UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
-------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number 1-13550
HAUPPAUGE DIGITAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 11-3227864
--------- ----------
( State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
91 Cabot Court, Hauppauge, New York 11788
(Address of principal executive offices)
(631) 434-1600
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes No X
----
As of August 6, 2003, 8,878,248 shares of .01 par value Common Stock of the
registrant were outstanding, not including treasury shares.
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
- -----------------------------
Item 1.Financial Statements Page No.
Condensed Consolidated Balance Sheets- 3
June 30, 2003 (unaudited) and September 30, 2002
Condensed Consolidated Statements of Income-
Nine Months ended June 30, 2003 (unaudited) and 2002 (unaudited) 4
Condensed Consolidated Statements of Income-
Three Months ended June 30, 2003 (unaudited) and 2502 (unaudited) 5
Condensed Consolidated Statements of Other Comprehensive Income -
Three months and nine months ended June 30, 2003 (unaudited) and 2002
(unaudited) 6
Condensed Consolidated Statements of Cash Flow-
Nine Months ended June 30, 2003 (unaudited) and 2002 (unaudited) 7
Notes to Condensed Consolidated Financial Statements 8-12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13-26
Item 3. Quantitative and Qualitative Disclosures about Market Risks 26-27
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings 28
Item 6. Exhibits and Reports on form 8-K 28
SIGNATURES 29
2
PART I. FINANCIAL INFORMATION
- -----------------------------
Item 1. Financial Statements
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, September 30,
2003 2002
(Unaudited)
-----------------------------------------
Assets:
Current Assets:
Cash and cash equivalents $ 5,347,255 $ 4,964,522
Accounts receivable, net of various allowances of $2,887,000 4,085,333 5,182,738
Income taxes receivable 175,000 501,000
Inventories 8,312,832 8,091,495
Prepaid expenses and other current assets 588,411 416,734
------------- -----------
Total current assets 18,508,831 19,156,489
Property, plant and equipment, net 572,474 611,054
Security deposits and other non current assets 76,216 78,616
------------- -----------
$ 19,157,521 $ 19,846,159
============= ============
Liabilities and Stockholders' Equity:
Current Liabilities:
Accounts payable $ 4,776,158 $ 6,105,588
Accrued expenses 2,198,674 1,442,475
Income taxes payable 112,000 331,484
------------- ------------
Total current liabilities 7,086,832 7,879,547
Stockholders' Equity
Common stock $.01 par value; 25,000,000 shares authorized, 9,414,833
and 9,392,164 issued, respectively 94,148 93,923
Additional paid-in capital 12,286,105 12,233,170
Retained earnings 975,541 914,019
Accumulated other comprehensive income 212,111 187,074
Treasury Stock, at cost, 542,067, and 514,317 shares, respectively (1,497,216) (1,461,574)
------------- ----------
Total stockholders' equity 12,070,689 11,966,612
------------- ----------
$ 19,157,521 $ 19,846,159
============= ============
See accompanying notes to consolidated financial statements
3
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Nine months ended June 30,
----------------------------------
2003 2002
----------------------------------
Net Sales $39,450,126 $32,924,368
Cost of Sales 29,905,216 24,512,946
------------- -----------
Gross Profit 9,544,910 8,411,422
Selling, General and Administrative Expenses 8,068,951 6,650,857
Research & Development Expenses 1,429,171 1,128,266
------------- -----------
Income from operations 46,788 632,299
Other Income (expense):
Interest income 13,148 28,085
Foreign currency (11,350) 2,318
Non operational USD to Euro currency re-measurement 51,936 (82,143)
------------- -----------
Other income (expense) 53,734 (51,740)
------------- -----------
Income before taxes on income 100,522 580,559
Tax provision 39,000 53,497
------------- -----------
Net income $ 61,522 $ 527,062
------------- -----------
Net income per shares:
Basic and Diluted $ 0.01 $ 0.06
============= ============
See accompanying notes to consolidated financial statements
4
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three months ended June 30,
----------------------------------
2003 2002
----------------------------------
Net Sales $10,010,782 $10,113,135
Cost of Sales 7,756,306 7,444,435
----------- -----------
Gross Profit 2,254,476 2,668,700
Selling, General and Administrative Expenses 2,638,177 2,189,484
Research & Development Expenses 487,847 404,829
----------- -----------
Income (loss) from operations (871,548) 74,387
Other Income (expense):
Interest income 3,143 6,457
Foreign currency 4,144 (15,718)
Non operational USD to Euro currency re-measurement 8,796 (28,003)
----------- -----------
Other income (expense) 16,083 (37,264)
----------- -----------
Income (loss) before taxes on income (855,465) 37,123
Tax provision - 10,997
----------- -----------
Net income (loss) $ (855,465) $ 26,126
----------- -----------
Net income (loss) per share:
Basic and Diluted $ (0.10) $0.00
============ ===========
See accompanying notes to consolidated financial statements
5
HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
Three months ended June 30,
-----------------------------
2003 2002
---- ----
Net income (loss) $ (855,465) $ 26,126
Forward exchange contracts marked to market 18,169 -
Foreign currency translation gain (loss) 197,917 411,902
---------- ----------
Other comprehensive income (loss) $ (639,379) $ 438,028
---------- ----------
Nine months ended June 30,
-----------------------------
2003 2002
---- ----
Net income $ 61,522 $ 527,062
Forward exchange contracts marked to market (336,926) -
Foreign currency translation gain (loss) 361,963 301,504
========= ==========
Other comprehensive income $ 86,559 $ 828,566
========= ==========
See accompanying notes to consolidated financial statements
6
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
Nine months ended June 30,
2003 2002
----------------------------
Net income $ 61,522 $527,062
----------------------------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 205,945 248,067
Provision for uncollectible accounts receivable - 20,000
Other non cash items 30,903 29,507
Changes in current assets and liabilities:
Accounts receivable 1,122,442 161,301
Income taxes receivable 326,000 -
Inventories (221,337) 1,424,765
Prepaid expenses and other current assets (171,677) (162,151)
Accounts payable and other current liabilities (792,715) (1,086,858)
--------- ---------
Total adjustments 499,561 634,631
--------- ---------
Net cash provided by operating activities 561,083 1,161,693
--------- ---------
Cash Flows From Investing Activities:
Purchases of property, plant and equipment (167,365) (62,775)
-------- --------
Net cash used in investing activities (167,365) (62,775)
-------- --------
Cash Flows From Financing Activities:
Proceeds from employee stock purchases 24,657 22,768
Purchase of treasury stock (35,642) (71,267)
-------- ---------
Net cash used in financing activities (10,985) (48,499)
-------- ---------
Net increase in cash and cash equivalents 382,733 1,050,419
Cash and cash equivalents, beginning of period 4,964,522 4,422,239
--------- ---------
Cash and cash equivalents, end of period $5,347,255 $5,472,658
========== ==========
Supplemental disclosures:
Income taxes paid $ 40,262 $ 25,386
========== ==========
See accompanying notes to consolidated financial statements
7
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements included
herein have been prepared in accordance with generally accepted accounting
principles for interim period reporting in conjunction with the instructions to
Form 10-Q. Accordingly, these statements do not include all of the information
required by generally accepted accounting principles for annual financial
statements. In the opinion of management, all known adjustments (consisting of
normal recurring accruals and reserves) necessary to present fairly the
financial position, results of operations and cash flows for the three and nine
month periods ended June 30, 2003 have been included. It is suggested that these
interim statements be read in conjunction with the financial statements and
related notes included in the Company's September 30, 2002 Form 10-K.
The operating results for the three and nine month periods ended June 30, 2003
are not necessarily indicative of the results to be expected for the September
30, 2003 year end.
Note 2. Derivative Financial Instruments
The strength or weakness of the U.S. Dollar against the Euro and British Pound
Sterling impacts our financial results. Changes in exchange rates may positively
or negatively affect our revenues, gross margins, operating income and retained
earnings (which are all expressed in U.S. Dollars). We use derivatives to reduce
our exposure to fluctuations in foreign currencies. Foreign currency forward
contracts are used to hedge the foreign currency market exposures underlying
forecasted U.S. Dollar denominated inventory purchases. As of June 30, 2003, we
had foreign currency contracts outstanding of approximately $1,590,900 against
the delivery of the Euro. The contracts expire through August 2003. Our
accounting policies for these instruments designate such instruments as cash
flow hedging transactions. We do not enter into such contracts for speculative
purposes. We record all derivative gains and losses on the balance sheet as a
component of stockholders' equity under the caption "Accumulated other
comprehensive income (loss)". The Company recorded a deferred gain of $18,169
for the three months ended June 30, 2003. As of June 30, 2003, a deferred loss
of $146,007, reflecting the cumulative mark to market loss of our derivatives,
was recorded as a component of accumulated other comprehensive income on the
balance sheet.
For the three months and nine months ended June 30, 2003, we recorded a decrease
in sales of $366,300 and $1,525,100, respectively, related to our contracts that
closed during these periods and the changes in the fair value of our derivative
contracts. For the three months and nine months ended June 30, 2002, we recorded
a decrease in sales of $750,000 and $653,000, respectively, related to our
contracts that closed during these periods and the changes in the fair value of
our derivative contracts.
Note 3. Inventories
Inventories have been valued at the lower of average cost or market. The
components of inventory consist of:
June 30, September 30,
2003 2002
---- ----
Component Parts $ 3,088,772 $2,842,460
Work in Progress - 42,616
Finished Goods 5,224,060 5,206,419
--------- ---------
$ 8,312,832 $8,091,495
=========== ==========
8
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 4. Net Income Per Share
Basic net income per share includes no dilution and is computed by dividing net
income by the weighted average number of common shares outstanding for the
period. Diluted net income per share reflects, in the periods in which they have
a dilutive effect, the dilution which would occur upon the exercise of stock
options. A reconciliation of the shares used in calculating basic and diluted
net income per share is as follows:
Three Months Ended Nine months Ended
June 30, June 30,
2003 2002 2003 2002
------ ----- ----- -----
Weighted average shares outstanding-basic 8,869,832 8,886,755 8,863,663 8,888,926
Number of shares issued on the assumed exercise of stock options - 155,816 143,625 168,476
--------- --------- --------- ---------
Weighted average shares outstanding-diluted 8,869,832 9,042,571 9,007,288 9,057,402
========= ========= ========= =========
Options to purchase 1,782,601 and 1,025,822 shares of common stock at prices
ranging $1.05 to $ 10.06 and $2.07 and $10.06, respectively, were outstanding
for the three month periods ending June 30, 2003 and 2002, respectively, but
were not included in the computation of diluted earnings per share because they
were anti-dilutive.
Options to purchase 1,028,522 and 1,025,822 shares of common stock at prices
ranging $1.88 to $ 10.06 and $2.07 and $10.06, respectively, were outstanding
for the nine month periods ending June 30, 2003 and 2002, respectively, but were
not included in the computation of diluted earnings per share because they were
anti-dilutive.
Note 5. Accumulated other comprehensive income
The Euro is the functional currency of the Company's European subsidiary,
Hauppauge Digital Europe Sarl. Assets and liabilities of this subsidiary are
translated to U.S. Dollars at the spot exchange rate in effect at end of each
reporting period, while equity accounts are translated to U.S. Dollars at the
historical rate in effect at the date of the contribution. Operating results are
translated to U.S. Dollars at the average prevailing exchange rate for the
period, with the exception of sales which are translated to U.S. Dollars at the
average monthly forward exchange contract rate. The use of translating accounts
at the spot, historical and average exchange rates results in foreign currency
translation gains or losses. These translation gains losses are recorded on the
balance sheet under accumulated other comprehensive income.
The Company uses forward exchange contracts to reduce our exposure to
fluctuations in foreign currencies. Mark to market gains and losses on these
open contracts result from the difference between the USD value of our open
foreign currency forward contracts at the average contract rate as opposed to
the same contracts translated at the month end spot rate. The Company qualifies
for cash flow hedge accounting as prescribed under FAS 133, which allows the
Company to record the mark to market gains and losses in the equity section of
our balance sheet under accumulated other comprehensive income.
As of June 30, 2003, appearing in the equity section under " Accumulated other
comprehensive income" was a deferred gain of $212,111, which consisted of a
deferred translation gain of $358,118 and a deferred loss of $146,007 due to the
mark to market losses on the difference between the value of our open forward
exchange contracts at the contract rates versus the same contracts valued at the
period ending forward rate.
The Company's Asian subsidiary reports its financial position and results of
operations in the reporting currency of the Company.
9
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 6. Revenue Recognition
We sell through a sales channel which consist of retailers and distributors. Our
prices are fixed consistently over the entire sales channel. The majority of our
customers are granted open payment terms. Those customers deemed as large credit
risks either pay in advance or issue us a letter of credit.
The Company requires the customer to submit a purchase order to the Company. The
price of the product and payment terms are fixed per the terms of the purchase
order. Upon shipment of the order to the customer, the title to the goods is
passed to the customer. The customer is legally obligated to pay for the order
within the payment terms stated on the customer's purchase order. The obligation
to insure the boards and the cost of any pilferage while in the customer's
possession is the responsibility of the customer. The product we sell is a plug
and play computer board that is stocked on the shelves of retailers, and is
subject to the normal consumer traffic that retail stores attract. Aside from
normal store promotions such as end-caps and advertisements in the store's
circular, the Company has no further obligation to assist in the resale of the
product.
The Company offers it customers a right of return, but does not offer stock
balancing. Our accounting complies with SFAS 48 as typically at the end of every
quarter, the Company, based on historical data, evaluates its sales reserve
level based on the previous six months sales. Due to seasonal nature of our
business coupled with the changing economic environment, management exercises
some judgement with regard to the historical data to arrive at the reserve.
Note 7. Product segment and Geographic Information
The Company sells a family or group of products called WinTV. Using a television
signal source which can be either through a cable hookup, terrestrial antenna or
digital satellite, the WinTV family of products allow a PC user to watch TV in a
resizable window on their PC. Our products are either sold, or can be sold, by
the same retailers and distributors in our marketing channel. We also sell
product directly to OEM customers. The Company evaluates its product lines under
the functional categories of analog and digital products. Sales by functional
category are as follows:
Three months ended June 30, Nine months ended June 30,
2003 2002 2003 2002
---- ---- ---- ----
Product line sales
- ------------------
Analog sales $ 6,948,851 $ 6,931,537 $ 28,371,468 $26,464,786
Digital sales 3,061,931 3,181,598 11,078,658 6,459,582
----------- ----------- ------------ -----------
$10,010,782 $ 10,113,135 $ 39,450,126 $32,924,368
=========== ============ ============ ===========
The Company sells its product through a worldwide network of distributors and
retailers. European sales accounted for 67% and 68% of sales for the three moths
ended June 30, 2003 and 2002 and 69% and 74% of sales for the nine months ended
June 30, 2003 and 2002, respectively. Sales percent by geographic region are as
follows:
Three months ended June 30, Nine months ended ended June 30,
2003 2002 2003 2002
---- ---- ---- ----
Sales percent by geographic region
- ----------------------------------
United States 31% 30% 30% 24%
Europe 67% 68% 69% 74%
Asia 2% 2% 1% 2%
---- ---- ---- ----
Total 100% 100% 100% 100%
==== ==== ==== ====
10
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 8. Stock-Based Compensation
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", ("APB 25"), and related interpretations in
accounting for its employee stock options. Under APB 25, no compensation expense
is recorded so long as the quoted market price of the stock at the date of the
grant is equal to the exercise price.
Pro forma information regarding net income and earnings per share has been
determined as if the Company had accounted for its employee stock options under
the fair value method of Financial Accounting Standards Board Statement No. 123
"Accounting for Stock-Based Compensation", ("FAS 123"). The weighted average
fair value of options granted during the three months and nine months ended June
30, 2003 and June 30, 2002 was $0.43 and $0.42, respectively. The fair value for
these options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted average assumptions for the three and
nine months ended June 30, 2003 and June 30, 2002: risk-free interest rates of
3.25%, volatility factor of the expected market price of the Company's Common
Stock of 40%, assumed dividend yield of 0%, and a weighted-average expected life
of the option of 5 years.
Under the accounting provisions of FAS 123, the Company's net income and net
income per share would have been adjusted to the pro forma amounts indicated
below:
Three months ended Nine months ended
-------------------- -------------------
June 30, June 30, June 30, June 30
2003 2002 2003 2002
-------- --------- ---------- --------
Net income (loss) as reported....................... $ (855,465) $ 26,126 $ 61,522 $ 527,062
Deduct: Total stock-based employee compensation expense
determined under fair value method, net of related taxes (11,626) (19,865) (34,877) (56,220)
----------- ---------- --------- -----------
Pro forma net income (loss)......................... $ (867,091) $ 6,261 $ 26,645 $ 470,842
=========== ========== ======== ==========
Net income (loss) per share - as reported:
Basic and diluted................................... $ (0.10) $ 0.00 $ 0.01 $ 0.06
========== ========== ======== ==========
Net income (loss) per share - pro forma:
Basic and diluted................................... $ (0.10) $ 0.00 $ 0.00 $ 0.05
========= ========== ======== ==========
Note 9. Arrangements with Off-Balance Sheet Risk - Guarantees
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of the Indebtedness of Others, which clarifies the requirements of
SFAS No. 5, Accounting for Contingencies, relating to a guarantor's accounting
for and disclosures of certain guarantees issued. FIN 45 requires enhanced
disclosures for certain guarantees. It also requires certain guarantees that are
issued or modified after December 31, 2002, including certain third-party
11
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 9. Arrangements with Off-Balance Sheet Risk - Guarantees-continued
guarantees, to be initially recorded on the balance sheet at fair value. For
guarantees issued on or before December 31, 2002, liabilities are recorded when
and if payments become probable and estimable. FIN 45 has the general effect of
delaying recognition for a portion of the revenue for product sales that are
accompanied by certain third-party guarantees. The financial statement
recognition provisions became effective prospectively beginning January 1, 2003.
The Company has not entered into any new guarantees, not have they ammended
their existing guarantee since the effective date.
We occupy a facility located in Hauppauge, New York and use it as our executive
offices and for the testing, storage, and shipping of our products. The building
is owned by a partnership comprised of certain of our principal stockholders'
and is leased to us under a lease agreement expiring on January 31, 2006, which
may be extended, at our option, for an additional three years. The premises are
subject to two mortgages which have been guaranteed by us upon which the
outstanding principal amount due as of June 30, 2003 was $745,000. The two
mortgages guaranteed expire on Janauary 31, 2010, at which time the related
gurantees expire.
Note 10. Recent Accounting Pronouncements
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" (" SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures three
classes of freestanding financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability. SFAS 150 was effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The Company has not entered into any financial instruments within the
scope of SFAS 150 since May 31, 2003, nor does it currently hold any significant
financial instruments within its scope.
12
Item 2. Management's Discussion and Analysis of Financial Condition and
- -------------------------------------------------------------------------
Results of Operations
- ---------------------
Nine Month Period ended June 30, 2003 Compared to June 30, 2002
- ---------------------------------------------------------------
Results of operations for the nine months ended June 30, 2003 compared to June
30, 2002 are as follows:
Nine Nine
Months Months
Ended Ended Variance Percentage of sales
6/30/03 6/30/02 $ 2003 2002 Variance
-------- --------- --------- ---- ---- --------
Net Sales $ 39,450,126 $ 32,924,368 $6,525,758 100.0% 100.0% 0
Cost of sales 29,905,216 24,512,946 5,392,270 75.8% 74.5% 1.3%
------------ ---------- ---------- ------ ------ -----
Gross Profit 9,544,910 8,411,422 1,133,488 24.2% 25.5% -1.3%
Gross Profit % 24.19% 25.55% -1.36%
Costs:
Sales & Marketing 5,356,753 4,204,455 1,152,298 13.6% 12.8% 0.8%
Technical Support 314,318 287,999 26,319 0.8% 0.9% -0.1%
General & Administrative 2,397,880 2,158,403 239,477 6.1% 6.6% -0.5%
------------- ---------- --------- ----- ----- -----
Total Selling, General and Administrative costs 8,068,951 6,650,857 1,418,094 20.5% 20.3% 0.2%
Research & Development 1,429,171 1,128,266 300,905 3.6% 3.4% 0.2%
------------- ---------- --------- ----- ----- -----
Total Costs 9,498,122 7,779,123 1,718,999 24.1% 23.7% 0.4%
------------- ---------- --------- ----- ----- -----
Net operating income 46,788 632,299 (585,511) 0.1% 1.8% -1.7%
Other income (expense)
- ---------------------
Interest income 13,148 28,085 (14,937) 0.0% 0.1% -0.1%
Foreign currency (11,350) 2,318 (13,668) 0.0% 0.0% 0.0%
Non operational USD to Euro re-measurement 51,936 (82,143 134,079 0.1% -0.2% 0.3%
------------- ---------- ---------- ----- ----- -----
Total other income (expense) 53,734 (51,740) 105,474 0.1% -0.1% 0.2%
------------- ---------- ---------- ----- ----- -----
Income before taxes 100,522 580,559 (480,037) 0.2% 1.7% -1.5%
Taxes on income 39,000 53,497 (14,497) 0.1% 0.2% -0.1%
------------- ---------- ---------- ----- ----- -----
Net income $ 61,522 $ 527,062 $ (465,540) 0.1% 1.5% -1.4%
============= ========== =========== ===== ===== =====
Net sales for the nine months ended June 30, 2003 increased $6,525,758 compared
to last year. Domestic and European sales increased by $3,965,811 and $2,782,748
while Asian sales decreased $202,801 as follows:
Increase
(decrease) Increase Percentage of sales by
Location Nine Months Nine Months Dollar (decrease) Geographic region
- -------- ended 6/30/03 ended 6/30/02 Variance Variance % 2003 2002
------------- ------------- ----------- ---------- ----- ----
Domestic $ 11,779,917 $ 7,814,106 $ 3,965,811 51% 30% 24%
Europe 27,127,121 24,344,373 2,782,748 11% 69% 74%
Asia 543,088 765,889 (222,801) -29% 1% 2%
------------ ------------- ------------- ---------- ----- ---
Total $ 39,450,126 $32,924,368 $ 6,525,758 20% 100% 100%
============ ============= ============= ========== ===== ====
The primary forces contributing to the sales increase were:
o Digital and digital satellite products:$4,619,076
o Analog and personal video recorder sales:$1,906,682
13
Nine Month Period ended June 30, 2003 Compared to June 30, 2002-continued
- ---------------------------------------------------------------------------
Netsales to domestic customers were 30% of net sales for the nine months ended
June 30, 2003 compared to 24% for the nine months ended June 30, 2002. Net sales
to European customers were 69% of net sales compared to 74% for same period of
last year. Net sales to Asian customers were 1% for the nine months ended June
30, 2003 as compared to 2% for the nine months ended June 30, 2002.
Gross profit increased $1,133,488 for the nine months ended June 30, 2003. Gross
profit percentage for the nine months ended June 30, 2003 was 24.19% compared to
25.55% for the prior year.
The increases and (decreases) in the gross profit are detailed below:
Increase
(decrease)
----------
Due to increased sales $2,146,516
Higher margins due to product mix 181,904
Third quarter fiscal 2002 inventory reserve adjustment (149,059)
Margin reduction due to OEM sales (660,107)
Due to increases in labor related and other costs (385,766)
----------
Total increase in gross profit $1,133,488
==========
The decrease in gross profit percent of (1.36)% for the nine months ended June
30, 2003 compared to the nine months ended June 30, 2002 is as follows:
Increase
(decrease)
----------
Higher margins due to product mix 0.46%
Third quarter fiscal 2002 inventory reserve adjustment (0.46)%
Margin reduction due to OEM sales (1.67)%
Labor related and other costs 0.31%
----------
Net decrease gross profit % (1.36%)
==========
The 0.46% improved gross profit percent on assembled boards was primarily
derived from unit price reductions from our suppliers and subcontractors on our
analog product lines, offset somewhat by sales of lower average margin digital
products.
Although OEM sales require minimal sales and marketing support, the gross profit
margin percent is substantially less than our retail products. Our OEM sales had
an average gross profit margin of about 10.24% for the nine months ended June
30, 2003. OEM sales accounted for about 7.24% of our sales for the nine months
ended June 30, 2003. There were no significant OEM sales for the same periods of
the previous year. The increase in OEM sales caused a 1.67% reduction in gross
profit margin percentage compared to last year.
During the latter part of fiscal 2001, the factors below affected the
realization of the Company's inventory:
o The loss during the quarter 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
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.
14
Nine Month Period ended June 30, 2003 Compared to June , 2002-continued
- -------------------------------------------------------------------------
During fiscal 2002, there was 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 margin percentage 1.67% between
fiscal 2003 and fiscal 2002.
The increase in the gross margin percent of 0.31% due to labor related and other
costs is related to the increase in net sales of 19.82% being in excess of the
increase in labor related and other costs of 15.03%.
The chart below illustrates the components of Selling, General and
Administrative expenses:
Nine months ended June 30,
--------------------------
Dollar Costs Percentage of Sales
--------------------------------------------- ---------
Increase Increase
2003 2002 (Decrease) 2003 2002 (Decrease)
---- ---- ---------- ---- ---- ----------
Sales and Marketing $ 5,356,753 $ 4,204,455 $ 1,152,298 13.6% 12.8% 0.8%
Technical Support 314,318 287,999 26,319 0.8% 0.9% -0.1%
General and Administrative 2,397,880 2,158,403 239,477 6.1% 6.6% -0.5%
------------ ------------ ------------ ----- ----- -----
Total $ 8,068,951 $ 6,650,857 $ 1,418,094 20.5% 20.3% 0.2%
============ ============ ============ ===== ===== =====
Selling, General and Administrative expenses increased $1,418,094 from the prior
year. As a percentage of sales, Selling, General and Administrative expenses
increased by 0.2% when compared to the nine months ended June 30, 2002.
The increase in Sales and Marketing expense of $1,152,298 which accounted for
about 81% of the total increase in Selling, General and Administrative expenses,
was mainly due to:
o Higher advertising costs of $627,757 due to higher sales based
co-operative advertising, higher customer rebate realization and
increased special promotions
o Higher advertising costs of $235,794 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 $93,548 due to increased sales
o Increased sales commission expense of $45,062 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 $100,678
o Increased European sales office costs of $244,444 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 $194,593 due to smaller show presence and
frequency
The increase in General and Administrative expenses of $239,477 was primarily
due to:
o Addition of senior executive officer $109,976
o Higher legal costs of $28,241
o Increased travel costs of $15,540
o Directors fees of $18,335
o Banking fees of $51,560
o Consulting fees for investment advice and public relations $49,009
o Decreased amortization costs of $42,122 due to amortization in full of
an intangible asset during fiscal 2002
Research and Development expenses increased $300,905 or approximately 27%. The
increase was mainly due to higher compensation costs attributable to additional
staff and increased material and contract services cost for current projects
under development.
15
Nine Month Period ended June 30, 2003 Compared to June, 2002-continued
- ----------------------------------------------------------------------
Other income (expense)
Net other income for the nine months ended June 30, 2003 was $53,734 compared to
net other expense of ($51,740) for the nine months ended June 30, 2002 as
detailed below:
Nine months ended June 30,
2003 2002
---- ----
Interest income $ 13,148 $ 28,085
Foreign currency transaction gains (losses) (11,350) 2,318
Non operational USD to Euro currency re-measurement 51,936 (82,143)
-------- ---------
Total other income (expense) $ 53,734 $(51,740)
======== =========
The decrease in total other expense was due to the lower losses resulting from
the Non operational USD to Euro currency re-measurements and lower interest
income due to lower investment yields.
Non Operational USD to Euro currency re-measurement
We follow the rules prescribed in paragraph 15 of SFAS 52 "Foreign Currency
Translation", which states that accounts denominated in a currency other than an
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.
Since the functional currency of Hauppauge Digital Europe Sarl ("HDE Sarl") is
the Euro, any asset, liability or equity accounts which are invested in or
purchased using U.S. Dollars or Great British Pounds by HDE Sarl are revalued
into Euros at the end of each period. The gains or losses on HDE Sarl's books
resulting from the revaluation of U.S. Dollar and Great British Pound accounts
into Euros are booked on the Company's profit and loss statement in the other
income (loss) section under the description " Non operational USD to Euro
currency re-measurement."
Primarily due to a decrease in U.S Dollar denominated inventory on HDE Sarl's
books, HDE Sarl experienced a net asset decrease for the nine month period
ending June 30, 2003. The increase in the value of the Euro versus the U.S.
Dollar coupled with the decrease in net assets resulted in a re-measurement gain
of $51,936 for the nine months ended June 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 nine months
ended June 30, 2003, the Company recorded in other comprehensive income deferred
translation gains $361,963, resulting in a translation gain of $358,118 recorded
as a component of accumulated other comprehensive income as of June 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
16
Nine Month Period ended June 30, 2003 Compared to June , 2002-continued
- -----------------------------------------------------------------------
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 nine months ended June 30, 2003, the Company
recorded in other comprehensive income a mark to market loss of $336,926,
reflecting the difference between open contracts at September 30, 2002 and June
30, 2003. Recorded as a component of accumulated other comprehensive income on
the balance sheet as of June 30, 2003 was a cumulative mark to market loss for
open contracts of $146,007.
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 to Balance January to Balance April to Balance
Accumulated other comprehensive income loss as of December 2002 as of March 2003 as of June 2003 as of
- ------------------------------------------- September 30, Gains December 31, Gains March 31, Gains June 30,
2002 (losses) 2002 (losses) 2003 (losses) 2003
------------ ------------- ----------- ---------- --------- --------- --------
Translation gains and (losses) $ (3,845) $ 150,728 $ 146,883 $ 13,318 $ 160,201 $197,917 $ 358,118
FAS 133 mark to market adjustments 190,919 (518,974) (328,055) 163,879 (164,176) 18,169 (146,007)
---------- --------- --------- --------- --------- -------- ---------
$ 187,074 $(368,246) $(181,172) $ 177,197 $ 3,975) $216,086 $ 212,111
========== ========= ========= ========= ========== ======== =========
Tax provision
Our net tax provision for the nine months ended June 30, 2003 and 2002 is as
follows:
Nine months ended June 30,
--------------------------
2003 2002
------ ------
Tax (benefit) attributable to U.S operations $ 590,000) $(640,000)
Tax expense European operations 39,000 53,497
Deferred tax asset valuation allowance 590,000 640,000
--------- ---------
Net tax provision $ 39,000 $ 53,497
========= =========
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 June 30, 2003 and we concluded that under the
present circumstances, it would be appropriate for us to record a valuation
allowance against the increase in the deferred tax asset attributable to the
current quarter's loss from domestic operations.
During the nine months ended June 30, 2003, we reduced our Income Tax Receivable
and Accrued Income Tax Payable by $326,000, partially due to tax examinations
and adjustments of amounts previously recorded.
As a result of all of the above items mentioned in the Management's Discussion
and Analysis of Financial Condition and Results of Operations, we recorded net
income of $61,522 for the nine months ended June 30, 2003, which resulted in
basic and diluted net income per share of $0.01 on weighted average basic and
diluted shares of 8,863,663 and 9,007,288, respectively, compared to a net
income of $527,062 for the nine months ended June 30, 2002, which resulted in
basic and diluted net loss per share of $0.06 on weighted average basic and
diluted shares of 8,888,926 and 9,057,402, respectively.
Options to purchase 1,028,522 and 1,025,822 shares of common stock at prices
ranging $1.88 to $ 10.06 and $2.07 and $10.06, respectively, were outstanding
for the nine month periods ending June 30, 2003 and 2002, respectively, but were
not included in the computation of diluted earnings per share because they were
anti-dilutive.
17
Results of operations-three Month Period ended June 30, 2003 Compared to June
- --------------------------------------------------------------------------------
30, 2002
- --------
Results of operations for the three months ended June 30, 2003 compared to June
30, 2002 are as follows:
Three Three
Months Months
Ended Ended Variance Percentage of sales
6/30/03 6/30/03 $ 2003 2002 Variance
------- ------- -------- ---- -------------
Net Sales $ 10,010,782 $ 10,113,135 $ (102,353) 100.0% 100.0% 0
Cost of sales 7,756,306 7,444,435 311,871 77.5% 73.6% 3.9%
------------ ------------ ----------- ------ ------ ----
Gross Profit 2,254,476 2,668,700 (414,224) 22.5% 26.4% -3.9%
Gross Profit % 22.52% 26.39% -3.87%
Costs:
Sales & Marketing 1,655,344 1,332,194 323,150 16.5% 13.1% 3.4%
Technical Support 114,543 96,656 17,887 1.1% 0.9% 0.2%
General & Administrative 868,290 760,634 107,656 8.7% 7.5% 1.2%
------------ --------- ----------- ------ ----- ----
Total Selling, General and Administrative costs 2,638,177 2,189,484 448,693 26.3% 21.5% 4.8%
Research & Development 487,847 404,829 83,018 4.9% 4.0% 0.9%
------------ --------- ----------- ------ ----- ----
Total Costs 3,126,024 2,594,313 531,711 31.2% 25.5% 5.7%
------------ --------- ----------- ------ ----- ----
Net operating income (871,548) 74,387 (945,935) -8.7% 0.9% -9.6%
Other income (expense)
- ----------------------
Interest income 3,143 6,457 (3,314) 0.0% 0.1% -0.1%
Foreign currency 4,144 (15,718) 19,862 0.1% -0.2% 0.3%
Non operational USD to Euro re-measurement 8,796 (28,003) 36,799 0.1% -0.3% 0.4%
------------ --------- ----------- ------ ----- -----
Total other income (expense) 16,083 (37,264) 53,347 0.2% -0.4% 0.6%
------------ --------- ----------- ------ ----- -----
Income before taxes (855,465) 37,123 (892,588) -8.5% 0.5% -9.0%
Taxes on income - 10,997 (10,997) 0.0% 0.1% -0.1%
------------ --------- ----------- ------ ----- -----
Net income $ (855,465) $ 26,126 $ (881,591) -8.5% 0.4% -8.9%
============ ========= =========== ====== ===== =====
Net sales for the three months ended June 30, 2003 decreased $102,353 compared
to the three months ended June 30, 2002. European and Asian sales decreased by
$116,319 and $83,793, while domestic sales increased $97,759 as follows:
Increase
(decrease) Increase Percentage of sales by
Location Three Months Three Months Dollar (decrease) Geographic region
- ------------ ended 6/30/03 ended 6/30/02 Variance Variance % 2003 2002
------------- ------------- ---------- ----------- ---- ----
Domestic $ 3,104,548 $ 3,006,789 $ 97,759 3% 31% 30%
Europe 6,746,029 6,862,348 (116,319) -2% 67% 68%
Asia 160,205 243,998 (83,793) -34% 2% 2%
------------ ------------- ---------- ----- ---- ----
Total $ 10,010,782 $ 10,113,135 $ (102,353) -1% 100% 100%
============ ============= =========== ===== ==== ====
The primary forces contributing to the sales decrease were:
o Decrease in sales of digital and digital satellite product of $119,667
o Increase in analog and personal video recorder sales of $17,314
Net sales to domestic customers were 31% of net sales for the quarter ended June
30, 2003 compared to 30% for the quarter ended June 30, 2002. Net sales to
European customers were 67% of net sales compared to 68% for the same quarter of
last year. Net sales to Asian customers were 2% for both quarters.
Gross profit decreased $414,224 for the three months ended June 30, 2003. Gross
profit percentage for the three months ended June 30, 2003 was 22.52% compared
to 26.39% for the prior year's third quarter.
18
Results of operations-three Month Period ended June 30, 2003 Compared to June
- --------------------------------------------------------------------------------
30, 2002-continued
- ------------------
The increases and (decreases) in the gross profit are detailed below:
Increase
(decrease)
----------
Due to (decreased) sales $ (34,149)
Higher margins due to product mix 50,619
Third quarter fiscal 2002 inventory reserve adjustment (151,189)
Margin reduction due to OEM sales (216,523)
Due to increases in labor related and other costs (62,982)
----------
Total decrease in gross profit $(414,224)
==========
The decrease in gross profit margin percent of 3.87% for the three months ended
June 30, 2003 compared to the three months ended June 30, 2002 was as follows:
Increase
(decrease)
----------
Higher margins due to product mix 0.50%
Third quarter fiscal 2002 inventory reserve adjustment (1.49)%
Margin reduction due to OEM sales (2.16)%
Labor related and other costs (.72)%
----------
Net decrease in gross profit % (3.87)%
==========
The 0.50% improved gross profit margin percent on assembled boards was primarily
derived from unit price reductions from our suppliers and subcontractors on our
analog product lines, offset somewhat by sales of lower average gross profit
margin percentage digital products.
Although OEM sales require minimal sales and marketing support, the margins are
substantially less than our retail products. Our OEM sales had an average gross
profit margin of about 12.31% for the three months ended June 30, 2003. OEM
sales accounted for about 10.03% of our sales for the three months ended June
30, 2003. There were no significant OEM sales for the same period of the
previous year. The increase in OEM sales caused a 2.16% reduction in gross
profit margin percent compared to last year.
During the latter part of fiscal 2001, the factors below affected the
realization of the Company's inventory:
o The loss during the quarter 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
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 was 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 the third quarter of fiscal
2003, which resulted in a comparative reduction in our gross profit margin
percentage 1.49% between the third quarters fiscal 2003 and fiscal 2002.
19
Results of operations-three Month Period ended June 30, 2003 Compared to June
- --------------------------------------------------------------------------------
30, 2002-continued
- ------------------
The decrease in the gross profit margin percent of 0.72% relating to labor
related and other costs was due to the sales decreasing by 1.01% from last
year's third quarter while labor related and other costs increased 7.35% over
last year's third quarter.
The chart below illustrates the components of Selling, General and
Administrative expenses:
Three months ended June 30,
----------------------------
Dollar Costs Percentage of Sales
---------------------------------------------------------------------
Increase Increase
2003 2002 (Decrease) 2003 2002 (Decrease)
---- ---- ---------- ---- ---- ----------
Sales and Marketing $ 1,655,344 $ 1,332,194 $ 323,150 16.5% 13.1% 3.4%
Technical Support 114,543 96,656 17,887 8.7% 0.9% 0.2%
General and Administrative 868,290 760,634 107,656 8.7% 7.5% 1.2%
------------ ----------- --------- ----- ----- ----
Total $ 2,638,177 $ 2,189,484 $ 448,693 26.3% 21.5% 4.8%
============ =========== ========= ===== ===== ====
Selling, General and Administrative expenses increased $448,693 from the prior
year's third quarter. As a percentage of sales, Selling, General and
Administrative expenses increased by 4.8% when compared to the three months
ended June 30, 2002.
The increase in Sales and Marketing expense of $323,150, which accounted for
about 72% of the total increase in Selling, General and Administrative expenses,
was mainly due to:
o Higher advertising costs of $192,544 due to higher sales based
co-operative advertising, higher customer rebate realization and
increased special promotions
o Higher advertising costs of $57,974 due to higher translated Euro
to U.S dollar amounts due to the strengthening of the Euro
against the USD
o Lower commissions expense of $18,075 due to decreased sales
o Increased commission expense of $16,398 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 $62,200
o Increased European sales office costs of $90,468 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 $64,542 due to smaller show presence
and frequency
The increase in General and Administrative expenses of $107,656 was primarily
due to:
o Addition of senior executive officer $16,177
o Other salary increases of $12,820
o Higher legal costs of $15,498
o Directors fees of $18,335
o Banking fees of $13,518
o Consulting fees for investment advice and public relations
$37,498
o Decreased amortization costs of $12,491 due to amortization in
full of an intangible asset during fiscal 2002
Research and Development expenses increased $83,018 or approximately 21%. The
increase was mainly due to higher compensation costs attributable to additional
staff and increased material and contract services cost for current development
projects.
20
Three Month Period ended June 30, 2003 Compared to June 30, 2002-continued
- --------------------------------------------------------------------------
Other income (expense)
Net other income for the three months ended June 30, 2003 was $16,083 compared
to net other expense of $37,264 for the three months ended June 30, 2002 as
detailed below:
Three months ended June 30,
2003 2002
---- ----
Interest income $ 3,143 $ 6,457
Foreign currency transaction gains (losses) 4,144 (15,718)
Non operational USD to Euro currency re-measurement 8,796 (28,003)
--------- ---------
Total other income (expense) $ 16,083 $(37,264)
========= =========
The increase in total other income was due to the higher gains resulting from
the Non operational USD to Euro currency re-measurements and lower interest
income due to lower investment yields.
Non Operational USD to Euro currency re-measurement
We follow the rules prescribed in paragraph 16 of SFAS 52 "Foreign Currency
Translation", which states that accounts denominated in a currency other than an
entities functional currency need to be re-measured into the entities functional
currency, and any gain or loss from this re-measurement are included in the
determination of net income.
Since the functional currency of Hauppauge Digital Europe Sarl ("HDE Sarl") is
the Euro, any asset, liability or equity accounts which are invested in or
purchased using U.S. Dollars or Great British Pounds by HDE Sarl are revalued
into Euros at the end of each period. The gains or losses on HDE Sarl's books
resulting from the revaluation of U.S. Dollar and Great British Pound accounts
into Euros are booked in the Company's profit and loss statement in the other
income (loss) section under the description " Non operational USD to Euro
currency re-measurement."
Primarily due to a decrease in U.S Dollar denominated inventory on HDE Sarl's
books, HDE Sarl experienced a net asset decrease for the three month period
ending June 30, 2003. The increase in the value of the Euro versus the U.S.
Dollar coupled with the decrease in net assets resulted in a re-measurement gain
of $8,796 for the three months ended June 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. For the three months ended June 30, 2003, the
Company recorded in other comprehensive income deferred translation gains of
$197,917. Recorded as a component of accumulated other comprehensive income on
the balance sheet as of June 30, 2003 was a cumulative translation gain of
$358,118.
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
21
Three Month Period ended June 30, 2003 Compared to June 30,
- ----------------------------------------------------------------------
2002-continued
- --------------
of our balance sheet under accumulated other comprehensive income. For the three
months ended June 30, 2003, the Company recorded in other comprehensive income a
mark to market gain of $18,169, reflecting the difference between open contracts
at March 31, 2003 and June 30, 2003. Recorded as a component of accumulated
other comprehensive income on the balance sheet as of June 30, 2003 was a
cumulative mark to market loss for open contracts of $146,007.
As stated above, accumulated other comprehensive income (loss) consists of two
components:
o Translations 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 to Balance January to Balance April to Balance
Accumulated other comprehensive income (loss) as of December 2002 As of March 2003 as of June 2003 as of
- --------------------------------------------- September 30, Gains December 31, Gains March 31, Gains June 30,
2002 (losses) 2002 (losses) 2003 (losses) 2003
------------- ------------- ------------ ---------- --------- ---------- --------
Translation gains and (losses) $ (3,845) $ 150,728 $ 146,883 $ 13,318 $ 160,201 $ 197,917 $358,118
FAS 133 mark to market adjustments 190,919 (518,974) (328,055) 163,879 (164,176) 18,169 146,007
------------- ------------- ------------ ---------- --------- ---------- --------
$187,074 $(368,246) $ 181,172) $177,197 $ (3,975) $ 216,086 $212,111
============= ============= ============ ========== ========= ========== ========
Tax provision
Our net tax provision for the three months ended June 30, 2003 and 2002 is as
follows:
Three months ended June 30,
---------------------------
2003 2002
------ -----
Tax (benefit) attributable to U.S operations $ (377,500) $ (163,000)
Tax expense European operations - 10, 997
Deferred tax asset valuation allowance 377,500 163,000
----------- -----------
Net tax provision $ - $ 10,997
=========== ===========
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 June 30 2003 and we concluded that under the
present circumstances, it would be appropriate for us to record a valuation
allowance against the increase in the deferred tax asset attributable to the
current quarter's loss from domestic operations.
During the nine months ended June 30, 2003, we reduced our Income Tax Receivable
and Accrued Income Tax Payable by $326,000, partially due to tax examinations
and adjustments of amounts previously recorded.
As a result of all of the above items mentioned in the Management's Discussion
and Analysis of Financial Condition and Results of Operations, we recorded net
loss of $855,465 for the three months ended June 30, 2003, which resulted in
basic and diluted net loss per share of $0.10 on weighted average basic and
diluted shares of 8,869,832, compared to a net income of $26,126 for the three
months ended June 30, 2002, which resulted in breakeven basic and diluted net
income per share on weighted average basic and diluted shares of 8,886,755 and
9,042,571, respectively.
Options to purchase 1,782,601 and 1,025,822 shares of common stock at prices
ranging $1.05 to $ 10.06 and $2.07 and $10.06, respectively, were outstanding
for the three month periods ending June 30, 2003 and 2002, respectively, but
were not included in the computation of diluted earnings per share because they
were anti-dilutive.
22
Seasonality
- -----------
As our sales are primarily to the consumer market, we have experienced certain
seasonal revenue trends. Our peak sales quarter, due to holiday season sales of
computer equipment, is our first fiscal quarter (October to December), followed
by our fourth fiscal quarter (July to September). In addition, our international
sales, mostly in the European market, were 73%, 77% and 71 % of sales for the
years ended September 30, 2002, 2001 and 2000, respectively. Our fiscal fourth
quarter sales (July to September) can be potentially impacted by the reduction
of activity experienced in Europe during the July and August summer holiday
period.
To offset the above cycles, we target a wide range of customer types in order to
moderate the seasonal nature of our retail sales.
Liquidity and Capital Resources
Our cash, working capital and stockholders' equity position is disclosed below:
June 30, September 30,
2003 2002
------- ----
Cash $ 5,347,255 $ 4,964,522
Working Capital 11,421,999 11,276,942
Stockholders' Equity 12,070,689 11,966,612
We had cash and cash equivalents as of June 30, 2003 of $5,347,255, a increase
of $382,733 over September 30, 2002.
The increase was due to:
Net income adjusted for non cash items $ 298,370
Decrease in accounts receivable 1,122,442
Decrease in income taxes receivable 326,000
Proceeds from employee stock purchases 24,657
Less cash used for:
Decrease in accounts payable and other current liabilities (792,715)
Increase in inventories (221,337)
Increase in prepaid expenses and other current assets (171,677)
Purchases of fixed assets (167,365)
Purchase of treasury stock (35,642)
---------
Net increase in cash $ 382,733
=========
Net cash of $561,083 provided by operating activities was primarily due to a
reduction in accounts receivable and income tax receivable of $1,122,442 and
$326,000, respectively, and net income adjusted for non cash items of $298,370
offset by cash used to fund decreases in accounts payable and other current
liabilities of $792,715, increase in inventory of $221,337 and increases in
prepaid assets and other current assets of $171,677. The decrease in accounts
receivable was the result of a decrease in sales of about $3.6 million between
the quarter ended March 31, 2002 and the quarter ended June 30, 2003.
Cash of $167,365 and $35,642 was used to purchase fixed assets and purchase
treasury stock. Proceeds from the stock purchased by employees through the
employee stock purchase plan provided additional cash of $24,657.
Our bank facility with JP Morgan Chase expired in April 2002. It is the
intention of the Company to procure a new credit facility on terms acceptable to
the Company, however, there can be no assurance that we will secure a
replacement line of credit at competitive terms.
On November 8, 1996, we approved a stock repurchase program. The program, as
amended, authorizes the Company to repurchase up to 850,000 shares of our own
stock. We intend to use the repurchased shares for certain employee benefit
programs. On December 17, 1997, the stock repurchase program was extended by a
resolution of our Board of Directors. As of June 30, 2003, we held 542,067
treasury shares purchased for $1,497,216 at an average purchase price of
approximately $2.76 per share.
We believe that our cash and cash equivalents as of June 30, 2003 and our
internally generated cash flow will provide us with sufficient liquidity to meet
our currently foreseeable short-term and long-term capital needs.
23
Future Contractual Obligations
- -------------------------------
The following table shows the Company's contractual obligations related to lease
obligations as of June 30, 2003:
Payments due by period
Contractual obligations Total 1 year 1-3 years
- ----------------------- ----- --------- ---------
Operating lease obligations $ 1,755,674 $ 662,838 $ 1,092,836
=========== ========= ===========
Critical Accounting Policies and Estimates
- ------------------------------------------
Financial Reporting Release No. 60, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements.
We believe the following critical accounting policies affect the significant
judgments and estimates used in the preparation of the our financial statements:
o Revenue Recognition
o Management's estimates
o Hedging program for sales denominated in a foreign currency
o Translation of assets and liabilities denominated in non functional
currencies on our European financial statements
Revenue Recognition
- -------------------
Our revenues are primarily derived from the sale of computer boards which enable
you to view television programs on your personal computer. Sales of computer
boards are commonly classified as computer hardware. Our sales are primarily to
retailers, distributors and original equipment manufacturers. Sales to our
customers are documented by a purchase order which describes the conditions of
sale. Sales are recorded when products are shipped to our customers. The product
price is fixed and determinable, collection of the resulting receivable is
probable and product returns are reasonably estimable. Revenue from freight
charged to customers is recognized when products are shipped. Provisions for
customer returns and other adjustments are provided for in the period the
related sales are recorded based upon historical data.
Management's Estimates
- ----------------------
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires management to make
estimates and judgments that affect the reported amounts of assets, liabilities
and related disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts for revenues and
expenses during the reporting period. On an ongoing basis, management evaluates
estimates, including those related to sales provisions, as described above,
income taxes, bad debts, inventory reserves and contingencies. We base our
estimates on historical data, when available, experience, and on various other
assumptions that are believed to be reasonable under the circumstances, the
combined results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates.
Since October 1, 1999, our European subsidiary has historically accounted for
approximately 68% to 77 % of our net sales. All of our European sales are
denominated in local currencies, primarily the Euro. As a result of this, we are
a net receiver of currencies other than the U.S Dollar. Changes in the exchange
rate subject us to market risks resulting from the fluctuation of the Euro to
the U.S. Dollar. In an attempt to minimize these risks, we enter into forward
exchange contracts with financial institutions.
24
Critical Accounting Policies and Estimates-continued
- ----------------------------------------------------
We do not enter into contracts for speculative purposes. We enter into monthly
window contracts covering an average period of three months based on existing or
anticipated future sales and inventory purchases. Although we enter into these
contracts to reduce the short term impact of currency rate changes, the
following risks are still inherent in hedging the Euro sales.
o Actual sales may fluctuate from our estimates, resulting in contracts in
excess of collections
o Short term volatility of currency markets has the potential to reduce the
effectiveness of our hedging program
o Historical volatility of the Euro has the potential to impact our revenues,
gross margins and operating income
o The magnitude of the success of our hedging program is dependent upon
movements in the Euro exchange rates. These movements are difficult to
predict over an extended period of time.
Translation of assets and liabilities denominated in non functional currencies
- --------------------------------------------------------------------------------
on our European financial statements
- ------------------------------------
The functional currency of our European subsidiary is the Euro. In preparing our
consolidated financial statements, we are required to translate assets and
liabilities denominated in a non functional currency, mainly U.S. Dollars, to
Euros on the books of our European subsidiary. This process results in exchange
gains and losses depending on the changes in the Euro to U.S. Dollar exchange
rate. Under the relevant accounting guidance, we are obligated to include these
gains and losses on our statement of operations, which we report in other income
or expense under the caption "Non operational USD to Euro currency
re-measurement".
The extent of these gains and losses can fluctuate greatly from month to month
depending on the change in the exchange rate, causing results to vary widely.
Due to the past volatility of the Euro, it is difficult to forecast the long
term trend of these gains and losses.
Inflation
- ---------
While inflation has not had a material effect on our operations in the past,
there can be no assurance that we will be able to continue to offset the effects
of inflation on the costs of our products or services through price increases to
our customers without experiencing a reduction in the demand for our products;
or that inflation will not have an overall effect on the computer equipment
market that would have a material affect on us.
Euro
- ----
On January 1, 1999, the Euro was adopted in Europe as the common legal currency
among 11 of the 15 member countries of the European Community. On that date, the
participating countries established fixed Euro conversion rates (i.e. the
conversion exchange rate between their existing currencies and the Euro). The
Euro now trades on currency exchanges and is available for non-cash
transactions. A new European Central Bank was established to direct monetary
policy for the participating countries.
25
Euro-continued
- --------------
Prior to the adoption of the Euro, we billed our European customers in German
Marks or British Pounds, depending upon which currency the customer preferred to
be billed in. Effective January 1, 1999, we began invoicing our customers who
are located in the eleven member countries in Euros. We continue to bill
customers located in the United Kingdom in British Pounds. The benefits to
billing customers in Euros were twofold:
o Our foreign currency hedging program was streamlined to the Euro and
the British Pound
o The pricing from country to country was harmonized, eliminating price
differences between countries due to the fluctuating local currencies
We handled the conversion to the Euro without any material disruptions to our
operations.
Recent Accounting Pronouncements
- --------------------------------
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" (" SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures three
classes of freestanding financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability. SFAS 150 was effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The Company has not entered into any financial instruments within the
scope of SFAS 150 since May 31, 2003, nor does it currently hold any significant
financial instruments within its scope.
Item 3. Quantitative and Qualitative Disclosures about Market Risks
- --------------------------------------------------------------------
Derivatives and Hedging Activities
- ----------------------------------
Due to extensive sales to European customers with payment made to us in those
local currencies and limited expenses paid in local currencies, we are a net
receiver of currencies other than the U.S. Dollar. As such, we benefit from a
weak Dollar and are negatively affected by a strong Dollar relative to the major
worldwide currencies, especially the Euro and British Pound Sterling.
Consequently, changes in exchange rates expose us to market risks resulting from
the fluctuations in the foreign currency exchange rates to the U.S. Dollar. We
attempt to reduce these risks by entering into foreign exchange forward
contracts with financial institutions to protect against currency exchange risks
associated with our foreign denominated sales.
Although we do not try to hedge against all possible foreign currency exposures
because we can not fully estimate the size of our exposure, the contracts we
procure are specifically entered into to as a hedge against existing or
anticipated foreign currency exposure. We do not enter into contracts for
speculative purposes. Although we maintain these programs to reduce the short
term impact of changes in currency exchange rates, when the U.S. Dollar sustains
a long term strengthening position against the foreign currencies in countries
where we sell our products, our revenues, gross margins, operating income and
retained earnings can be adversely affected. Factors that could impact the
effectiveness of our hedging program include volatility of the currency markets
and availability of hedging instruments.
The strength or weakness of the U.S. Dollar against the Euro and British Pound
Sterling impacts our financial results. Changes in exchange rates may positively
or negatively affect our revenues, gross margins, operating income and retained
earnings (which are all expressed in U.S. Dollars). We use derivatives to reduce
our exposure to fluctuations in foreign currencies. Foreign currency forward
contracts, are used to hedge the foreign currency market exposures underlying
forecasted sales transactions with customers. As of June 30, 2003, we had
foreign currency contracts outstanding of approximately $1,590,000 against the
delivery of the Euro. The
26
Derivatives and Hedging Activities-continued
- --------------------------------------------
contracts expire through August 2003. Our accounting policies for these
instruments are based on its designation of such instruments as cash flow
hedging transactions. We do not enter into such contracts for speculative
purposes. We record all derivative gains and losses on the balance sheet as a
component of stockholders' equity under the caption "Accumulated other
comprehensive income (loss)". As of June 30, 2003, a deferred loss of $146,007
reflecting the net mark to market loss of our derivatives was recorded as a
component of accumulated other comprehensive income on our balance sheet.
For the three months and nine months ended June 30, 2003, we recorded a decrease
in sales of $366,300 and $1,525,100 related to our contracts that closed during
these periods and the changes in the fair value of our derivative contracts. For
the three months and nine months ended June 30, 2002, we recorded an decrease in
sales of $750,000 and $653,000 related to our contracts that closed during these
periods and the changes in the fair value of our derivative contracts.
Item 4. Controls and Procedures
- -------------------------------
Our Chief Executive Officer and Chief Financial Officer conducted an evaluation
of the effectiveness of our disclosure controls and procedures. Based on this
evaluaution, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective as of June 30, 2003
in alerting them in a timely manner to materail information required to be
included in our SEC reports. In addition, no change in our internal control over
financial reporting occurred during the fiscal quarter ended June 30, 2003 that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
Special Note Regarding Forward Looking Statements
- -------------------------------------------------
This Quarterly Report contains forward-looking statements as that term is
defined in the federal securities laws. The events described in forward-looking
statements contained in this Quarterly Report may not occur. Generally these
statements relate to business plans or strategies, projected or anticipated
benefits or other consequences of our plans or strategies, projected or
anticipated benefits from acquisitions to be made by us, or projections
involving anticipated revenues, earnings or other aspects of our operating
results. The words "may," "will," "expect," "believe," "anticipate," "project,"
"plan," "intend," "estimate," and "continue," and their opposites and similar
expressions are intended to identify forward-looking statements. We caution you
that these statements are not guarantees of future performance or events and are
subject to a number of uncertainties, risks and other influences (including, but
not limited to, those set forth in our Annual Report on Form 10-K for the year
ended September 30, 2002), many of which are beyond our control, that may
influence the accuracy of the statements and the projections upon which the
statements are based. Our actual results, performance and achievements could
differ materially from those expressed or implied in these forward-looking
statements. We undertake no obligation to publicly update or revise any
forward-looking statements, whether from new information, future events or
otherwise.
27
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings
-----------------
We were informed by counsel for the estate of the late Mr. Kenneth Aupperle
("Estate") that they have filed a Demand for Arbitration with the American
Arbitration Association claiming property rights and interest in the Company,
certain amounts due and owing to the Estate based on various corporate
agreements with Mr. Aupperle and certain insurance policies, such amount to be
no less than $2,500,000. We are proceeding to arbitrate the claims. Based on the
preliminary information presented to us, management believes that the claim and
the basis for proceeding with arbitrating such claim is without merit and will
vigorously defend it.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
--------
31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes Oxley Act
of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes Oxley Act
of 2002.
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes Oxley Act of 2002.
(b) Reports on Form 8-K
-------------------
One Current Report on Form 8-K was filed by us during the quarter ended June 30,
2002 as follows:
(i) Date of Report: May 15, 2003
Item Reported: 7, 9
28
SIGNATURES
----------
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAUPPAUGE DIGITAL, INC.
-----------------------
Registrant
Date: August 13 , 2003 By /s/ Kenneth Plotkin
------------------------------------
KENNETH PLOTKIN
Chief Executive Officer and Director
Date: August 13, 2003 By /s/ Gerald Tucciarone
------------------------------------
GERALD TUCCIARONE
Treasurer and Chief
Financial Officer
29