinTV(R)PVR products, developing additional externally attached
TV products and additional high-definition digital TV products. We are also
developing more highly integrated versions of hardware products to further
improve performance and price points, and new versions of software to add
features, improve ease of use, and provide support for new operating systems.
We currently have two research and development ("R & D") 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 extending the range and features of
the WinTV(R)PVR products, developing additional externally attached TV products
and additional high-definition digital TV 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 R & D. We spent
approximately $1,902,000, $1,592,000 and $1,510,000 for R & D expenses for the
years ended September 30, 2003, 2002, and 2001, 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, 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."
Product Production and Suppliers
We design the hardware for most models of the WinTV(R), MediaMVP 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 systems, including Windows(R) XP, Windows(R)98,
Windows(R)Me, Windows(R)NT and Windows(R)2000. We subcontract the manufacturing
and assembly of most of these 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 U.S.(Hauppauge, New York),
Singapore, and Ireland before packaging the products and shipping them to our
customers. We also buy from others finished products such as the DEC and
WinTV(R)-DVB products, that we have not designed but are sold under our name, on
an OEM basis.
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Certain component parts, such as TV tuners, video decoder chips and software
compression chips, plus certain assembled products, such as the DEC and
WinTV(R)-DVB, that are essential to our business are available from a single
source or limited sources. Other essential component parts that are generally
available from multiple sources may be obtained by us from only a single source
or limited sources because of pricing concerns. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors."
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 attempt to 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. Purchased assembled products are normally
covered by longer term purchase orders.
If the supply of a key component, or a purchased assembled product, 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. Similar occurrences in the future could have
a material adverse effect on our business, operating results and financial
condition.
During fiscal 2003, other than for purchased assembled products like the DEC and
WinTV(R)-DVB, all manufacturing was 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 ensure 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 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 only utilize three out of the five contract manufacturers. During
fiscal 2003, these three contract manufacturers handled all of our international
production. If demand were to increase dramatically, we believe additional
production could be absorbed by these and the other qualified contract
manufacturers.
11
During a portion of fiscal 2003, we produced some of our European products
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.
Customer Service and Technical Support
We maintain customer service and technical support departments in our Hauppauge,
New York headquarters, as well as in the U.K., Germany, France, Italy, the
Netherlands and in Singapore. Technical support is provided to help with
installation problems or pre-sale and post-sale questions on our products, while
customer service provides repair service.
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
screen while the PC continues 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 2003, net sales to distributors and retailers totaled
approximately $44,404,000, or 87%, of our net sales compared to approximately
$41,458,000, or 97%, and $47,365,000, or 93%, for the years ended September 30,
2002 and 2001, 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 OEMs
- -------------
The OEM business is one where a PC manufacturer incorporates our products into
an item sold under the OEM's label. Factors that could impact the expansion of
our OEM business include the ability to successfully negotiate and implement new
agreements with OEMs. The OEM business is often project based, where the OEM
builds a specially configured PC to implement a project for a customer.
Our sales to OEMs totaled approximately $6,552,000, $1,338,000 and $3,546,000
for the years ended
12
September 30, 2003, 2002 and 2001, 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 ended Setepmber 30, 2003. Sales to OEM customers
accounted for approximately 13%, 3% and 7% of our net sales for 2003, 2002 and
2001, respectively.
Marketing and Sales
- -------------------
We market our products both domestically and internationally through our sales
offices in the U.S.(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,
2003, 2002 and 2001, approximately 32%, 27% and 23% of our net sales were made
within the U.S., respectively, while approximately 68%, 73% and 77% were made
outside the United States (predominately in Germany, the United Kingdom, France,
Italy and Asia), respectively.
Our analog WinTV(R)-PCI, WinTV(R)-USB, WinTV(R)-PVR 250 products and digital
WinTV(R)-DVB products contributed to 28.18%, 15.61%, 14.44% and 15.77%
respectively of our consolidated revenue for fiscal year 2003.
Our analog WinTV(R)-PCI and WinTV(R)-USB products and digital WinTV(R)-DVB
products contributed to 45.98%, 16.55% and 17.70% respectively of our
consolidated revenue for fiscal year 2002 and 56.21%, 8.44% and 10.20%
respectively of our consolidated revenue for fiscal year 2001.
More information on our geographic segments can be obtained from "Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations," and the notes to the "Consolidated Financial Statements which
comprise part of this Annual Report on Form 10-K.
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 14 sales people located in Europe, 1 sales person in the Far
East and 2 sales people in the U.S., located in New York and California. We also
utilize the services of 3 manufacturer representatives retained by us, on a
non-exclusive basis, who work with customers in certain domestic geographic
areas.
See "Item 7 -- 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
13
worldwide currencies, primarily the Euro and Great British Pound. 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, 2003, we had foreign currency forward contracts outstanding
of approximately $3,560,000 against delivery of the Euro. The contracts expire
through December 2003.
Although we do not try to hedge against all possible foreign currency exposures,
because we cannot fully estimate the size of our exposure, the contracts we
procure are specifically entered into 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 the volatility of the currency markets and availability of hedging
instruments.
For the years ended September 30, 2003 and 2002, respectively, we recorded
approximately $1,895,200 and $408,000 as a decrease to net sales related to the
changes in the fair value of our derivative contracts.
See "Item 7 -- 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 against companies such as ATI Technologies Inc. and Pinnacle Systems,
Inc. Our new MediaMVP(TM) and DEC products compete in the consumer electronics
market, where competition comes from Sony Corp., Toshiba Corporation, Cisco
Systems Inc. and others.
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 our business, operating results and financial
condition.
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 high quality
image, we view our products as the preferred way to watch TV on the PC versus
the delivery of TV via the internet.
14
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 or which party
eventually prevails. If we do not prevail in a litigation suit, we may be
required to pay significant damages and/or 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 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 certain of our designs and software
programs, but currently we have no patent on the WinTV(R) board or other
products 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. We have filed to register the SoftPVR(TM), HardPVR(TM) and
MediaMVP(TM) marks with the U.S. Patents and Trademarks Office.
15
See "Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Employees
As of September 30, 2003, we had 113 employees, 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 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 purposes of the restructuring were to
consolidate our international sales and marketing operations under Hauppauge
Digital Europe S.a.r.l., provide a more cost-effective and operationally
efficient distribution center for the European market and to take advantage of
certain tax benefits available to us.
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 British 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
16
our European warehousing and packing facility, just outside of Dublin in
Ballycoolin, Ireland. As mentioned above. The purpose of 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. The lease term expires on
January 31, 2006 and includes an option to extend for three additional years.
Rent relating to this facility is currently at the annual rate of approximately
$432,000 per year and will increase to approximately $454,000 per year on
February 1, 2004. The rent is payable in equal monthly installments and
increases at a rate of 5% per year on February 1st of each year thereafter,
including 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, 2003 was $745,567. We pay the taxes and operating costs of
maintaining the premises. See "Item 13 - Certain Relationships and Related
Transactions".
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.
17
Item 3. LEGAL PROCEEDINGS
We are presently involved in arbitration proceedings before the American
Arbitration Association, which had been brought against the Company by the
estate of the late Mr. Kenneth Aupperle ("Estate"). The Estate is 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. Based on the
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. However, due to the uncertainties inherent in litigation, we are
unable to predict the ultimate outcome.
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 22, 2003 at our offices:
Proposal No. 1: Election of Directors
The following directors were elected by the votes indicated:
For Withheld
--- --------
Kenneth Plotkin 7,384,917 1,493,331
Bernard Herman 7,388,317 1,489,931
Steven J. Kuperschmid 7,371,187 1,507,061
Robert S. Nadel 7,374,917 1,503,331
Christopher G. Payan 7,374,617 1,503,631
Neal Page 7,390,337 1,487,911
Seymour G. Siegel 7,374,917 1,503,331
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:
18
For Against Abstain
--- ------- -------
1,363,669 1,587,801 23,454
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
--- ------- -------
2,320,358 581,828 68,069
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
--- ------- -------
1,322,115 1,615,796 32,344
Proposal No. 5: Ratify the Board of Director's resolution to adopt the Company's
2003 Performance and Equity Incentive Plan, as further detailed in the Company's
Proxy Statement dated August 22, 2003.
The proposed amendment to ratify the Board of Director's resolution to adopt the
Company's 2003 Performance and Equity Incentive Plan, as further detailed in the
Company's Proxy Statement dated August 22, 2003, was approved by the
shareholders.
For Against Abstain
--- ------- -------
2,346,869 544,418 78,968
19
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 for the periods
indicated. Quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions.
Fiscal Year Ended
September 30, 2003 High Low
- ------------------ ---- ---
First Quarter 1.41 0.95
Second Quarter 1.67 1.28
Third Quarter 3.74 1.38
Fourth Quarter 3.10 2.34
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
(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 of
December 8, 2003 was 180. We believe there are in excess of 7,100
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.
The information required by this Item regarding equity compensation plans is
incorporated by reference to Item 12 of this Annual Report on Form 10-K.
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, 2003 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 and "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in this Annual Report on
Form 10-K.
20
Consolidated Statement of Operations Data 2003 2002 2001 2000 1999
Years ended September 30, ---- ---- ---- ---- ----
(in thousands, except for per share amounts)
--------------------------------------------
Net Sales $ 50,956 $ 42,797 $50,910 $ 66,292 $58,602
Cost of sales 38,715 31,661 42,056 54,425 43,027
--------- --------- ------- -------- -------
Gross Profit 12,241 11,136 8,854 11,867 15,575
Selling , general and administrative expenses 10,896 9,069 10,282 12,231 9,865
Research & development expenses 1,902 1,592 1,510 1,666 1,257
Write off of goodwill - - 702 - -
Litigation settlement - - 213 - -
--------- --------- ------- -------- -------
Income (loss) from operations (557) 475 (3,853) (2,030) 4,453
Other Income (Expense):
Interest income 16 35 42 104 201
Interest expense - - (31) (15) -
Life insurance proceeds - - 2,000 - -
Foreign currency (18) 5 7 (243) (61)
Non operational USD to Euro re-measurement gain (loss) 52 (98) (16)
Other, net - - - 1 -
--------- ---------- ------- -------- -------
Income (loss) before taxes (507) 417 (1,851) $ (2,183) 4,593
Income tax (benefit) provision 307 69 750 (1,184) 1,475
--------- ---------- ------- -------- -------
Income (loss) before cumulative effect of a change in accounting
principal (814) 348 (2,601) (999) 3,118
Cumulative effect of a change in accounting principle - - 319 - -
--------- ---------- ------- -------- -------
Net income (loss) $ (814) $ 348 $(2,282) $ (999) $ 3,118
========= ========== ======= ======== =======
Per share results-basic:
Income (loss) before cumulative effect of a change in
accounting principle $ (0.09) $ 0.04 $ (0.29) $ (0.11) $ 0.36
Cumulative effect of a change in accounting principle $ - $ - $ 0.03 $ - $ -
--------- ---------- ------- -------- -------
Net income (loss) per share-basic $ (0.09) $ 0.04 $ (0.26) $ (0.11) $ 0.36
========= ========== ======= ======== =======
Per share results-diluted:
Income (loss) before cumulative effect of a change in
accounting principle $ (0.09) $ 0.04 $ (0.29) $ (0.11) $ 0.33
Cumulative effect of a change in accounting principle $ - $ - $ 0.03 $ - $ -
========= ========== ======= ======== =======
Net income (loss) per share-diluted $ (0.09) $ 0.04 $ (0.26) $ (0.11) $ 0.33
========= ========== ======= ======== =======
Weighted average shares outstanding:
Basic 8,867 8,887 8,910 8,837 8,632
Diluted 8,867 9,002 8,910 8,837 9,480
Consolidated Balance Sheet Data (at period end):
Working capital $ 10,860 $ 11,266 $ 10,258 $ 11,767 $12,533
Total assets 21,650 19,846 18,784 26,316 27,728
Stockholders' equity 11,468 11,967 11,186 13,654 13,322
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.
21
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Results of operations
September 30, 2003 and 2002
Results of operations for the twelve months ended September 30, 2003 compared to
September 30, 2002 are as follows:
Twelve Twelve
months months
Ended Ended Variance Percentage of sales
9/30/03 9/30/02 $ 2003 2002 Variance
---------- ------------- -------- ---------------------
Net sales $50,956,034 $ 42,796,726 $ 8,159,308 100.0% 100.0% -
Cost of sales 38,715,103 31,661,073 7,054,030 75.98% 73.98% 2.00%
----------- ------------- ----------- ----- ----- ----
Gross profit 12,240,931 11,135,653 1,105,278 24.02% 26.02% -2.00%
Gross profit % 24.02% 26.02% -2.00%
Costs:
Sales & marketing 7,145,730 5,741,510 1,404,220 14.02% 13.42% 0.60%
Technical support 420,566 379,592 40,974 0.83% 0.89% -0.06%
General & administrative 3,329,815 2,947,943 381,872 6.53% 6.89% -0.36%
----------- ------------- ----------- ----- ----- ----
Total selling, general and administrative costs 10,896,111 9,069,045 1,827,066 21.38% 21.20% 0.18%
Research & development 1,901,843 1,591,551 310,292 3.73% 3.72% 0.01%
----------- ------------- ----------- ----- ----- ----
Total costs 12,797,954 10,660,596 2,137,358 25.11% 24.92% 0.19%
----------- ------------- ----------- ----- ----- ----
Net Operating (loss) income (557,023) 475,057 (1,032,080) -1.09% 1.10% -2.19%
Other income (expense)
- ---------------------
Interest income 15,858 34,781 (18,923) 0.03% 0.08% -0.05%
Foreign currency (17,913) 4,750 (22,663) -0.04% 0.01% -0.05%
Non operational USD to Euro re-measurement 51,936 (98,066) 150,002 0.10% -0.23% 0.33%
----------- ------------ ----------- ---- ---- ----
Total other income (expense) 49,881 (58,535) 108,416 0.09% -0.14% 0.23%
----------- ------------ ----------- ---- ---- ----
(Loss) income before taxes (507,142) 416,522 (923,664) -1.00% 0.96% -1.96%
Income tax provision 306,890 69,000 237,890 0.60% 0.16% 0.44%
---------- ------------ ----------- ---- ---- ----
Net (loss) income $ (814,032) $ 347,522 $(1,161,554) -1.60% 0.80% -2.40%
========== ============ =========== ==== ==== ====
Net sales for the twelve months ended September 30, 2003 increased $8,159,308
compared to the prior year. Domestic and European sales increased by $4,655,424
and $3,716,401 respectively while Asian sales decreased $212,517 as follows:
Increase
(decrease) Increase Percentage of sales by
Location Twelve Months Twelve Months Dollar (decrease) Geographic region
ended 9/30/03 ended 9/30/02 Variance Variance % 2003 2002
--------------- -------------- --------- ---------- -----------------------
Domestic $ 16,163,782 $ 11,508,358 $ 4,655,424 40% 32% 27%
Europe 34,082,082 30,365,681 3,716,401 12% 67% 71%
Asia 710,170 922,687 (212,517) -23% 1% 2%
-------------- ------------- ------------- ----- --- ---
Total $ 50,956,034 $ 42,796,726 $ 8,159,308 19% 100% 100%
============== ============= ============= ==== === ===
The primary forces contributing to the net sales increase were:
o Digital and digital satellite productsof $4,466,127 due to expanding
market
o Analog and personal video recorder sales of $3,693,181 due to new
product introductions
22
Net sales to domestic customers were 32% of net sales for the year ended
September 30, 2003 compared to 27% for the year ended September 30, 2002. Net
sales to European customers were 67% of net sales compared to 71% for same
period of the prior year. Net sales to Asian customers were 1% for the year
ended September 30, 2003 as compared to 2% for the year ended September 30,
2002.
Gross profit increased $1,105,278 for the year ended September 30, 2003. Gross
profit percentage for the year ended September 30, 2003 was 24.02% compared to
26.02% for the prior year.
The increases and (decreases) in the gross profit are detailed below:
Increase
(decrease)
----------
Due to increased sales $ 2,740,103
Higher margins due to product mix 161,443
Third quarter fiscal 2002 inventory obsolescence adjustment (151,119)
Effect of increased sales of lower margin OEM products (1,105,746)
Due to increases in labor related and other costs (539,404)
----------
Total increase in gross profit $ 1,105,278
============
The decrease in gross profit percentage of 2.00% for the twelve months ended
September 30, 2003 compared to the twelve months ended September 30, 2002 is as
follows:
Increase
(decrease)
---------
Higher margins due to product mix 0.31%
Third quarter fiscal 2002 inventory reserve adjustment (0.36%)
Effect of increased sales of lower margin OEM products (2.17%)
Labor related and other costs 0.22%
--------
Net decrease gross profit % (2.00%)
========
The 0.31% improved gross profit percentage on assembled boards due to product
mix was primarily caused by unit price reductions from our suppliers and
subcontractors on our analog product lines and digital video satellite products,
offset somewhat by sales of lower average margin set top box products.
OEM sales of media center boards for the twelve months ended September 30, 2003
were $4,828,040, which accounted for 9.47% of the net sales for fiscal 2003.
Although OEM sales require less sales and marketing support, their gross profit
percentages are substantially less than those of our retail products. Our OEM
sales had an average gross profit percentage of 11.02% for the twelve months
ended September 30, 2003. There were no significant OEM sales in the previous
year. The increased product mix of OEM sales during fiscal 2003 contributed to
the 2.00% reduction in our fiscal 2003 gross profit percentage when compared to
the previous year.
During the latter part of fiscal 2001, the factors below affected the
realization of the Company's inventory:
o The loss during the fourth quarter of 2001 of a long-time direct
corporate customer impacted the existing value of assembled boards and
component inventory relating to this customer
o A change with a major contract manufacturer from consigning component
parts to the contract manufacturer to purchasing the assembled boards
on a turnkey basis impacted the value of component inventory
o The second consecutive year of declining sales resulted in slower
sales of older models
o Engineering changes made to our USB and Macintosh products which
rendered certain inventory associated with this product obsolete
23
o The better use of new software that assisted the Company in
identifying slow moving inventory
With respect to the factors above, 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.
During fiscal 2002, there were certain assembled boards and component material
inventory that we were able to sell through the use of a liquidation firm. In
recognition of this, we reduced our inventory reserve to reflect the decrease in
the obsolete inventory value due to the liquidation of such products. There was
no similar obsolete inventory liquidation during fiscal 2003, which resulted in
a comparative reduction in our gross profit percentage 0.36% between fiscal 2003
and fiscal 2002.
For the twelve months ended September 30, 2003, the increase in the gross profit
margin percentage of 0.22% relating to labor related and other costs was due to
the percentage increase in sales of 19.07% for the twelve months ended September
30, 2003 over September 30, 2002 being in excess of the percentage increase in
labor related and other costs of 15.92% for the twelve months ended September
30, 2003 over September 30,2002.
The chart below illustrates the components of selling, general and
administrative expenses:
Twelve months ended September 30,
Dollar Costs Percentage of Sales
-----------------------------------------------------------------------------
Increase Increase
2003 2002 (Decrease) 2003 2002 (Decrease)
---- ---- -------- ---- ---- --------
Sales and Marketing $7,145,730 $5,741,510 $ 1,404,220 14.02% 13.42% 0.61%
Technical Support 420,566 379,592 40,974 0.83% 0.89% -0.06%
General and Administrative 3,329,815 2,947,943 381,872 6.53% 6.89% -0.35%
---------- ---------- ----------- ----- ----- -----
Total $10,896,111 $9,069,045 $ 1,827,066 21.38% 21.20% 0.19%
=========== ========== =========== ===== ===== =====
Selling, general and administrative expenses increased $1,827,066 from the prior
year. As a percentage of sales, selling, general and administrative expenses
increased by 0.19% when compared to the twelve months ended September 30, 2002.
The increase in sales and marketing expense of $1,404,220 which accounted for
about 77% of the total increase in aelling, general and administrative expenses,
was mainly due to:
o Higher advertising costs of $872,896 due to higher sales based
co-operative advertising, higher customer rebate realization and
increased special promotions
o Higher advertising costs of $188,765 due to higher translated Euro to
U.S dollar amounts due to the strengthening of the Euro against the
USD
o Higher commissions expense of $86,779 due to increased sales
o Increased sales commission expense of $53,232 due to higher translated
Euro to U.S dollar amounts due to the strengthening of the Euro
against the USD
o Increased European sales office costs of $123,675
o Increased European sales office costs of $302,216 due to higher
translated Euro to U.S dollar amounts due to the strengthening of the
Euro against the USD
o Lower trade show costs of $236,061 due to smaller show presence and
frequency
The increase in general and administrative expenses of $381,872 was primarily
due to:
24
o Addition of senior executive officer $109,976
o Higher legal costs of $78,785
o Increased travel costs of $11,961
o Increased Directors fees of $46,581
o Increased banking fees of $65,047
o Increased consulting fees for investment advice and public relations
$47,849
Research and development expenses increased $310,292 or approximately 19%. The
increase was mainly due to higher compensation costs attributable to additional
staff and increased material and contract services cost for product enhancements
and new projects under development.
Other income (expense)
Net other income for the twelve months ended September 30 , 2003 was $49,881
compared to net other expense of ($58,535) for the twelve months ended September
30, 2002 as detailed below:
Twelve months ended September 30,
2003 2002
---- ----
Interest income $ 15,858 $ 34,781
Foreign currency transaction gains (losses) (17,913) 4,750
Non operational USD to Euro currency re-measurement 51,936 (98,066)
-------- ----------
Total other income (expense) $ 49,881 $ (58,535)
======== ==========
The decrease in total other expense was due to current year gains on
non-operational USD-to-Euro currency re-measurements due to increases in the
Euro offset by lower interest income due to lower investment yields.
Non Operational USD to Euro currency re-measurement
We follow the rules prescribed in paragraph 15 of SFAS 52 "Foreign Currency
Translation", which states that accounts denominated in a currency other than an
entity's functional currency need to be re-measured into the entity's functional
currency, and any gain or loss from this re-measurement are included in the
determination of net income. Re-measurement gains and losses on inter company
accounts that are of a long term investment nature and for which settlement is
not planned or anticipated in the foreseeable future are excluded in determining
net income and are reported in the same manner as are translation gains and
losses.
Since the functional currency of Hauppauge Digital Europe Sarl ("HDE Sarl") is
the Euro, any asset, liability or equity accounts which are invested in or
purchased using U.S. Dollars or Great British Pound by HDE Sarl are revalued
into Euros at the end of each period. The gains or losses on HDE Sarl's books
resulting from the revaluation of U.S. Dollar and Great British Pound accounts
into Euros are booked on the Company's statement of operations in the other
income (loss) section under the description "Non operational USD to Euro
currency re-measurement." Re-measurement gains and losses on inter company
accounts that are of a long term investment nature and for which settlement is
not planned or anticipated in the foreseeable future are booked as a component
of translation gains and losses on the balance sheet under the stockholders'
equity section.
Primarily due to a decrease in U.S Dollar denominated inventory on HDE Sarl's
books, HDE Sarl experienced a net asset decrease for the year ended September
30, 2003. The increase in the value of the
25
Euro versus the U.S. Dollar coupled with the decrease in net assets resulted in
a re-measurement gain of $51,936 for the year ended September 30, 2003.
Accumulated other comprehensive income (loss)
The Euro is the functional currency of the Company's European subsidiary, HDE
Sarl. Assets and liabilities of this subsidiary are translated to U.S. Dollars
at the exchange rate in effect at the end of each reporting period, while equity
accounts are translated to U.S. Dollars at the historical rate in effect at the
date of the contribution. Operating results are translated to U.S. Dollars at
the average prevailing exchange rate for the period, with the exception of sales
which are translated to U.S. Dollars at the average monthly forward exchange
contract rate. The use of differing exchange rates results in foreign currency
translation gains or losses. Since the Euro accounts on HDE Sarl's books result
in a net asset position (total Euro assets are in excess of Euro liabilities),
an increase in the Euro value results in a deferred gain for the translation of
Euro accounts to U.S. Dollars. The Company had a translation loss of $3,845
recorded on the balance sheet as of September 30, 2002. For the year ended
September 30, 2003, the Company recorded in other comprehensive income deferred
translation gains $708,028, resulting in a translation gain of $704,183 recorded
as a component of accumulated other comprehensive income as of September 30,
2003.
The Company uses forward exchange contracts to reduce our exposure to
fluctuations in foreign currencies. Mark-to-market gains and losses on these
open contracts result from the difference between the USD value of our open
foreign currency forward contracts at the average contract rate as opposed to
the same contracts translated at the month-end forward rate. The Company
qualifies for cash flow hedge accounting as prescribed under FAS 133, which
allows the Company to record the mark-to-market gains and losses in the equity
section of our balance sheet under accumulated other comprehensive income. The
Company had mark-to-market gains of $190,919 recorded on the balance sheet as of
September 30, 2002. For the year ended September 30, 2003, the Company recorded,
as a component of other comprehensive income, a mark-to-market loss of $425,510,
resulting in a mark-to-market loss of $234,591 for contracts open as of
September 30, 2003.
As stated above, accumulated other comprehensive income (loss) consists of two
components:
o Translation gains and losses
o FAS 133 mark-to-market gains and losses on our open foreign exchange
contracts
The table below details the gains and losses recorded for the components that
make up accumulated other comprehensive income (loss):
Balance October - Balance January - Balance April- Balance July Balance
As of December 02 as of March 03 as of June 03 As of Sep. 03 As of
Sep. 30, Gains December 31, Gains March 31, Gains June Gains Sep. 30,
2002 (losses) 2002 (losses) 2003 (losses) 2003 (losses) 2003
---- ------ ---- ------ ---- ------ ---- ------ ----
Translation adjustments $ (3,845) $ 150,728 $ 146,883 $ 13,318 $160,201 $197,917 $ 358,118 $346,065 $704,183
FAS 133 mark to market 190,919 (518,974) (328,055) 163,879 (164,176) 18,169 (146,007) (88,584) (234,591)
-------- --------- --------- -------- -------- -------- --------- -------- --------
adjustments $187,074 $(368,246) $(181,172) $177,197 $ (3,975) $216,086 $ 212,111 $257,481 $469,592
======== ========= ========= ======== ======== ======== ========= ======== ========
Tax provision
Our net tax provision for the years ended September 30, 2003 and 2002 is as
follows:
26
Twelve months ended September 30,
2003 2002
---- ----
Tax (benefit) attributable to U.S operations $ (972,000) $ (980,000)
Tax expense European operations 108,465 69,000
Adjustment of prior year estimated income taxes 198,425 -
Deferred tax asset valuation allowance 972,000 980,000
----------- ----------
Net tax provision $ 306,890 $ 69,000
=========== ==========
Our Luxembourg operation had a profit net of licensing fees for fiscal 2003 and
fiscal 2002, which resulted in an income tax liability inclusive of commission
agents of $108,465 and $69,000, respectively.
For the last four fiscal years, our domestic operation has incurred losses. We
analyzed the future realization of our deferred tax assets as of September 30,
2003 and 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 loss incurred in fiscal 2003 from
domestic operations.
During the fiscal year ended September 30,2003, the Company adjusted the prior
year provision for estimated income tax receivable and income tax payable, based
in part upon the completion of a tax examination. The net result was a charge of
$198,425.
As a result of all of the above items mentioned in the Management's Discussion
and Analysis of Financial Condition and Results of Operations, we incurred a net
loss of $814,032 for the year ended September 30, 2003, which resulted in basic
and diluted net loss per share of $0.09 on weighted average basic and diluted
shares of 8,867,309, compared to a net income of $347,522 for the year 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.
Options to purchase 1,896,101 and 825,322 shares of Common Stock at prices
ranging $1.05 to $ 10.06 and $2.07 and $10.06, respectively, were outstanding
for the years ending September 30, 2003 and 2002, but were not included in the
computation of diluted earnings per share because they were anti-dilutive.
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
------- -------- -------- --------------------------
Net 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%
----------- ------------ ---------- ------ ------ ----
27
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%
========== =========== ========== ====== ===== ====
Net sales for the years ended September 30, 2002 decreased $8,113,737 when
compared to the prior year. Sales declined in all geographic locations as
follows:
Increase Percentage of sales by
(decrease) Increase Geographic region
Location Twelve Months Twelve Months Dollar (decrease) 2002 2001
- -------- 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%
============ ============ =========== === === ===
The primary forces causing the net sales decrease were:
o Sluggish economic conditions
o Reduction in analog board sales
o Lower OEM sales activity
o Lower Asian sales
Net 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. Net
sales to European customers were 71% of net sales compared to 70% for the same
period of the prior year. Net sales to Asian customers were 2% compared to 7%
for the same period the prior year.
Gross profit increased $2,282,049 for the year ended September 30, 2002. Gross
profit percentage for the year ended September 30, 2002 was 26.02% compared to
17.39% for the same period in the prior year.
The increases and (decreases) in the gross profit 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
28
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 profit percentage of 8.63% for the twelve months ended
September 30, 2002 compared to the prior 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 gross profit percentage on assembled boards was primarily a result
of unit price reductions from our suppliers and subcontractors coupled with a
larger sales mix of higher gross margin product. The increase in the gross
profit percentage 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 gross profit
percentage 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 Promotional $ 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%
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 year ended September 30, 2002 increased by 1.00% when compared
to the year 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
29
marketing personnel
The decrease in general and administrative expenses of $474,692 was primarily
due to:
o A 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(TM) Labs office in California
into our 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.
Other income (expense)
Net other expense for the year ended September 30, 2002 was $58,535 compared to
net other income of $2,002,181 for the year ended September 30, 2001 as detailed
below:
30
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)
Life insurance proceeds - 2,000,000
--------- ----------
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 year 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
loss incurred in 2002 from domestic operations.
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
31
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 year 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 year ended September 30, 2001, which resulted in basic and
dilut