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
diluted net loss per share of $0.26 on weighted average basic and diluted shares
of 8,910,117. Options to purchase 825,322 and 1,827,326 shares of Common Stock
at prices ranging from $2.07 to $ 10.06 and from $1.05 to $10.06, were
outstanding for the twelve month period ending September 30, 2002 and 2001,
respectively, but were not included in the computation of diluted net income or
net loss per share because they were anti-dilutive.
Seasonality
As our sales are primarily to the consumer market, we have experienced certain
seasonal revenue trends. Our peak sales quarter, due to holiday season sales of
computer equipment, is our first fiscal quarter (October to December), followed
by our second fiscal quarter (January to March). In addition, our international
sales, mostly in the European market, were 68%, 73% and 77% of sales for the
years ended September 30, 2003, 2002 and 2001, respectively. Our fiscal fourth
quarter sales (July to September) can be potentially impacted by the reduction
of activity experienced in Europe during the July and August summer holiday
period.
To offset the above cycles, we target a wide range of customer types in order to
moderate the seasonality of retail sales.
32
Liquidity and Capital Resources
Our cash, working capital and stockholders' equity position is disclosed below:
As of September 30,
2003 2002 2001
---- ---- ----
Cash $ 5,838,160 $ 4,964,522 $ 4,422,239
Working Capital 10,859,953 11,276,942 10,258,143
Stockholders' Equity 11,468,685 11,966,612 11,185,618
We had cash and cash equivalents as of September 30, 2003 of $5,838,160, an
increase of $873,638 over September 30, 2002.
The increase was due to:
Sources of cash:
- ---------------
Proceeds from employee stock purchase plan $ 31,227
Decrease in income taxes receivable 326,000
Decrease in inventories 2,617,121
Increase in accounts payable other current liabilities 2,302,120
Less cash used for:
- ------------------
Net loss adjusted for non cash items (498,846)
Increase in accounts receivable (3,542,502)
Increase in prepaid expenses and other current assets (129,594)
Purchases of fixed assets (196,246)
Purchase of treasury stock (35,642)
---------
Net cash increase $ 873,638
=========
Net cash of $1,074,299 provided by operating activities was primarily due to a
reduction in inventories and income taxes receivable of $2,617,121 and $326,000,
respectively, plus an increase in accounts payable and other liabilities of
2,302,120, offset by the net loss adjusted for non cash items of $498,846, an
increase in accounts receivable of $3,542,502 and increases in prepaid assets
and other current assets of $129,594. The decrease in inventories was due to an
inventory reduction program instituted by the Company in response to sluggish
economic conditions. The increase in accounts receivable was the result of an
increase in sales for the three months ended September 30, 2003 over the three
months ended September 30, 2002 in addition to a larger volume of component
parts that our contract manufacturer purchased from us during September 30,
2003, due to an increase in our September and October 2003 production volume
when compared to the same period of the prior year.
Cash of $196,246 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 $31,227. Since the
Company's production is handled by third party contract manufacturers, our
future anticipated capital expenditures are not material.
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, or secure a credit line at all.
33
On November 8, 1996, we approved a stock repurchase program. The program, as
amended, authorizes the Company to repurchase up to 850,000 shares of our own
stock. We intend to use the repurchased shares for certain employee benefit
programs. On December 17, 1997, the stock repurchase program was extended by a
resolution of our Board of Directors. As of September 30, 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 September 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.
Future Contractual Obligations
The following table shows the Company's contractual obligations related to lease
obligations as of September 30, 2003:
Payments due by period
Contractual obligations Total 1 year 1-3 years
----- ------ ---------
Operating lease obligations $ 1,592,748 $ 679,272 $ 913,476
=========== ========= =========
Critical Accounting Policies and Estimates
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements.
We believe the following critical accounting policies affect the significant
judgments and estimates used in the preparation of the our financial statements:
o Revenue Recognition
o Management's estimates
o Hedging program for sales denominated in a foreign currency
o Translation of assets and liabilities denominated in non-functional
currencies on our European financial statements
Revenue Recognition
Our revenues are primarily derived from the sale of computer boards which enable
you to view television programs on your personal computer. Sales of computer
boards are commonly classified as computer hardware. Our sales are primarily to
retailers, distributors and original equipment manufacturers. Sales to our
customers are documented by a purchase order which describes the conditions of
sale. Sales are recorded when products are shipped to our customers, the product
price is fixed and determinable, collection of the resulting receivable is
probable and product returns are reasonably estimable. Revenue from freight
charged to customers is recognized when products are shipped. Provisions for
customer returns and other adjustments are provided for in the period the
related sales are recorded based upon historical data.
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
34
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
allowances and contingencies. We base our estimates on historical data, when
available, experience, and on various other assumptions that are believed to be
reasonable under the circumstances, the combined results of which form the basis
for making judgments about the carrying values of assets and liabilities that
are not readily apparent from other sources. Actual results may differ from
these estimates.
Hedging program for sales denominated in a foreign currency
Our European subsidiary accounts for approximately 67% and 71% of our net sales
for fiscal 2003 and fiscal 2002. All of our European sales are denominated in
local currencies, primarily the Euro and Great British Pound. 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 and Great British Pound to the U.S. dollar. In an attempt to minimize
these risks, we enter into forward exchange contracts with financial
institutions.
We do not enter into contracts for speculative purposes. We enter into monthly
window contracts covering an average period of six months based on existing or
anticipated future 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".
35
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.
Prior to the adoption of the Euro, we billed our European customers in German
Marks or Great British Pound, 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 Great British Pound. The
benefits to billing customers in Euros were twofold:
o Our foreign currency hedging program was streamlined to the Euro and
the Great British Pound
o The pricing from country to country was harmonized, eliminating price
differences between countries due to the fluctuating local currencies
We handled the conversion to the Euro without any material disruptions to our
operations. See Item 7A- Market Risks.
Derivatives and Hedging Activities
Due to extensive sales to European customers with payment made to us in those
local currencies (primarily the Euro and Great British Pound) 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 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. 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
36
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 the availability of hedging
instruments.
The strength or weakness of the U.S. Dollar against the Euro and Great British
Pound 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 September 30, 2003, we had
foreign currency contracts outstanding of approximately $3,560,000 against the
delivery of the Euro. The contracts expire through December 2003. Our accounting
policies for these instruments are based on the 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 September 30, 2003 and 2002, a
deferred loss of $234,591 and a deferred gain of $190,919, reflecting the net
mark-to-market losses and gains of our derivatives, was recorded as a component
of accumulated other comprehensive income on our balance sheet.
For the year ended September 30, 2003, we recorded a decrease in sales of
$1,895,200 related to our contracts that closed during this period and the
changes in the fair value of our derivative contracts. For the twelve months
ended September 30, 2002, we recorded an decrease in sales of $408,000 related
to our contracts that closed during this period and the changes in the fair
value of our derivative contracts.
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.
In January 2003, the FASB issued Interpretation No.46, Consolidation of Variable
Interest Entities. Interpretation No. 46 requires companies with a variable
interest in a variable interest entity to apply this guidance as of the
beginning of the first reporting period ending after December 15, 2003. The
application of the guidance could result in the consolidation of a variable
interest entity. The only potential variable interest entity with which the
Company is associated is the real estate partnership owned by certain of the
Company's principal shareholders, as disclosed in Note 9 of the notice to
"Consolidated Financial Statements". The Company is evaluating whether the
partnership is a variable interest entity, whether the Company is the primary
beneficiary and, if so, the impact of this interpretation on its financial
position and results of operations.
With respect to Interpretation No. 46, the Company rents its principal office
and warehouse space in Hauppauge, New York from a real estate partnership owned
by certain of the Company's principal stockholders. The lease term expires on
January 31, 2006 and includes an option to extend for three
37
additional years. The lease provides for rent increases of 5% per year. Rent is
currently at the annual rate of $431,454 and will increase to $453,027 annually
as of February 1, 2004. On December 17, 1995 in connection with a re-negotiation
of the lease term, the Company granted options to purchase 120,000 shares to a
real estate partnership partially owned by the principal stockholder at an
exercise price of $1.905 per share, which are exercisable through the lease
term. The market price of the option equaled the exercise price at the date of
the grant. The effect of imputing the fair value of the options granted was
immaterial. The options were still outstanding as of September 30, 2003.
The Company had amounts payable to this related party for unpaid rent of
$302,128 as of September 30, 2003 and 2002.
The indebtedness partially incurred by the principal stockholder to purchase the
building is also guaranteed by the Company and totaled $745,567 at September 30,
2003.
Risk Factors
If TV technology for the PC, or our implementation of this technology, is not
accepted, we will not be able to sustain or expand our business.
Our future success depends on the growing use and acceptance of TV and video
applications for PCs. The market for these applications is still evolving, and
may not develop to the extent necessary to enable us to further expand our
business. We have invested, and continue to invest, significant time and
resources in the development of new products for this market.
Our:
o dependence on sales of TV and video products for the PC
o lack of market diversification
o lack of development of the market for our products
o potential inability to remain ahead of the development of competing
technologies
could each have a material adverse effect on our business, operating results and
financial condition.
We rely upon sales of a small number of product lines, and the failure of any
one product line to be successful in the market could substantially reduce our
sales.
We currently rely upon sales from our internal and external products to generate
a majority of our sales. While we continue to develop additional products within
these and other product lines, there can be no assurance that we will be
successful in doing so. Consequently, if the existing or future products are not
successful, sales could decline substantially, which would have a material
adverse effect on our business, operating results and financial condition.
We rely heavily on the success of dealers and OEMs to market, sell and
distribute our products. If these resellers do not succeed in effectively
distributing our products, our sales could be reduced.
These resellers may not effectively promote or market our products or they may
experience financial difficulties and even close operations. These dealers and
retailers are not contractually obligated to sell our products. Therefore, they
may, at any time:
o refuse to promote our products and
38
o discontinue the use of our products in favor of a competitor's product
Also, with this distribution channel standing between us and the actual end
user, we may not be able to accurately gauge current demand and anticipate
future demand for our products. For example, dealers may place large initial
orders for a new product just to keep their stores stocked with the newest
products and not because there is a significant demand for them.
Our distribution network includes several consumer channels, including large
distributors of products to computer software and hardware retailers, which in
turn sell products to end users. They also sell consumer products directly to
certain retailers. Rapid change and financial difficulties of distributors have
characterized distribution channels for consumer retail products. These
arrangements have exposed us to the following risks, among others:
o we may be obligated to provide price protection to certain retailers
and distributors and, while certain agreements limit the conditions
under which products can be returned, we may be faced with product
returns or price protection obligations
o the distributors or retailers may not continue to stock and sell our
products and
o retailers and retail distributors often carry competing products
If these resellers do not succeed in effectively distributing our products, this
could have a material adverse effect on our business, operating results and
financial condition.
We operate in a highly competitive market, and many of our competitors have much
greater resources, which may make it difficult for us to remain competitive.
Our business is subject to significant competition. Competition exists from
larger companies that possess substantially greater technical, financial, human,
sales and marketing resources than we do. The dynamics of competition in this
market involve short product life cycles, declining selling prices, evolving
industry standards and frequent new product introductions. We compete 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 assurance that we will
not experience increased competition in the future. Such increased competition
may have a material adverse affect on our ability to successfully market our
products. Competition is expected to remain intense and, as a result, we may
lose some of our market share to our competitors. Further, we believe that the
market for our products will continue to be price competitive and thus we could
continue to experience lower selling prices, lower gross profit margins and
reduced profitability levels for such products than in the past.
Rapid technological changes and short product life cycles in our industry could
harm our business.
The technology underlying our products and other products in the computer
industry, in general, is subject to rapid change, including the potential
introduction of new types of products and technologies, which may have a
material adverse impact upon our business, operating results and financial
condition. We will need to maintain an ongoing research and development program,
and our potential future success, of which there can be no assurances, will
depend, in part, on our ability to respond quickly to technological advances by
developing and introducing new products, successfully incorporating such
advances in existing products, and obtaining licenses, patents, or other
proprietary technologies to be used in connection with new or
39
existing products. We expended approximately $1,902,000, $1,592,000, and
$1,510,000 for research and development expenses for the years ended September
30, 2003, 2002 and 2001, respectively. There can be no assurance that our
research and development will be successful or that we will be able to foresee
and respond to such advances in technological developments and to successfully
develop additional products. Additionally, there can be no assurances that the
development of technologies and products by competitors will not render our
products or technologies non-competitive or obsolete.
If TV or video capabilities are included in PCs or in operating systems, it
could result in a reduction in the demand for add-on TV and video devices.
Although we believe that our software is a competitive strength, as operating
systems such as Windows move to integrate and standardize software support for
video capabilities, we will be challenged to further differentiate our products.
Our operating results and ability to retain our market share are also dependent
on continued growth in the underlying markets for PC, TV and video products.
We may not be able to timely adopt emerging industry standards, which may make
our products unacceptable to potential customers, delay our product
introductions or increase our costs.
Our products must comply with a number of current industry standards and
practices established by various international bodies. Failure to comply with
evolving standards, including video compression standards, TV transmission
standards, and PC interface standards, will limit acceptance of our products by
the market. If new standards are adopted in the industry, we will be required to
adopt those standards in our products. It may take a significant amount of time
to develop and design products incorporating these new standards, and we may not
succeed in doing so. We may also become dependent upon products developed by
third parties and have to pay royalty fees, which may be substantial, to the
developers of the technology that constitutes the newly adopted standards.
We are heavily dependent upon foreign markets for sales of our products,
primarily the European market, and adverse changes in these markets could reduce
our sales.
Our future performance will likely be dependent, in large part, on our ability
to continue to compete successfully in the European markets, where a large
portion of our current and potential customers are located. Our ability to
compete in these markets will depend on many factors, including:
o the economic conditions in these regions
o the stability of the political environment in these regions
o adverse changes in the relationships between major countries in these
regions
o the state of trade relations among these regions and the United States
o restrictions on trade in these regions
o the imposition or changing of tariffs by the countries in these
regions on products of the type that we sell
o changes in the regulatory environment in these regions
o export restrictions and export license requirements
o restrictions on the export of critical technology
o our ability to develop PC TV products that meet the varied technical
requirements of customers in each of these regions
o our ability to maintain satisfactory relationships with our foreign
customers and distributors
o changes in freight rates
40
o our ability to enforce agreements and other rights in the countries in
these regions
o difficulties in staffing and managing international operations
o difficulties assessing new and existing international markets and
credit risks
o potential insolvency of international customers and difficulty in
collecting accounts
If we are unable to address any of these factors, it could have a material
adverse effect on our business, operating results and financial condition.
We are heavily dependent upon foreign manufacturing facilities for our products,
primarily facilities in Europe and Asia, which exposes us to additional risks.
The majority of our products are built at contract manufacturing facilities in
Asia and Europe. Our ability to successfully build products at overseas
locations will depend on several factors, including:
o the economic conditions in these regions
o the stability of the political environment in these regions
o adverse changes in the relationships between major countries in these
regions
o the state of trade relations among these regions and the United States
o restrictions on trade in these regions
o the imposition or changing of tariffs by the countries in these
regions on products of the type that we sell
o changes in the regulatory environment in these regions
o import restrictions and import license requirements
o our ability to maintain satisfactory relationships with our foreign
manufacturers
o changes in freight rates
o difficulties in staffing and managing international operations
o potential insolvency of vendors and difficulty in obtaining materials
If we are unable to address any of these factors, it could have a material
adverse effect on our business, operating results and financial condition.
Foreign currency exchange fluctuations could adversely affect our results.
Due to extensive sales to European customers with payment made to us in those
local currencies (primarily the Euro and Great British Pound) 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 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. We attempt to reduce these risks by
entering into foreign exchange forward contracts with financial institutions to
protect against currency exchange risks associated with our foreign denominated
sales.
The strength or weakness of the U.S. dollar against the Euro and Great British
Pound impacts our financial results. Changes in exchange rates may positively or
negatively affect our revenues, gross margins, operating income and retained
earnings (which are all expressed in U.S. dollars). We engage in hedging
programs aimed at limiting, in part, the impact of currency fluctuations. By
selling foreign currency
41
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. For the years ended September 30, 2003 and 2002, we had
recorded in sales related to our contracts that closed during these periods and
the changes in the fair value of our derivative contracts of $1,895,200 and
$408,000, respectively.
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 as a hedge against existing or anticipated
exposure. We do not enter into contracts for speculative purposes. Although we
maintain these programs to reduce the short term impact of changes in currency
exchange rates, when the U.S. dollar sustains a long term strengthening position
against the foreign currencies in countries where we sell our products, our
revenues, gross margins, operating income and retained earnings can be adversely
affected. Factors that could impact the effectiveness of our hedging program
include volatility of the currency markets and availability of hedging
instruments.
Additionally, there is the risk that foreign exchange fluctuations will make our
products less competitive in foreign markets, which would substantially reduce
our sales.
We may be unable to develop new products that meet customer requirements in a
timely manner.
Our success is dependent on our ability to continue to introduce new products
with advanced features, functionality and performance that our customers demand.
We may not be able to introduce new products on a timely basis, that are
accepted by the market, and that sell in quantities sufficient to make the
products viable for the long-term. Sales of new products may negatively impact
sales of existing products. In addition, we may have difficulty establishing our
products' presence in markets where it does not currently have significant brand
recognition.
We may experience declining margins.
We may experience declining gross margins due to the following factors, among
others:
o changes in foreign currency exchange rates
o larger sales mix of lower margin products
o possible future allowances for excess inventory
o increases in costs charged by contract manufacturers
o increases in duty and tariff rates
o increases in shipping costs
o lower average selling prices
o increases in material acquisition costs and
o different gross margins for like products in different markets
Consequently, as margins may decline, our profitability will be more dependent
upon effective cost management controls. There can be no assurances that such
cost and management controls can be implemented and maintained, and if
implemented, that they will be successful.
We have experienced, and expect to continue to experience, intense downward
pricing pressure
42
on our products, which could substantially impair our operating performance.
We are experiencing, and are likely to continue to experience, downward pricing
pressure on our products. As a result, we have experienced, and we expect to
continue to experience, declining average sales prices for our products.
Increases in the number of units that we are able to sell and reductions in per
unit costs may not be sufficient to offset reductions in per unit sales prices,
in which case our net income would be reduced and we could incur losses. Since
we typically negotiate supply arrangements far in advance of delivery dates, we
may need to commit to price reductions for our products before we are aware of
how, or if, these cost reductions can be obtained. As a result, any current or
future price reduction commitments and our inability to respond to increased
price competition could have a material adverse effect on our business,
operating results and financial condition.
We are dependent upon contract manufacturers for our production. If these
manufacturers do not meet our requirements, either in volume or quality, then we
could be materially harmed.
During fiscal 2003, we subcontracted the manufacturing and assembly of our
products to three independent third parties at facilities in various countries.
Relying on subcontractors involves a number of significant risks, including:
o loss of control over the manufacturing process
o potential absence of adequate production capacity
o potential delays in production lead times
o unavailability of certain process technologies
o reduced control over delivery schedules, manufacturing yields, quality
and costs, and
o unexpected increases in component costs
We may need to hold more inventory than is immediately required to compensate
for potential manufacturing disruptions.
If our significant subcontractor becomes unable or unwilling to continue to
manufacture these products in required volumes, we will have to identify
qualified alternate subcontractors. Additional qualified subcontractors may not
be available, or may not be available on a timely or cost competitive basis. Any
interruption in the supply of, or increase in, the cost of the products
manufactured by third party subcontractors could have a material adverse effect
on our business, operating results and financial condition.
We are dependent upon single or limited source suppliers for our components and
assembled products. If these suppliers do not meet the demand, either in volume
or quality, then we could be materially harmed.
If the supply of a key component or assembled product such as the DEC and
WinTV(R)-DVB were to be delayed or curtailed or in the event a key manufacturing
or sole vendor delays shipment of such components or completed products, our
ability to ship products in desired quantities and in a timely manner would be
adversely affected. Our business, operating results and financial condition
could also be adversely affected, depending on the time required to obtain
sufficient quantities from the original source or, if possible, to identify and
obtain sufficient quantities from an alternative source. We attempt to mitigate
these potential risks by working closely with our key suppliers on product
introduction plans,
43
strategic inventories, coordinated product introductions, and internal and
external manufacturing schedules and levels. We are also seeking out alternative
sources for assembled products, making us less dependent on a single or limited
source.
We may need to hold more inventory than is immediately required to compensate
for potential component shortages or discontinuation. This could lead to an
increase in the costs of manufacturing or assembling our products.
If any single or limited source supplier becomes unable or unwilling to continue
to supply these components or assembled products in required volumes, we will
have to identify and qualify acceptable replacements or redesign our products
with different components. Additional sources may not be available, or product
redesign may not be feasible on a timely basis. Any interruption in the supply
of or increase in the cost of the components and assembled products provided by
single or limited source suppliers could have a material adverse effect on our
business, operating results and financial condition.
We may incur excessive expenses if we are unable to accurately forecast sales of
our products.
We generally ship products within one to four weeks after receipt of orders.
Therefore, our sales backlog is typically minimal. Accordingly, our expectations
of future net sales and our product manufacturing and materials planning are
based largely on our own estimates of future demand and not on firm customer
orders.
If we obtain orders in excess of our internal forecasts, we may be unable to
timely increase production to meet demand which could have a material adverse
effect on our business, operating results and financial condition. If our net
sales do not meet expectations, our business, operating results and financial
condition would be adversely affected, we may be burdened with excess inventory,
and we may be subject to excess costs or inventory write-offs.
We may experience a reduction in sales if we are unable to respond quickly to
changes in the market for our products.
Our net sales can be affected by changes in the quantity of products that our
distributor and OEM customers maintain in their inventories. We may be directly
and rapidly affected by changes in the market, including the impact of any
slowdown or rapid increase in end user demand. Despite efforts to reduce
distribution channel inventory exposure, distribution partners and OEM customers
may still choose to alter their inventory levels, which could cause a reduction
in our net sales; this could have a material adverse effect on our business,
operating results and financial condition.
We may accumulate inventory to minimize the impact of shortages from
manufacturers and suppliers, which may result in obsolete inventory that we may
need to write off resulting in losses.
Managing our inventory is complicated by fluctuations in the demand for our
products as well as the issues of using contract manufacturers and procuring
components from suppliers mentioned above. As we must plan to have sufficient
quantities of products available to satisfy our customers' demands, we sometimes
accumulate inventory for a period of time to minimize the impact of possible
insufficient capacity or availability of components from our manufacturers and
suppliers. Although we expect to sell the inventory within a short period of
time, products may remain in inventory for extended periods of time and may
become obsolete because of the passage of time and the introduction of new
products or new components
44
within existing products. In these situations, we would be required to write off
obsolete inventory which could have a material adverse effect on our business,
operating results and financial condition.
We may need financing, and may not be able to raise financing on favorable
terms, if at all, which could limit our ability to grow and increase our costs.
We anticipate that we may need to raise additional capital in the future to
continue our long term expansion plans, to respond to competitive pressures or
to respond to unanticipated requirements. We cannot be certain that we will be
able to obtain additional financing on commercially reasonable terms, if at all.
Our failure or inability to obtain financing on acceptable terms could require
us to limit our plans for expansion, incur indebtedness that has high rates of
interest or substantial restrictive covenants, issue equity securities that will
dilute existing stockholders' holdings or discontinue a portion of our
operations, each of which could have a material adverse effect on our business,
operating results and financial condition.
We may become involved in costly intellectual property disputes.
With the proliferation of new products and rapidly changing technology, there is
a significant volume of patents and other intellectual property rights held by
third parties. There are a number of companies that hold patents for various
aspects of the technologies incorporated in some of the PC and TV industries'
standards. Given the nature of our products and development efforts, there are
risks that claims associated with such patents or intellectual property rights
could be asserted by third parties against us. We expect that parties seeking to
gain competitive advantages will increase their efforts to enforce any patent or
intellectual property rights that they may have. The holders of patents from
which we may have not obtained licenses may take the position that it is
required to obtain a license from them.
If a patent holder refuses to offer such a license or offers such a license on
terms unacceptable to us, there is a risk of incurring substantial litigation or
settlement costs regardless of the merits of the allegations, or which party
eventually prevails. If we do not prevail in a litigation suit, we may be
required to pay significant damages and/or to cease sales and production of
infringing products and accordingly, may incur significant defense costs.
Additionally, we may need to attempt to design around a given technology,
although there can be no assurances that this would be possible or economical.
We currently use technology licensed from third parties in certain products. Our
business, financial condition and operating results could be adversely affected
by a number of factors relating to these third-party technologies, including:
o failure by a licensor to accurately develop, timely introduce, promote
or support the technology
o delays in shipment of products
o excess customer support or product return costs due to problems with
licensed technology; and
o termination of our relationship with such licensors
We may be unable to enforce our intellectual property rights.
We may not be able to adequately protect our intellectual property through
patent, copyright, trademark and other means of protection. If we fail to
adequately protect our intellectual property, our intellectual
45
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 intend to aggressively assert our intellectual property rights when
necessary.
Even though we typically develop our products independently, our success, of
which there can be no assurances, will depend, in a large part, on our ability
to innovate, obtain or license patents, protect trade secrets, copyrights and
trademarks, and draw upon our proprietary technology without infringing on the
proprietary rights of others. We maintain copyrights on our designs and software
programs, but currently we have no patent on the WinTV(R) board as we believe
that such technology cannot be patented.
We have no patents issued or pending that relate to our technology. We are
subject to a number of risks relating to intellectual property rights, including
the following:
o the means by which we seek to protect our proprietary rights may not
be adequate to prevent others from misappropriating our technology or
from independently developing or selling technology or products with
features based on or similar to our products
o our products may be sold in foreign countries that provide less
protection to intellectual property than is provided under U.S. laws;
and
o our intellectual property rights may be challenged, invalidated,
violated or circumvented and may not provide us with any competitive
advantage
We may not be able to attract and retain qualified managerial and other skilled
personnel.
Our success, of which there can be no assurances, depends, in part, on our
ability to identify, attract, motivate and retain qualified managerial,
technical and sales personnel. Our success, of which there can be no assurances,
is dependent on our ability to manage effectively the enhancement and
introduction of existing and new products and the marketing of such products. We
are particularly dependent on our ability to identify, attract, motivate and
retain qualified managers, engineers and salespersons. The loss of the services
of a significant number of engineers or sales people or one or more senior
officers or managers could be disruptive to product development efforts or
business relationships and could seriously harm our business.
We depend on a limited number of key personnel, and the loss of any of their
services could adversely affect our future growth and profitability and could
substantially interfere with our operations.
Our products are complex and our market is evolving. The success of our business
depends in large part upon the continuing contributions of our management and
technical personnel. The loss of the services of any of our key officers or
employees could adversely affect our future growth and profitability and could
have a material adverse effect on our business, operating results and financial
condition.
Our dependence upon our key officers and employees is increased by the fact that
they are responsible for our sales and marketing efforts, as well as our overall
operations. We do not have key person life insurance policies covering any of
our employees other than Mr. Plotkin, our Chairman of the Board and Chief
Executive Officer and the insurance coverage that we have on him may be
insufficient to compensate us for the loss of his services.
46
We may not be able to effectively integrate businesses or assets that we acquire
We may identify and pursue acquisitions of complementary companies and strategic
assets, such as customer bases, products and technology. However, there can be
no assurance that we will be able to identify suitable acquisition
opportunities.
If any such opportunity involves the acquisition of a business, we cannot be
certain that:
o we will successfully integrate the operations of the acquired business
with our own
o all the benefits expected from such integration will be realized
o management's attention will not be diverted or divided, to the
detriment of current operations
o amortization of acquired intangible assets will not have a negative
effect on operating results or other aspects of our business
o delays or unexpected costs related to the acquisition will not have a
detrimental effect on the combined business, operating results and
financial condition
o customer dissatisfaction with, or performance problems at, an acquired
company will not have an adverse effect on our reputation; and
o respective operations, management and personnel will be compatible
In most cases, acquisitions will be consummated without seeking and obtaining
stockholder approval, in which case stockholders will not have an opportunity to
consider and vote upon the merits of such an acquisition. Although we will
endeavor to evaluate the risks inherent in a particular acquisition, there can
be no assurance that we will properly ascertain or assess such risks.
Our products could contain defects, which could result in delays in recognition
of sales, loss of sales, loss of market share, or failure to achieve market
acceptance, or claims against us.
We develop complex products for TV and video processing. Despite testing by our
engineers, subcontractors and customers, errors may be found in existing or
future products. This could result in, among other things, a delay in
recognition of sales, loss of sales, loss of market share, failure to achieve
market acceptance or substantial damage to our reputation. We could be subject
to material claims by customers, and may need to incur substantial expenses to
correct any product defects. We do not have product liability insurance to
protect against losses caused by defects in our products, and we also do not
have "errors and omissions" insurance. As a result, any payments that we may
need to make to satisfy our customers may be substantial and may result in a
substantial charge to earnings.
We may experience fluctuations in our future operating results, which will make
predicting our future results difficult.
Historically, our quarterly and annual operating results have varied
significantly from period to period, and we expect that our results will
continue to do so. These fluctuations result from a variety of factors,
including:
o market acceptance of our products
o changes in order flow from our customers, and their inability to
forecast their needs accurately
o the timing of our new product announcements and of announcements by
our competitors
47
o increased competition, including changes in pricing by us and our
competitors
o delays in deliveries from our limited number of suppliers and
subcontractors; and
o difficulty in implementing effective cost management constraints
As our sales are primarily to the consumer market, we have experienced certain
seasonal revenue trends. Our peak sales quarter, due to holiday season sales of
computer equipment, is our first fiscal quarter (October to December), followed
by our second fiscal quarter (January to March). In addition, our international
sales, mostly in the European market, were 68%, 73% and 77% of sales for the
years ended September 30, 2003, 2002 and 2001, respectively. Our fiscal fourth
quarter sales (July to September) can be potentially impacted by the reduction
of activity experienced in Europe during the July and August summer holiday
period. Accordingly, any sales or net income in any particular period may be
lower than the sales and net income in a preceding or comparable period.
Period-to-period comparisons of our results of operations may not be meaningful,
and should not be relied upon as indications of our future performance. In
addition, our operating results may be below the expectations of securities
analysts and investors in future periods. Failure to meet such expectations,
should such an event occur, will likely cause our share price to decline.
Our Common Stock price is highly volatile.
The market price of our Common Stock has been, and may continue to be, subject
to a high degree of volatility. Numerous factors may have a significant impact
on the market price of our Common Stock, including:
o general conditions in the PC and TV industries
o product pricing
o new product introductions
o market growth forecasts
o technological innovations
o mergers and acquisitions
o announcements of quarterly operating results
o overall U.S. and worldwide economic health
o stability of the U.S. and worldwide securities markets
In addition, stock markets have experienced extreme price volatility and broad
market fluctuations in recent years. This volatility has had a substantial
effect on the market price of securities issued by many high technology
companies in many cases for reasons unrelated to the operating performance of
the specific companies. The price of our Common Stock has experienced volatility
not necessarily related to our performance.
The Company's Amended and Restated By-Laws and the Rights Agreement in which the
Company is party to may have anti-takeover effects, limiting the ability of
outside stockholders to seek control of management, and any premium over market
price that an acquirer might otherwise pay may be reduced and any merger or
takeover may be delayed.
Effective August 16, 2001, the Board of Directors unanimously approved Amended
and Restated By-laws for the Company (the "By-Laws"). The By-Laws do not permit
stockholders to call a special meeting of stockholders and consequently, an
expensive proxy contest cannot occur other than in connection with the annual
meeting of stockholders. The By-laws also impose strict requirements for
shareholder proposals
48
and nominations of prospective Board members other than those nominated by or at
the discretion of the Board of Directors. These amendments may collectively or
individually impact a person's decision to purchase voting securities in the
Company and may have anti-takeover effects in that any merger or takeover may be
delayed. Accordingly, any premium over market price that an acquirer might
otherwise pay may be reduced.
On July 19, 2001, the Board of Directors declared a dividend distribution of one
Right for each outstanding share of the Company's Common Shares to stockholders
of record at the close of business on August 5, 2001. Each Right entitles the
registered holder to purchase from the Company one Common Share at a purchase
price of $11.00 per share, subject to adjustment and terms set out in the Rights
Agreement between the Company and North American Transfer Agent, as Rights
Agent. The Rights may have certain anti-takeover effects. The Rights will cause
substantial dilution to a person or group that attempts to acquire the Company
in a manner which causes the Rights to become discount Rights unless the offer
is conditional on a substantial number of Rights being acquired. Accordingly,
any premium over market price that an acquirer might otherwise pay may be
reduced.
No dividends and none anticipated.
We have never paid any cash dividends on our common stock and do not contemplate
or anticipate paying any cash dividends on our Common Stock in the foreseeable
future. It is currently anticipated that earnings, if any, will be used to
finance the development and expansion of the business.
From time to time, information provided by us, statements made by our employees
or information provided in our Securities and Exchange Commission filings,
including information contained in this Annual Report on Form 10-K, may contain
forward looking information. Our actual future results may differ materially
from those projections or statements made in such forward looking information as
a result of various risks and uncertainties, including, but not limited to,
rapid changes in technology, lack of funds for research and development,
competition, proprietary patents and rights of others, loss of major customers,
loss of sources of supply for our components, non-availability of management,
government regulation, currency fluctuations and our inability to profitably
sell our products. The market price of our Common Stock may be volatile at times
in response to fluctuations in our quarterly operating results, changes in
analysts' earnings estimates, market conditions in the computer hardware
industry, seasonality of the business cycle, as well as general conditions and
other external factors.
Item 7A. Market Risks
Due to extensive sales to European customers with payment made to us in those
local currencies (primarily the Euro and Great British Pound) 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 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. We attempt to reduce these risks by
entering into foreign exchange forward contracts with financial institutions to
protect against currency exchange risks associated with our foreign denominated
sales.
The strength or weakness of the U.S. dollar against the Euro and Great British
Pound impacts our financial results. Changes in exchange rates may positively or
negatively affect our revenues, gross margins, operating income and retained
earnings (which are all expressed in U.S. dollars). We engage in hedging
49
programs aimed at limiting, in part, the impact of currency fluctuations. By
selling foreign currency futures, we fix the rate of exchange at the time we
enter into the contract. We deliver these currencies to the financial
institutions at a later date when we actually receive the foreign currency. For
the years ended September 30, 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.
Although we do not try to hedge against all possible foreign currency exposures
because we can not fully estimate the size of our exposure, the contracts we
procure are specifically entered into to as a hedge against existing or
anticipated exposure. We do not enter into contracts for speculative purposes.
Although we maintain these programs to reduce the short term impact of changes
in currency exchange rates, when the U.S. dollar sustains a long term
strengthening position against the foreign currencies in countries where we sell
our products, our revenues, gross margins, operating income and retained
earnings can be adversely affected. Factors that could impact the effectiveness
of our hedging program include volatility of the currency markets and
availability of hedging instruments.
Item 8. Financial Statements and Supplementary Data
See Consolidated Financial Statements annexed hereto.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9a. Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer conducted an evaluation
of the effectiveness of our disclosure controls and procedures. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective as of September 30,
2003 in alerting them in a timely manner to material information required to be
included in our SEC reports. In addition, no change in our internal control over
financial reporting occurred during the fiscal quarter ended September 30, 2003
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
PART III
--------
Item 10. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
50
Directors and Executive Officers
The following table sets forth the positions and offices presently held with the
Company by each present Director and executive officer, and his age as of
September 30, 2003:
- --------------------- --------------- -----------------------------------------
Name Age Officer and Positions Held
- --------------------- --------------- -----------------------------------------
Kenneth Plotkin 52 Chairman of the Board of Directors, Chief
Executive Officer, Vice President of
Marketing and Director
- --------------------- --------------- -----------------------------------------
Dean Cirielli 37 President, Chief Operating Officer
- --------------------- --------------- -----------------------------------------
Gerald Tucciarone 48 Chief Financial Officer and Treasurer
- --------------------- --------------- -----------------------------------------
John Casey 47 Vice President in Charge of Technology
- --------------------- --------------- -----------------------------------------
Bernard Herman 76 Director
- --------------------- --------------- -----------------------------------------
Steven J. Kuperschmid 43 Director
- --------------------- --------------- -----------------------------------------
Robert S. Nadel 64 Director
- --------------------- --------------- -----------------------------------------
Christopher G. Payan 29 Director
- --------------------- --------------- -----------------------------------------
Neal Page 44 Director
- --------------------- --------------- -----------------------------------------
Seymour G. Siegel 61 Director
- --------------------- --------------- -----------------------------------------
Kenneth Plotkin is a co-founder of the Company and has served as a Director
since the Company's inception in 1994. He has been the Company's Chairman of the
Board of Directors and Chief Executive Officer since the Company's
incorporation. From March 14, 2001 until May 1, 2002, Mr. Plotkin served as the
Chief Operating Officer and President of the Company. Mr. Plotkin has been the
Company's Vice-President of Marketing since August 2, 1994. He holds a BS and an
MS in Electrical Engineering from the State University of New York at Stony
Brook.
Dean Cirielli joined the Company on May 1, 2002 as President and Chief Operating
Officer. Previously he served as Vice President of R&D from 2000-2001 at
Priority Call, a telecommunications subsidiary of SchlumbergerSema, which he
joined in 1993. His early career includes telecommunications software and
systems engineering at Boston Technology, Inc.; R&D program management at
Philips Display Components, a television display tube manufacturer, and a series
of internships at IBM, including Yorktown Heights' Watson Labs. Mr. Cirielli
received a BA in 1988 and a Masters of Engineering in 1991, both in Applied and
Engineering Physics from Cornell University.
Gerald Tucciarone joined the Company in January 1995 and has served as Chief
Financial Officer and Treasury since such time. Prior to his joining the Company
he served as Vice-President of Finance, from 1985 to 1992, with
Walker-Telecommunications, Inc., a manufacturer of phones and voice-mail
equipment, and from 1992 to 1995, as Assistant Controller with Chadbourne and
Parke. Mr. Tucciarone is a certified public accountant.
51
John Casey has been the Company's Vice President in charge of Technology for
more than six years.
Bernard Herman has served as a Director of the Company since 1996. From 1979 to
1993 Mr. Herman was Chief Executive Officer of Okidata Corp. of Mount Laurel,
New Jersey, a distributor of computer peripheral products. Since then he has
served as a consultant with reference to computer products. He is also an
Arbitration Neutral for the American Arbitration Association and the National
Association of Security Dealers.
Steven J. Kuperschmid has served as a Director of the Company since 1998 and as
Assistant Secretary since June 2001. He has been practicing law since 1986 and
has been a partner with Certilman Balin Adler & Hyman, LLP, counsel to the
Company, since January 1, 1994. Mr. Kuperschmid received his BA from New York
University and JD from Fordham University School of Law.
Robert S. Nadel has served as a Director of the Company since May 16, 2003. He
is the President of Human Resources Spectrum, Inc., a management consulting firm
specializing in executive and employee compensation and benefits and
organizational effectiveness. From 1989 to 1991, Dr. Nadel served as Partner in
Charge of the Actuarial Benefits and Compensation Practice of Deloitte and
Touche, and from 1969 to 1989, he was Managing Partner of the Northeast Region
for the Hay Group. Dr. Nadel received a BBA from City College in 1959, an MS in
General Psychology from Yeshiva University in 1962 and a Doctorate in Public
Administration from NYU in 1968.
Christopher G. Payan has served as a Director of the Company since May 16, 2003.
He has served as Senior Vice-President, Co-Chief Operating Officer, Chief
Financial Officer, Secretary and Treasurer of Emerging Vision, Inc. ("EVI"), a
publicly held company involved in the operation and franchising of retail
optical stores in the United States. From July 2001 through December 2001, he
served as EVI's Vice President of Finance. From March 1995 through July 2001,
Mr. Payan worked for Arthur Andersen LLP, where he provided various audit,
accounting, consulting and advisory services to various small and mid-sized
private and public companies in various industries. Mr. Payan is a certified
public accountant.
Neal Page has served as a Director of the Company since May 16, 2003. After
founding Osprey Technologies in 1994, he served as corporate Vice President and
General Manager of the Osprey Video Division of ViewCast Corporation from 1995
to March 2003. From 1994 to 1998, Mr. Page held both management and engineering
positions with Sun Microsystems, Inc. From 1983 to 1988, Mr. Page developed
advanced multimedia products at General Electric and Data General. Mr. Page
serves as a board member for a private software firm. He holds Bachelor of
Science and Master of Science degrees in Electrical and Computer Engineering
from North Carolina State University, and has completed executive business
programs at University of North Carolina's Kenan-Flagler Business School.
Seymour G. Siegel has served as a Director of the Company since May 16, 2003. He
is a Certified Public Accountant and a principal in the Siegel Rich Division of
Rothstein, Kass & Company, P.C., an accounting and consulting firm. From 1974 to
1990 he was managing partner and founder of Siegel Rich and Co, P.C., CPAs which
merged into Weiser LLC, where he was a senior partner. He formed Siegel Rich
Inc. in 1994 which in April, 2000 became a division of Rothstein, Kass &
Company, P.C. Mr. Siegel has been a director, trustee and officer of numerous
businesses, philanthropic and civic organizations. He has served as a director
and member of the audit committees of Barpoint.com, Oak Hall Capital Fund, Prime
Motor Inns Limited Partnership and Noise Cancellation Technologies, all public
companies.
52
Audit Committee Financial Expert
Our Board of Directors has determined that it has an "audit committee
financial expert," as defined by Item 401(h) of Regulation S-K. Our audit
committee financial expert is Seymour G. Siegel. Mr. Siegel is "independent," as
such term is used in Item 7(d)(3)(iv) of Schedule 14A.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16 of the Securities Exchange Act of 1934, as amended ("Section
16"), requires that reports of beneficial ownership of capital stock and changes
in such ownership be filed with the Securities and Exchange Commission (the
"SEC") by Section 16 "reporting persons," including directors, certain officers,
holders of more than 10% of the outstanding Common Stock and certain trusts of
which reporting persons are trustees. The Company is required to disclose in
this Annual Report on Form 10-K each reporting person whom it knows to have
failed to file any required reports under Section 16 on a timely basis during
the fiscal year ended September 30, 2003.
To the Company's knowledge, based solely on a review of copies of Forms 3,
4 and 5 furnished to it and representations that no other reports were required,
during the fiscal year ended September 30, 2003, the Company's officers,
Directors and 10% stockholders complied with all Section 16(a) filing
requirements applicable to them.
Code of Ethics for Senior Financial Officers
Our Board of Directors has adopted a Code of Ethics for our principal
executive officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. A copy of the Code of
Ethics is filed as an exhibit to this Annual Report on Form 10-K.
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth certain information for the fiscal years ended
September 30, 2003, 2002 and 2001 concerning the compensation of Kenneth
Plotkin, Chairman of the Board, Chief Executive Officer, Vice President of
Marketing, and Director, Dean Cirielli, our President and Chief Operating
Officer, John Casey, our Vice President of Technology of the Company and Gerald
Tucciarone, our Chief Financial Officer and Treasurer of the Company. No other
Executive Officer of the Company had a combined salary and bonus in excess of
$100,000 for the fiscal year ended September 30, 2003.
Annual Long Term
Compensation Compensation
--------- ---------- -------------- ------------ ------------------
Common Shares
Name and Principal Position Year Salary Bonus Other Annual Underlying Options
Compensation Granted
- -------------------------------------- --------- ---------- -------------- ------------- --------------------
Kenneth Plotkin 2003 $180,000 -0- $8,748(1) 10,000
Chairman of the Board, Chief
Executive Officer, Vice President of 2002 $180,000 -0- $6,000(1) 10,000
Marketing, and Director
2001 $180,000 -0- $6,000(1) -0-
- -------------------------------------- --------- ----------------- ----------- ------------- --------------------
53
- -------------------------------------- --------- ----------------- ----------- ------------- --------------------
Dean Cirielli (2) 2003 $175,000 -0- -0- -0-
President, Chief Operating Officer
2002 $70,000 -0- -0- 50,000
- -------------------------------------- --------- ----------------- ----------- ------------- --------------------
John Casey 2003 $133,913 -0- -0- 30,000
Vice President of Technology
2002 $130,000 $5,000 -0- 10,000
2001 $128,365 -0- -0- -0-
- -------------------------------------- --------- ----------------- ------------ ------------- --------------------
Gerald Tucciarone 2003 $130,995 -0- -0- 30,000
Chief Financial Officer and Treasurer
2002 $124,866 -0- -0- 10,000
2001 $123,231 -0- -0- -0-
- -------------------------------------- --------- ----------------- ------------ ------------- --------------------
(1) Represents non-cash compensation in the form of the use of a car and
related expenses.
(2) Mr Cirielli joined the Company on May 1, 2002
Option Grants in Last Fiscal Year
The following table sets forth certain information concerning individual
grants of stock options granted during the fiscal year ended September 30, 2003:
- ----------------------- ---------------------- --------------------- ----------------------- ----------------- -------------------
Number of Common Percentage of Total
Shares Underlying Options Granted to
Option Granted Employees in Fiscal Grant
Name Year Exercise Price Expiration Date Present Value ($)
- ----------------------- ---------------------- --------------------- ----------------------- ----------------- -------------------
Kenneth Plotkin 10,000 2.6% 1.13 October 2012 $4,300
- ----------------------- ---------------------- --------------------- ----------------------- ----------------- -------------------
Dean Cirielli -0- -0- -0- - -
- ----------------------- ---------------------- --------------------- ----------------------- ----------------- -------------------
John Casey 30,000 7.8% 1.08 October 2012 $12,600
- ----------------------- ---------------------- --------------------- ----------------------- ----------------- -------------------
Gerald Tucciarone 30,000 7.8% 1.08 October 2012 $12,600
- ----------------------- ---------------------- --------------------- ----------------------- ----------------- -------------------
54
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Value
Table
The following table sets forth certain information concerning the value of
stock options unexercised as of September 30, 2003:
- --------------------------- --------------------- --------------------- ------------------------------------ -----------------------
Value of Unexercised
Number of In-the-Money Options at
Number of Commom Common Shares Underlying September 30, 2003
Shares Acquired on Unexercised Options at September Exerciseable/
Name Exercise Realized Value 30, 2003 Exerciseable/Unexercisable Unexerciseable
- --------------------------- --------------------- --------------------- ------------------------------------ -----------------------
Kenneth Plotkin -0- -0- 403,850/146,150 $752,525/$244,975
- --------------------------- --------------------- --------------------- ------------------------------------ -----------------------
Dean Cirielli -0- -0- 12,500/37,500 $22,625/$67,875
- --------------------------- --------------------- --------------------- ------------------------------------ -----------------------
John Casey -0- -0- 52,500/40,500 $97,215/$52,800
- --------------------------- --------------------- --------------------- ------------------------------------ -----------------------
Gerald Tucciarone -0- -0- 33,500/40,500 $59,085/$52,800
- --------------------------- --------------------- --------------------- ------------------------------------ -----------------------
Compensation of Directors
Prior to May 16, 2003, Directors of the Company received no cash compensation
solely for being on the Board of Directors.
Effective May 16, 2003, the Board of Directors resolved to pay an annual
retainer of $10,000 (to be paid in quarterly installments in advance) to each
non-employee Director and $1,000 for each Board of Directors meeting or
Committee meeting he/she attends in person and $250 if he /she attends by
telephone.
On June 23, 2003, each of Mr. Page, Dr. Nadel, Mr. Payan and Mr. Siegel was
granted an option to purchase 20,000 shares of Common Stock of the Company, at
an exercise price of $3.05 per share (for the purposes of the Company's 1996
Non-Qualified Stock Option Plan, the fair market value of the Company's Common
Stock as of June 23, 2003 was $3.05 per share). Such options are exercisable at
the rate of 5,000 shares on each of June 23, 2003, 2004, 2005 and 2006, with
each installment being exercisable over a ten year period commencing on the date
of grant of the options; and that such options are not intended to qualify as
incentive stock options, as defined in Section 422 of the Internal Revenue Code,
as amended.
55
Employment Contracts; Termination of Employment and Change-in-Control
Arrangements
As of January 10, 1998, after the expiration of a prior employment agreement
with the Company, Kenneth Plotkin entered into an employment agreement (the
"1998 Employment Agreement") with the Company to serve in certain offices of the
Company. The 1998 Employment Agreement provided for a three-year term, which
term automatically renews from year to year thereafter unless otherwise
terminated by the Board of Directors or the executive. The 1998 Employment
Agreement provided for an annual base salary of $125,000 during the first year,
$150,000 during the second year, and $180,000 during the third year. For each
Annual Period (as defined in the 1998 Employment Agreement) thereafter, the 1998
Employment Agreement provides that compensation shall be as mutually determined
between the Company and the executive, but not less than that for the preceding
Annual Period. In addition, the 1998 Employment Agreement provides for a bonus
to be paid as follows: an amount equal to 2% of the Company's earnings,
excluding earnings that are not from operations and before reduction for
interest and income taxes ("EBIT"), for each fiscal year starting with the year
ended September 30, 1998, provided that the Company's EBIT for the applicable
fiscal year exceeds 120% of the prior fiscal year's EBIT, and if not, then 1% of
the Company's EBIT. The determination of EBIT shall be made in accordance with
the Company's audited filings with the Securities and Exchange Commission on its
Form 10-KSB or Form 10-K. Pursuant to the 1998 Employment Agreement, on January
21, 1998, incentive stock options to acquire a total of 90,000 Common Shares
each were granted to Mr. Plotkin, exercisable, beginning on January 21, 1999, in
increments of 33 1/3% per year at $2.544 per share. Each increment of these
options expires five (5) years after it first becomes exercisable. Also on
January 21, 1998, pursuant to the 1998 Employment Agreement, non-qualified
options to acquire a total of 60,000 Common Shares each were granted to Mr.
Plotkin, exercisable immediately for a period of ten (10) years. These options
expire as of January 20, 2008. Options granted under the 1998 Incentive Stock
Option Plan shall become immediately vested and exercisable in the event of a
Change in Control (as defined in the 1998 Incentive Stock Option Plan). The 1998
Employment Agreement further provides for disability benefits, the obligation of
the Company to pay the premiums on a term life insurance policy or policies in
the amount of $500,000 on the life of Mr. Plotkin owned by Mr. Plotkin or his
spouse, or a trust for his respective benefit or for the benefit of his family,
a car allowance of $500 per month, reasonable reimbursement for automobile
expenses, and medical insurance as is standard for executives of the Company.
The 1998 Employment Agreement further provides that the Company may apply for
and own life insurance on the life of Mr. Plotkin for the benefit of the
Company, in such amounts as the Board of Directors of the Company may from time
to time determine. As set forth in the 1998 Employment Agreement, the Company
shall pay the premiums as they become due on any such insurance policies, and
all dividends and any cash value and proceeds on such insurance policies shall
belong to the Company. In the event of a termination of employment associated
with a Change in Control of the Company (as defined in the 1998 Employment
Agreement), a one-time bonus shall be paid to the executive equal to three times
the amount of the executive's average annual compensation (including salary,
bonus and benefits, paid or accrued) received by him for the thirty-six month
period preceding the date of the Change of Control.
As of May 1, 2002, Dean Cirielli entered into an Employment Agreement with the
Company (the "Cirielli Employment Agreement"). The Cirielli Employment Agreement
provides for a two-year term, unless terminated earlier by either Mr. Cirielli
or the Company. The Cirielli Employment Agreement provides that Mr. Cirielli
shall be paid an annual salary of $175,000 for the first year of the Cirielli
Employment Agreement, with annual performance evaluations and upward adjustments
as determined by the
56
Compensation Committee of the Board of Directors, based on his performance. In
addition, the Cirielli Employment Agreement provides that he shall also receive
a yearly bonus totaling one percent of the operating income of the Company,
provided that earnings are at least 120% of the prior fiscal year's earnings.
Pursuant to the Cirielli Employment Agreement, Mr. Cirielli was granted an
option to purchase 50,000 shares of Common Stock of the Company, on May 1, 2002
at an exercise price of $1.81 per share (for the purposes of the Company's 2000
Performance and Equity Incentive Plan, the fair market value of the Company's
Common Stock as May 1, 2002) was $1.81 per share. Such options are exercisable
to the extent of 12,500 shares on each of May 1, 2003, 2004, 2005 and 2006, with
each installment being exercisable over a ten year period commencing on the date
of grant of the options; and that such options are not intended to qualify as
incentive stock options, as defined in section 422 of the Internal Revenue Code,
as amended. All outstanding options as of the date such Change in Control (as
defined in the Company's 2000 Performance and Equity Incentive Plan) shall
become fully exercisable and vested, unless the terms of the award provide
otherwise. Pursuant to the Cirielli Employment Agreement, the Company and Mr.
Cirielli entered into a Relocation Package Agreement providing for, amongst
other things, a relocation reimbursement of no more than $100,000. Such
relocation reimbursement shall be paid as follows:
(i) 50% of the Relocation Costs (as defined in his Relocation Package
Agreement) or $50,000 (whichever is lower) on or before he physically
and permanently relocates to Long Island, NY, such date to be the date
of signing a definitive sale and purchase agreement to either sell his
existing residence or buy a house in the Long Island area, NY,
whichever is earlier (the "Relocation Date"),
(ii) 25% of the Relocation Costs or $25,000 (whichever is lower) on the
first anniversary of the Relocation Date and
(iii)25% of the Relocation Costs or $25,000 (whichever is lower) on the
second anniversary of the Relocation Date.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
The following table sets forth, to the knowledge of the Company based solely
upon records available to it, certain information as of December 8, 2003
regarding the beneficial ownership of the Company's Common Stock (i) by each
person who the Company believes to be the beneficial owner of more than 5% of
its outstanding Common Stock, (ii) by each current Director, (iii) by each
person listed in the Summary Compensation Table under "Item 11 -- Executive
Compensation" and (iv) by all current executive officers and Directors as a
group:
Name of Management Person
and Name and Address
of Beneficial Owner Number Percent
- ------------------------- ------ -------
Kenneth Plotkin 1,012,950(1)(4)(5)(7) 11.4%
91 Cabot Court
Hauppauge, NY 11788
Estate of Kenneth R. Aupperle(3) 603,220(2)(3)(4)(6) 6.8%
23 Sequoia Drive
Hauppauge, NY 11788
57
Laura Aupperle 572,440(2)(3)(4)(6) 6.5%
23 Sequoia Drive
Hauppauge, NY 11788
Dorothy Plotkin 559,560(1)(4)(7) 6.3%
91 Cabot Court,
Hauppauge, NY 11788
John Casey 142,200(8) 1.6%
Bernard Herman 53,996(9) *
Gerald Tucciarone 36,500(10) *
Steven J. Kuperschmid 30,000(11) *
Dean Cirielli 12,500(12) *
Robert S. Nadel 5,000(13) *
Christopher G. Payan 5,000(13) *
Neal Page 5,400(13) *
Seymour G. Siegel 5,000(13) *
Directors and executive officers 1,308,546(1)(4)(5)(8) 14.7%
as a group (10 persons) (9)(10)(11)(12)(13)
- ---------------------------------
* Less than one (1%) percent.
(1) Dorothy Plotkin, wife of Kenneth Plotkin, beneficially owns 559,560 shares
of Common Stock or 6.3% of the outstanding shares of Common stock.
Ownership of shares of Common Stock by Mr. Plotkin does not include
ownership of shares of Common Stock by Mrs. Plotkin, and ownership of
shares of Common Stock by Mrs. Plotkin does not include ownership of shares
of Common Stock by Mr. Plotkin.
(2) To the Company's knowledge, Laura Aupperle, the widow of Kenneth R.
Aupperle, beneficially owns 572,440 shares of Common Stock, or 6.5% of the
outstanding shares of Common Stock. Ownership of shares of Common Stock by
the Estate of Kenneth R. Aupperle does not include ownership of shares of
Common Stock by Laura Aupperle and ownership of shares of Common Stock of
Laura Aupperle does not include ownership of shares of Common Stock by the
Estate of Kenneth R. Aupperle.
(3) The Company is unaware of any filings made by the Estate of Kenneth R.
Aupperle with the Securities and Exchange Commission. The Company has
assumed that any securities of the
58
Company beneficially owned by Mr. Aupperle prior to his death, and of which
the Company is aware, are now beneficially owned by the Estate of Kenneth
R. Aupperle.
(4) One presently exercisable warrant has been issued for 120,000 shares of
Common Stock to LADOKK Realty Co. ("LADOKK"), a partnership, which prior to
Mr. Aupperle's death, consisted of Kenneth Plotkin, Dorothy Plotkin,
Kenneth Aupperle and Laura Aupperle. Mr. Plotkin expressly disclaims any
percentage interest in the warrant other than that which represents his
percentage interest in the partnership, which is equal to 30,000 shares of
Common Stock. The Company has assumed that the Estate of Kenneth R.
Aupperle now owns the interest which Mr. Aupperle formerly had in LADOKK.
(5) Includes 180,000 shares of Common Stock issuable upon the exercise of
currently exercisable non-qualified stock options granted on January 10,
1995 and exercisable until September 29, 2006, which options were part of
an overall grant of a non-qualified stock option to purchase 300,000 shares
of Common Stock at $1.575 per share. Also includes 105,400 shares of Common
Stock issuable upon the exercise of currently exercisable non-qualified
options and 118,450 shares of Common Stock issuable upon the exercise of
currently exercisable incentive stock options. Does not include 120,000
shares of Common Stock issuable upon the exercise of currently
unexercisable non-qualified stock options and 26,150 shares of Common Stock
issuable upon the exercise of currently unexercisable incentive stock
options.
(6) Does not include 50,000 shares of Common Stock, in the aggregate, owned by
Mr. Aupperle's brother, as custodian for each of Mrs. Aupperle's minor
children (25,000 Common Shares to each minor child) under the New York
Uniform Gifts to Minors Act.
(7) Does not include 18,000 shares of Common Stock owned by the Plotkins' adult
daughter. Does not include 25,000 shares of Common Stock, owned by Mr.
Plotkin's father as custodian for the Plotkins' minor child under the New
York Uniform Gifts to Minors Act. Each of Mr. and Mrs. Plotkin disclaim
beneficial ownership of all such 43,000 shares of Common Stock.
(8) Includes 52,000 shares of Common Stock issuable upon the exercise of
currently exercisable incentive stock options. Does not include 40,500
shares of Common Stock issuable upon the exercise of currently
unexercisable incentive stock options.
(9) Includes 30,000 shares of Common Stock issuable upon the exercise of
currently exercisable non-qualified stock options.
(10) Includes 33,500 shares of Common Stock issuable upon the exercise of
currently exercisable incentive stock options. Does not include 40,500
shares of Common Stock issuable upon the exercise of currently
unexercisable incentive stock options.
(11) Includes 30,000 shares of Common Stock issuable upon the exercise of
currently exercisable non-qualified stock options.
(12) Includes 12,500 shares of Common Stock issuable upon the exercise of
currently exercisable incentive stock options. Does not include 37,500
shares of Common Stock issuable upon the exercise of currently
unexercisable incentive stock options.
59
(13) Includes 5,000 shares of Common Stock issuable upon the exercise of
currently exercisable non-qualified stock options. Does not include 15,000
shares of Common Stock issuable upon the exercise of currently
unexercisable non-qualified stock options.
Equity Compensation Plan Information
Set forth in the table below is certain information regarding the number of
shares of common stock that may be issued under options, warrants and rights
under all of the Company's existing equity compensation plans as of September
30, 2003.
- --------------------------------------- -------------------------- ----------------------------- -------------------------------
Number of securities
remaining available for
Number of securities to future issuance under equity
be issued upon exercise Weighted average exercise compensation plans (excluding
Plan Category of outstanding options price of outstanding securities reflected in
and warrants options and warrants column (a))
- --------------------------------------- -------------------------- ----------------------------- -------------------------------
Equity compensation plans approved by
stockholders 1,546,101 $ 2.53 623,885
- --------------------------------------- -------------------------- ----------------------------- -------------------------------
Equity compensation plans not
approved by shareholders 230,000 $ 3.41 120,000
- --------------------------------------- -------------------------- ----------------------------- -------------------------------
Total
1,776,101 $ 2.67 743,885
- --------------------------------------- -------------------------- ----------------------------- -------------------------------
Item 13. Certain Relationships and Related Transactions
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.
On December 17, 1995 in connection with a re-negotiation of the lease term, the
Company granted options to purchase 120,000 shares to a real estate partnership
partially owned by the principal stockholder at an exercise price of $1.905 per
share, which are exercisable through the lease term. The market price of the
option equaled the exercise price at the date of the grant. The effect of
imputing the fair value of the options granted was immaterial. The options were
still outstanding as of September 30, 2003.
The Company had amounts payable to this related party for unpaid rent of
$302,128 as of September 30, 2003 and 2002.
On December 17, 1996 the Board of Directors approved the issuance of warrants to
LADOKK in consideration of LADOKK's agreement to cancel the last three years of
the Company's lease and to grant
60
an option to the Company to extend the lease for three years. The Stock Option
Committee authorized the grant of a warrant to LADOKK to acquire 120,000 Common
Shares at an exercise price of $1.906, which warrant is exercisable for a term
of ten years.
Certilman Balin Adler & Hyman, LLP, a law firm of which Mr. Kuperschmid is a
member, serves as counsel to the Company. It is presently anticipated that such
firm will continue to represent the Company and its subsidiaries and affiliates
and will receive fees for its services at rates and amounts not greater than
would be paid to unrelated law firms performing similar services.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Not Applicable.
61
PART IV
-------
Item 15. Exhibits, financial statement schedules, and Reports on Form 8-K
(a)(1) Financial Statements
The following consolidated financial statements are incorporated by
reference in Item 8 of this Annual Report on Form 10-K:
Page
----
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheet as of September 30, 2003 and 2002 F-3
Consolidated Statements of Operations
for the years ended September 30, 2003, 2002 and 2001 F-4
Consolidated Statements of Other Comprehensive Income (Loss)
for the years ended September 30, 2003, 2002 and 2001 F-5
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 2003, 2002 and 2001 F-6
Consolidated Statements of Cash Flows for the years
ended September 30, 2003, 2002 and 2001 F-7
Notes to Consolidated Financial Statements F-8
Report of Independent Certified Public Accountants F-27
(a)(2) Financial Statement Schedules
Schedule II Valuation and Qualifying Accounts--Allowance for Doubtful
Accounts
Schedule II Valuation and Qualifying Accounts--Reserve for Obsolete
and Slow Moving Inventory
Schedule II Valuation and Qualifying Accounts--Reserve for Sales
Returns
(a)(3) Exhibits.
Exhibit
Number Description of Exhibit
3.1 Certificate of Incorporation, as amended to date (1)
3.2 By-laws, as amended to date (2)
4.1 Form of Common Stock Certificate (1)
4.2 1994 Incentive Stock Option Plan (1)
4.3 1996 Non-Qualified Stock Option Plan
4.4 1998 Incentive Stock Option Plan
4.5 2000 Hauppauge Digital Inc. Performance and Equity Incentive Plan (3)
4.6 Hauppauge Digital Inc. Employee Stock Purchase Plan (4)
4.7 Stockholder Rights Plan (5)
4.8 2003 Hauppauge Digital Inc. Performance and Equity Incentive Plan (6)
10.1 Employment Agreement with Kenneth Plotkin
10.2 Lease dated February 7, 1990 between Ladokk Realty Company and Hauppauge
Computer Works, Inc. (1)
10.2 (a) Modification made February 1, 1996 to lease dated February 7, 1990
between LADOKK Realty and Hauppauge
62
Computer Works, Inc.
10.3 Long Island Development Corporation (""LIDC"") Mortgage Loan Agreements (1)
10.4 The Company's Guaranty of LIDC Loan Agreements (1)
10.5 Shawmut Mortgage Loan Agreements (1)
10.6 The Company's Guaranty of the Shawmut Mortgage Loan Agreements (1)
10.7 Employment Agreement with Dean Cirielli
10.8 Relocation Agreement with Dean Cirielli
14 Code of Ethics
21 Subsidiaries of the Company
23 Consent of BDO Seidman, LLP
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule
15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or
Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
---------------------------------------------------------------------------
---------------------------------------------------------------------------
1. Denotes document filed as an Exhibit to the Company's Registration
Statement on Form SB-2 (No. 33-85426), as amended, effective January 10,
1995 and incorporated herein by reference.
2. Denotes document filed as an Exhibit to the Company's Form 8-K dated August
22, 2001 and incorporated herein by reference.
3. Denotes document filed as an Exhibit to the Company's Registration
Statement on Form S-8 (No. 333-46906), and incorporated herein by
reference.
4. Denotes document filed as an Exhibit to the Company's Registration
Statement on Form S-8 (No. 333-46910), and incorporated herein by
reference.
5. Denotes document filed as an Exhibit to the Company's Form 8-K dated July
20, 2001 and as an Exhibit to the Company's Registration Statement on Form
8-A12G and incorporated herein by reference.
6. Denotes document filed as an Exhibit to the Company's Registration
Statement on Form S-8 (No. 333-109065), and incorporated herein by
reference.
(b) Reports on Form 8-K
The Company filed one Current Report on Form 8-K during the fourth quarter of
the fiscal year ended September 30, 2003 as follows:.
Date of Report: August 18, 2003
Item Reported: 7,12
63
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page(s)
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets as of September 30, 2003 and 2002 F-3
Consolidated Statements of Operations
for the years ended September 30, 2003, 2002 and 2001 F-4
Consolidated Statements of Other Comprehensive Income (Loss)
for the years ended September 30, 2003, 2002 and 2001 F-5
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 2003, 2002 and 2001 F-6
Consolidated Statements of Cash Flows for the years ended
September 30, 2003, 2002 and 2001 F-7
Notes to Consolidated Financial Statements F-8 to F-28
Report of Independent Certified Public Accountants F-29
Schedule II Valuation and Qualifying Accounts-Allowance for Doubtful Accounts F-30
Schedule II Valuation and Qualifying Accounts-Reserve for Obsolete
and Slow Moving Inventory F-31
Schedule II Valuation and Qualifying Accounts-Reserve for Sales Returns F-32
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
Hauppauge Digital, Inc. and Subsidiaries
Hauppauge, New York
We have audited the accompanying consolidated balance sheets of Hauppauge
Digital, Inc. and Subsidiaries as of September 30, 2003 and 2002 and the related
consolidated statements of operations, other comprehensive income (loss),
stockholders' equity and cash flows for each of the three years in the period
ended September 30, 2003. These financial statements are the responsibility of
the management of Hauppauge Digital, Inc. and Subsidiaries. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hauppauge Digital,
Inc. and Subsidiaries as of September 30, 2003 and 2002 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2003 in conformity with accounting principles generally accepted
in the United States of America.
/s/ BDO Seidman, LLP
- -----------------------
BDO Seidman, LLP
Melville, New York
December 4, 2003
F-2
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, September 30,
2003 2002
---------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 5,838,160 $ 4,964,522
Accounts receivable, net of various allowances 9,182,758 5,683,738
Inventories 5,474,374 8,091,495
Prepaid expenses and other current assets 546,328 416,734
---------------------------------------
Total current assets 21,041,620 19,156,489
Property, plant and equipment, net 532,516 611,054
Security deposits and other non current assets 76,216 78,616
---------------------------------------
$ 21,650,352 $ 19,846,159
=======================================
LIABILITIES AND STOCKHOLDERS' EQUITY :
Current Liabilities:
Accounts payable $ 7,452,867 $ 6,105,588
Accrued expenses 2,539,678 1,442,475
Income taxes payable 189,122 331,484
---------------------------------------
Total current liabilities 10,181,667 7,879,547
Stockholders' Equity
Common stock $.01 par value; 25,000,000 shares authorized, 9,420,315
and 9,392,164 issued, respectively 94,203 93,923
Additional paid-in capital 12,302,119 12,233,170
Retained earnings 99,987 914,019
Accumulated other comprehensive income 469,592 187,074
Treasury Stock, at cost, 542,067 and 517,317 shares, respectively (1,497,216) (1,461,574)
---------------------------------------
Total stockholders' equity 11,468,685 11,966,612
---------------------------------------
$ 21,650,352 $ 19,846,159
=======================================
See accompanying notes to consolidated financial statements
F-3
HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended September 30,
-----------------------------------------------
2003 2002 2001
-----------------------------------------------
Net sales $50,956,034 $42,796,726 $50,910,463
Cost of sales 38,715,103 31,661,073 42,056,859
-----------------------------------------------
Gross Profit 12,240,931 11,135,653 8,853,604
Selling, general and administrative expenses 10,896,111 9,069,045 10,282,474
Research & development expenses 1,901,843 1,591,551 1,510,092
Write off of goodwill - - 701,919
Litigation settlement - - 212,500
-----------------------------------------------
(Loss) income from operations (557,023) 475,057 (3,853,381)
Other Income (expense):
Interest income 15,858 34,781 42,137
Interest expense - - (30,833)
Life insurance proceeds - - 2,000,000
Foreign currency (17,913) 4,750 6,740
Non operational USD to Euro currency re-measurement 51,936 (98,066) (15,863)
-----------------------------------------------
Total other (expense) income 49,881 (58,535) 2,002,181
-----------------------------------------------
(Loss) income before taxes on income (507,142) 416,522 (1,851,200)
Income tax provision 306,890 69,000 749,497
-----------------------------------------------
(Loss) income before cumulative effect of a change in accounting principle (814,032) 347,522 (2,600,697)
Cumulative effect of a change in accounting principle - - 319,000
-----------------------------------------------
Net (loss) income ($814,032) $347,522 ($2,281,697)
===============================================
Net (loss) income per share-basic and diluted:
(Loss) income before cumulative effect of a change in accounting principle ($0.09) $0.04 ($0.29)
Cumulative effect of a change in accounting principle - - $0.03
-----------------------------------------------
Net (loss) income per share-basic and diluted ($0.09) $0.04 ($0.26)
===============================================
See accompanying notes to consolidated financial statements
F-4
HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)
Years ended September 30,
-------------------------
Other comprehensive income (loss): 2003 2002 2001
---- ---- ----
Net (loss) income $ (814,032) $ 347,522 $ (2,281,697)
Forward exchange contracts marked to market (425,510) 190,919 -
Foreign currency translation gain (loss) 708,028 263,359 (267,204)
--------------------------------------------------------------
Other comprehensive (loss) income $ (531,514) $ 801,800 $ (2,548,901)
==============================================================
See accompanying notes to consolidated financial statements
F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
Common Stock
----------------
Accumulated
Number Additional Other
Of Paid-in Retained Comprehensive Treasury
Shares Amount Capital Earnings Income (loss) Stock Total
===============================================================================
BALANCE AT SEPTEMBER 30, 2000 9,312,578 $93,126 $12,046,421 $2,848,194 - $(1,334,064) $13,653,677
Net (loss) for the year ended September 30, 2001 - - - (2,281,697) - - (2,281,697)
Purchase of treasury stock - - - - (37,498) (37,498)
Exercise of Stock Options 11,000 110 15,712 - - - 15,822
Foreign currency translation loss and change in fair
value of forward contracts - - - - (267,204) - (267,204)
Compensation in options for consulting services - - 38,004 - - - 38,004
Stock issued to pay bonuses 800 8 1,755 - - - 1,763
Stock issued through Employee Stock Purchase plan 39,981 400 62,351 - - - 62,751
-------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2001 9,364,359 $93,644 $12,164,243 $ 566,497 $(267,204) $(1,371,562) $11,185,618
Net income for the year ended September 30, 2002 - - - 347,522 - - 347,522
Purchase of treasury stock - - - - - (90,012) (90,012)
Foreign currency translation gain and change in fair
value of forward contracts - - - - 454,278 - 454,278
Compensation in options for consulting services - - 38,000 - - - 38,000
Stock issued through Employee Stock Purchase plan 27,805 279 30,927 - - - 31,206
------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2002 9,392,164 $93,923 $12,233,170 $ 914,019 $187,074 $(1,461,574) $11,966,612
Net (loss) for the year ended September 30, 2003 - - - (814,032) - - (814,032)
Purchase of treasury stock - - - - - (35,642) (35,642)
Exercise of Stock Options 3,000 30 3,445 - - - 3,475
Foreign currency translation gain and change in fair
value of forward contracts - - - - 282,518 - 282,518
Compensation in options for consulting services - - 38,002 - - - 38,002
Stock issued through Employee Stock Purchase plan 25,151 250 27,502 - - - 27,752
------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2003 9,420,315 $94,203 $12,302,119 $ 99,987 $469,592 $(1,497,216) $11,468,685
==============================================================================
See accompanying notes to consolidated financial statements
F-6
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30,
2003 2002 2001
-------------------------------------------------------
Cash Flows From Operating Activities:
Net (loss) income $ (814,032) $ 347,522 $(2,281,697)
---------------------------------------------------------
Adjustments to reconcile net (loss) income to net cash
Provided by (used in) operating activities:
Depreciation and amortization 274,784 318,801 400,438
Goodwill write-down - - 701,919
Provision for uncollectible accounts receivable - 20,000 10,000
Provision for inventory reserve - (386,409) 1,862,776
Deferred tax expense (benefit) - - 1,082,797
Other non cash items 40,402 44,212 39,768
Changes in current assets and liabilities:
Accounts receivable (3,542,502) (504,866) 1,652,195
Income taxes receivable 326,000 - 995,045
Inventories 2,617,121 466,481 2,255,632
Prepaid expenses and other current assets (129,594) 101,531 (61,834)
Accounts payable 1,347,279 372,617 (4,748,743)
Accrued expenses and income taxes 954,841 (91,592) 871,068
---------------------------------------------------------
Total adjustments 1,888,331 340,775 5,061,061
---------------------------------------------------------
Net cash provided by operating activities 1,074,299 688,297 2,779,364
---------------------------------------------------------
Cash Flows From Investing Activities:
Purchases of property, plant and equipment (196,246) (87,208) (143,055)
---------------------------------------------------------
Net cash used in investing activities (196,246) (87,208) (143,055)
---------------------------------------------------------
Cash Flows From Financing Activities:
Loan repayments - - (1,000,000)
Proceeds from employee stock purchases 31,227 31,206 78,573
Purchase of treasury stock (35,642) (90,012) (37,498)
---------------------------------------------------------
Net cash (used in) financing activities (4,415) (58,806) (958,925)
---------------------------------------------------------
Net increase in cash and cash equivalents 873,638 542,283 1,677,384
Cash and cash equivalents, beginning of year 4,964,522 4,422,239 2,744,855
---------------------------------------------------------
Cash and cash equivalents, end of year $ 5,838,160 $ 4,964,522 $ 4,422,239
=========================================================
Supplemental disclosures:
Interest paid $ - $ - $ 24,546
Income taxes paid $ 40,262 $ 31,948 $ 4,506
=========================================================
See accompanying notes to consolidated financial statements
F-7
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Hauppauge Digital,
Inc. and its wholly-owned subsidiaries, Hauppauge Computer Works, Inc., HCW
Distributing Corp., Eskape Acquisition Corporation and Hauppauge Digital Europe
S.a.r.l. and its wholly-owned subsidiaries, Hauppauge Digital Asia Pte Ltd,
Hauppauge Computer Works, GmbH, Hauppauge Computer Works, Ltd., and Hauppauge
Computer Works S.a.r.l. All inter-company accounts and transactions have been
eliminated.
Nature of Business
We engineer, develop, subcontract for manufacture, market and sell products for
the personal computer ("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").
Product segment and Geographic Information
The Company sells its product through a worldwide network of distributors and
retailers. Net sales to international and domestic customers were approximately
68% and 32%, 73% and 27%, and 77% and 23% of total sales for the years ended
September 30, 2003, 2002 and 2001, respectively. It maintains sales offices in
both Europe and Asia.
Net sales to customers by geographic location consist of:
F-8
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended September 30,
Sales to: 2003 2002 2001
--------- ---- ---- ----
United States 32% 27% 23%
Germany 30% 37% 41%
United Kingdom 15% 14% 12%
France 8% 8% 6%
Asia 1% 2% 7%
Italy 2% 2% 2%
Netherlands 3% 2% 1%
Other Countries 9% 8% 8%
--- --- ---
Total 100% 100% 100%
Product Segment and Geographic Information
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.
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:
Twelve months ended September 30,
2003 2002 2001
---- ---- ----
Product line sales
- ------------------
Analog sales $38,219,898 $34,526,717 $43,483,587
Digital sales 12,736,136 8,270,009 7,426,876
---------- --------- ---------
$50,956,034 $42,796,726 $50,910,463
=========== =========== ===========
Net long lived assets located in the United States, Europe and Asia locations
were approximately 70%, 26% and 4% of total net long lived assets, respectively,
at September 30, 2003, and 73%, 22% and 5%, respectively, at September 30, 2002.
F-9
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Use of Estimates
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. The Company reviews all significant estimates
affecting the financial statements on a recurring basis and records the effect
of any adjustments when necessary.
Cash and Cash Equivalents
For the purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with an original maturity date of three
months or less to be cash equivalents.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of cash and accounts receivable. At times such
cash in banks are in excess of the FDIC insurance limit. Concentration of credit
risk with respect to accounts receivable exists because the Company operates in
one industry (also see Note 8). Although the Company operates in one industry
segment, it does not believe that it has a material concentration of credit risk
either from an individual counter party or a group of counter parties, due to
the large and diverse user group for its products. The Company performs ongoing
credit evaluations of its customers and generally does not require collateral.
The Company maintains allowances to cover potential or anticipated losses for
uncollectible amounts.
Shipping and Handling Costs
The Company records all shipping and handling charges in Cost of Sales.
Revenue Recognition
We sell through a sales channel which consist of retailers, OEMS 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 products we sell are
analog or digital computer boards that are stocked on the shelves of retailers,
and are subject to the normal consumer traffic that retail stores attract. Aside
from normal store promotions such as advertisements in the store's circular, the
Company has no further obligation to assist in the resale of the products.
The Company offers 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.
F-10
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warranty Policy
The Company warrants that its products are free from defects in material and
workmanship for a period of one year from the date of initial retail purchase.
The warranty does not cover any losses or damage that occur as a result of
improper installation, misuse or neglect and repair or modification by anyone
other than the Company or its authorized repair agent. The Company accrues
anticipated warranty costs based upon historical percentages of items returned
for repair within one year of the initial sale. The Company's repair rate of
product under warranty has been minimal and the warranty reserve has not been
material.
Inventories
Inventories are valued at the lower of cost (principally average cost) or
market. A reserve has been provided to reduce obsolete and/or excess inventory
to its net realizable value.
Property, Plant and Equipment
Depreciation of office equipment and machinery and amortization of leasehold
improvements is provided for using both accelerated and straight line methods
over the estimated useful lives of the related assets as follows:
Office Equipment and Machinery: 5 to 7 years
Leasehold improvements: Asset life or lease term, whichever is shorter
Income taxes
The Company follows the liability method of accounting for income taxes.
Deferred income taxes are recorded to reflect the temporary differences in the
tax bases of the assets or liabilities and their reported amounts in the
financial statements.
Long-Lived Assets
Long-lived assets, such as property and equipment and goodwill, are evaluated
for impairment when events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable through the estimated
undiscounted future cash flows from the use of these assets. When any such
impairment exists, the related assets will be written down to fair value. (See
Note 11)
Research and Development
Expenditures for research and development are charged to expense as incurred.
Foreign Currency Translations and Transactions
The Company's Asian subsidiary reports its financial position and results of
operations in the reporting currency of the Company.
The financial position and results of operations of the Company's European
subsidiaries are determined using Euros as the functional currency. Certain
assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each year end. Euro-denominated income statement accounts that
pertain to sales are translated at the average monthly forward exchange contract
rate. Currencies other than Euros (primarily Great British Pound) and Euro
accounts other than sales are translated at the average prevailing exchange rate
during the year. Translation adjustments arising from the translation to U.S.
dollars at differing exchange rates are included in the accumulated other
comprehensive income (loss) account in stockholders' equity. Gains and losses
resulting from transactions that are denominated in currencies other than Euros
are included in earnings
F-11
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
as a component of other income. During the years ended September 30, 2003 and
2002, the Company recorded on the balance sheet translation gains of $708,028
and $215,142, respectively, under other comprehensive income (loss) in
stockholders' equity section.
Derivatives and Hedging Activities
Due to extensive sales to European customers with payment made to us in local
currencies (primarily the Euro and Great British Pound) , the Company uses
derivatives to reduce its exposure to fluctuations in foreign currencies.
Derivative products, such as foreign currency forward contracts, are used to
hedge the foreign currency market exposures underlying forecasted sales
transactions with customers. The Company's accounting policies for these
instruments are based on its designation of such instruments as cash flow
hedging transactions. The Company does not use derivative instruments for
purposes other than hedging. All open derivative contracts are recorded on the
balance sheet under accounts receivable at fair value. Prior to July 1, 2002,
the Company did not qualify for cash hedge accounting under FAS 133, therefore
material gains or losses were recorded through operations.
The Company recognizes gains and losses on closed derivative contracts as an
adjustment to net sales.
Derivatives and Hedging Activities
For derivative instruments that are designated and qualify as a fair value hedge
(i.e., hedging the exposure to changes in the fair value of an asset or a
liability or an identified portion thereof that is attributable to a particular
risk), the gain or loss on the derivative instrument as well as the offsetting
gain or loss on the hedged item attributable to the hedged risk are recognized
in earnings in the current period. For derivative instruments that are
designated and qualify as a cash flow hedge (i.e., hedging the exposure of
variability in expected future cash flows that is attributable to a particular
risk), the effective portion of the gain or loss on the derivative instrument is
reported as a component of Accumulated Other Comprehensive Income (Loss) (a
component of stockholders' equity) and reclassified into earnings in the same
period or periods during which the hedged transaction affects earnings. The
remaining gain or loss on the derivative instrument, if any (i.e. the
ineffective portion and any portion of the derivative excluded from the
assessment of effectiveness) is recognized in earnings in the current period.
For derivative instruments not designated as hedging instruments, changes in
their fair values are recognized in earnings in the current period.
The effect of implementing SFAS No.133, "Accounting for Derivative Instruments
and Hedging Activities", which was adopted on October 1, 2000, is presented in
this annual report on form 10-K as a cumulative effect of a change in accounting
principle.
Fair Value of Financial Instruments
The carrying amounts of certain financial instruments, including cash,
receivables and accounts payable, approximate fair value as of September 30,
2003 and 2002 because of the relatively short term maturity of these
instruments.
F-12
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net income (loss) per share
Basic net income (loss) per share includes no dilution and is computed by
dividing net income (loss) by the weighted average number of Common Stock
outstanding for the period. Diluted net income (loss) per share reflect, in
periods in which they have a dilutive effect, the dilution which would occur
upon the exercise of stock options. A reconciliation of the shares used in
calculating basic and diluted earnings (loss) per share follows:
Years ended September 30,
2003 2002 2001
---- ---- ----
Weighted average common stock outstanding-basic 8,867,309 8,887,107 8,910,117
Common stock equivalents-stock options - 115,043 -
--------- --------- ---------
Weighted average shares outstanding-diluted 8,867,309 9,002,150 8,910,117
========= ========= =========
Options to purchase 1,896,101, 825,322 and 1,827,326 shares of Common Stock at
prices ranging $1.05 to $10.06, $2.07 to $10.06 and 1.05 to $10.06,
respectively, were outstanding as of September 30, 2003, 2002 and 2001, but were
not included in the computation of diluted net income (loss) per share of Common
Stock because they were anti-dilutive.
Stock Based Compensation
The Company accounts for its stock option awards under the intrinsic value based
method of accounting as prescribed by APB Opinion Number 25, "Accounting for
Stock Issued to Employees". Under the intrinsic value based method, compensation
cost is the excess, if any, of the quoted market price of the stock at grant
date or other measurement date over the amount an employee must pay to acquire
the stock. The Company discloses the pro forma impact on net income and earnings
per share as if the fair value based method had been applied as required by SFAS
No. 123, "Accounting for Stock Based Compensation".
Stock Based Compensation
SFAS Statement 123 "Accounting for Stock Based Compensation," ("SFAS 123")
requires the Company to provide pro forma information regarding net income or
(loss) and net income or (loss) per share as if compensation cost for the
Company's stock option plans had been determined in accordance with the fair
value based method prescribed in SFAS123. The fair value for these options was
estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions for 2003, 2002 and 2001: risk free interest rates of 3.25%, 3.25%
and 4.25%, volatility factor of the expected market price of the Company's stock
of 40%, 40% and 40% and expected lives of either five or ten years. The weighted
average fair value ranges of options granted in 2003, 2002 and 2001 were $0.43
to $1.22, $0.42 and $0.57 to $1.72, respectively.
F-13
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under the accounting provisions of FASB Statement 123, the Company's net income
and earnings per share would have been reduced to the pro forma amounts
indicated below:
Years ended September 30,
-------------------------
2003 2002 2001
---- ---- ----
Net (loss) income as reported $(814,032) $ 347,522 $(2,281,697)
Deduct: Total stock-based employee compensation expense
Determined under fair value method, net of related taxes ... (99,154) (79,461) (288,196)
--------- --------- ----------
Pro forma net income (loss)...................................... $(913,186) $(268,061) (2,569,893)
========= ========= ==========
Net income per share - as reported:
Basic and diluted................................................ $ (0.09) $ 0.04 $ (0.26)
========= ========= ===========
Net income per share - pro forma:
Basic and diluted................................................ $ (0.10) $ 0.03 $ (0.29)
========= ========= ===========
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.
In January 2003, the FASB issued Interpretation No.46, Consolidation of Variable
Interest Entities. Interpretation No. 46 requires companies with a variable
interest in a variable interest entity to apply this guidance as of the
beginning of the first reporting period ending after December 15, 2003. The
application of the guidance could result in the consolidation of a variable
interest entity. The only potential variable interest entity with which the
Company is associated is the real estate partnership owned by certain of the
Company's principal shareholders, as disclosed in Note 9. The Company is
evaluating whether the partnership is a variable interest entity, whether the
Company is the primary beneficiary and, if so, the impact of this interpretation
on financial position and results of operations.
2. Accounts receivable
Receivables consist of:
o Trade receivables from sales to customers
o Receivables pertaining to component parts purchased from us by our
contract manufacturer, which are excluded from sales
o General services tax (GST) and value added tax (VAT) reclaimable on
goods purchased by our Singapore and Ireland locations
F-14
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
o Allowances, consisting of sales and bad debt
o Income tax receivables
o Other minor non trade receivables
Attached below is a listing by category of our accounts receivable as of
September 30, 2003 and 2002.
As September 30,
2003 2002
---- ----
Trade receivables $ 7,435,539 $ 6,027,048
Receivable from contract manufacturers 4,134,456 1,345,584
GST and VAT taxes receivables 289,700 659,667
Income tax receivables 175,000 501,000
Allowances (2,887,184) (2,887,184)
Other 35,247 37,623
----------- -----------
$ 9,182,758 $ 5,683,738
=========== ===========
3. Inventories
Inventories consist of the following:
September 30,
2003 2002
---- ----
Component Parts $1,446,670 $2,842,460
Work in Process - 42,616
Finished Goods 4,027,704 5,206,419
--------- ---------
$5,474,374 $8,091,495
========== ==========
In recognition of the sales decline experienced in during fiscal 2001, which
primarily occurred in the third and fourth quarters of fiscal 2001, slower sales
of older product lines and engineering changes to products during the latter
part of fiscal 2001, the Company reviewed the net realizable value of its
inventory. The Company deemed it necessary to increase its reserve for obsolete
and slow moving inventory. An additional reserve of approximately $1,863,000 was
recognized during the fourth quarter of fiscal 2001 and charged to cost of
sales. During fiscal 2002, the Company recorded a net reduction to cost and
sales of $386,000 for adjustments to inventory allowances.
4. Property, Plant and Equipment
The following is a summary of property, plant and equipment:
September 30,
2003 2002
---- ----
Office Equipment and Machinery $2,095,268 $1,885,094
Leasehold Improvements 77,916 76,622
---------- ----------
2,173,184 1,961,716
Less: Accumulated depreciation and amortization 1,640,668 1,350,662
---------- ----------
$ 532,516 $ 611,054
========== ===========
Depreciation expense totaled $ 274,784, $ 302,401 and $ 294,234 for the total
years ended September 30, 2003, 2002 and 2001, respectively.
F-15
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Income Taxes
The Company's income tax provision consists of the following:
Years ended September 30,
2003 2002 2001
---- ---- ----
Current tax expense (benefit):
Federal income tax (benefit) $ - $ - $ (439,985)
State income taxes (benefit) - - (61,015)
Foreign income taxes 108,465 69,000 167,700
Adjustment of prior year estimated income taxes 198,425 - -
------- ------- ----------
Total current 306,890 69,000 (333,300)
------- ------- ----------
Deferred tax expense (benefit)
Federal - - 969,103
State - - 113,694
-------- ------- ----------
Total deferred - - 1,082,797
-------- ------- ----------
Total taxes on income $306,890 $69,000 $ 749,497
======== ======= ==========
Components of deferred taxes are as follows:
Years ended September 30,
2003 2002
---- ----
Deferred tax assets:
Net operating loss carry forwards $2,554,807 $ 1,498,761
Tax credit carry forward 407,971 407,971
Inventory allowances 1,061,750 1,038,333
Warranty reserve 9,158 9,158
Allowance for doubtful accounts 76,853 76,853
Deferred rent payments 5,344 24,344
Capitalized inventory costs 16,130 92,130
Sales return reserve 289,826 289,826
Goodwill amortization 239,926 258,496
Other allowances (1,637) (16,839)
---------- -----------
Total deferred assets 4,660,128 3,679,033
Valuation allowance (4,660,128) (3,679,033)
---------- -----------
Net deferred assets - -
========== ===========
As of September 30, 2003, the Company had $125,295 of restricted net operating
losses, (which expire in the years through 2010) and $6,597,885 of unrestricted
net operating losses (which expire between 2010 and 2022) available to offset
future taxable income. As of September 30, 2003, the Company has an income tax
receivable for $175,000, relating to the anticipated refund of taxes paid for
fiscal 1999. In addition, as of September 30, 2003, the Company has a tax credit
carry forward for research and development expenses totaling $407,000.
F-16
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the last four fiscal years, the Company's domestic operation has incurred
losses. On September 30, 2000, the Company's domestic operation had a deferred
tax benefit of $1,267,997. The Company analyzed the future realization of the
deferred tax asset during the fourth quarter of fiscal 2001 and it concluded
that under the present circumstances, it would be appropriate for the Company to
record a valuation allowance against the deferred tax asset and reduce certain
income tax liabilities. The net result was a charge to the Company's tax
provision for approximately $1,082,000. Due to the domestic losses incurred for
the last four fiscal years , as of September 30, 2003, the Company has recorded
a valuation allowance of $4,660,138 against the deferred tax asset.
5. Income Taxes
The difference between the actual income tax provision (benefit) and the tax
provision (benefit) computed by applying the Federal statutory income tax rate
of 34% to the income before income tax is attributable to the following:
Years ended September 30,
2003 2002 2001
---- ---- ----
Income tax (benefit) at federal statutory rate $(886,322) $(1,040,729) $ (629,408)
Increase in deferred income tax valuation allowance 981,095 1,175,298 3,122,292
Change in estimate of prior year income taxes 198,425 - (300,000)
Permanent differences-life insurance 3,400 884 (680,000)
Permanent differences-other 5,100 3,400 11,590
Income taxed at lower than statutory rates - - (822,579)
State income taxes, (benefit) net of federal benefit (104,273) (108,481) (34,768)
Foreign income taxes 108,465 69,000 167,700
Other 1,000 (30,372) (85,330)
--------- ----------- ----------
Taxes on income $ 306,890 $ 69,000 $ 749,497
========= =========== ==========
Effective October 1, 1999, the Company restructured its foreign operations. The
result of the restructuring eliminated the foreign sales corporation and
established a new Luxembourg corporation which functions as the entity which
services the Company's European customers. The new structure created separate
domestic and foreign tax entities, with the new Luxembourg entity paying a
license fee to the Company's domestic operation for use of the Hauppauge name.
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 change of
$198,425.
For the years ended September 30, 2003, 2002 and 2001 the Company's domestic
operation incurred a pretax loss of $2,606,829, $2,623,414 and $3,951,550
respectively, and the Company's international operations had pretax net income
of $2,099,687, $3,039,936 and $2,419,350, respectively.
F-17
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Line of Credit
On April 5, 2001, the Company extended its agreement with Chase Manhattan Bank,
to provide it with a $6,500,000 credit facility. The facility was secured by our
assets, and expired in fiscal 2002. It is the intention of the Company to
procure a new credit facility on terms acceptable to the Company. However, there
can be no assurance that we will secure a replacement line of credit at
competitive terms, or secure a credit line at all.
7. Stockholders' Equity
a. Treasury Stock
On November 8, 1996, the Company approved a stock repurchase program. The
program, as amended, authorizes the Company to repurchase up to 850,000 shares
of its own Common Stock. The repurchased shares will be used by the Company for
certain employee benefit programs. As of September 30, 2003 and 2002, 542,067
and 517,317 treasury shares with an accumulated cost of $1,497,216 and
$1,461,574 and average prices of $2.76 and $2.84 were held by the Company as
treasury shares.
b. Stock Compensation Plans
In August 1994, the Company adopted an Incentive Stock Option Plan ("ISO"), as
defined in section 422(A) of the Internal Revenue Code. Pursuant to the ISO, up
to 400,000 options may be granted for up to ten years with exercise prices at
the fair market value of the Common Stock at the date of the grant, subject to
adjustment as provided in the plan. As of September 30, 2003, 2002 and 2001,
118,500, 118,500 and 151,000 options were outstanding, respectively, ranging in
prices from $1.35 to $2.55.
On December 14, 1995, the Board of Directors authorized the adoption of the 1996
Non-Qualified Stock Option Plan (the "1996 Non-Qualified Plan") which was
approved by the Company's stockholders on March 5, 1996. The 1996 Non-Qualified
Plan authorizes the grant of 500,000 shares of Common Stock, subject to
adjustment as provided in the plan. The plan terminates on March 5, 2006. This
plan does not qualify for treatment as an incentive stock option plan under the
Internal Revenue Code. There are various tax benefits which could accrue to the
Company upon exercise of non-qualified stock options that may not be available
to the Company upon exercise of qualified incentive stock options. The purpose
of the plan is to provide the Company greater flexibility in rewarding key
employees, consultants, and other entities without burdening the Company's cash
resources. As of September 30, 2003, 2002 and 2001, 346,479, 235,404 and 328,804
options ranging in prices from $1.08 to $10 were outstanding under the 1996
Non-Qualified Plan.
On December 17, 1997 the Company's Board of Directors adopted and authorized a
new incentive stock option plan ("1997 ISO") pursuant to section 422A of the
Internal Revenue Code. This plan was approved by the Company's stockholders at
its March 12, 1998 annual stockholders' meeting. The 1997 ISO plan as adopted
authorizes the grant of up to 700,000 shares of Common Stock, subject to
adjustment as provided in the plan. This plan terminates on December 16, 2007.
The options terms may not exceed ten years. Options cannot be granted at less
than 100% of the market value at the time of grant. Options granted to employees
who own more than 10% of the Company's outstanding common stock cannot be
granted at less than 110% of the market value at the time of grant. As of
September 30, 2003, 2002 and 2001, 634,122, 545,822 and 603,822 options were
outstanding with exercise prices from $1.08 to $ 10.06.
F-18
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's Board of Directors on May 9, 2000 adopted the 2000 Performance and
Equity Incentive Plan (the "2000 Plan"). This plan was approved by the
stockholders at its July 18, 2000 annual stockholders' meeting. The purpose of
the 2000 Plan is to attract, retain and motivate key employees, directors and
non-employee consultants.
The 2000 Plan as adopted reserves 500,000 shares of Common Stock to be issued
pursuant to stock options grants or other awards, subject to adjustment for any
merger, reorganization, consolidation, recapitalization, stock dividend, stock
split or any other changes on corporate structure affecting the common stock.
This plan is to be administered by the Board of Directors. Grants of awards to
non-employee directors require the approval of the Board of Directors.
The 2000 plan allows the granting of options as either incentive stock options
or non-qualified options. Non-employee directors and non-employee consultants
may only be granted Non-Qualified Stock Options. Incentive stock options are
priced at the market value at the time of grant and shall be exercisable no more
than ten years after the date of the grant. Incentive stock options granted to
employees who own 10% or more of the Company's combined voting power cannot be
granted at less than 110% of the market value at the time of grant.
Non-qualified options shall be granted at a price determined by the Board of
Directors, or a committee thereof, and shall be exercisable no more than 10
years and one month after the grant. The aggregate fair market value of shares
subject to an incentive stock option granted to an optionee in any calendar year
shall not exceed $100,000.
As of September 30, 2003, 2002 and 2001, 497,000, 243,100 and 263,700 shares
have been issued from this plan ranging in prices from $1.05 to $ 5.78.
The Company's Board of Directors on May 16, 2003 adopted the 2003 Performance
and Equity Incentive Plan (the "2003 Plan"). This plan was approved by the
stockholders at its September 22, 2003 annual stockholders' meeting. The purpose
of the 2003 Plan is to provide equity ownership opportunities and performance
based incentives to attract and retain the services of key employees, Directors
and non-employee consultants of the Company and to motivate such individuals to
put forth maximum efforts on behalf of the Company.
The 2003 Plan as adopted reserves up to 500,000 shares of Common Stock to be
issued pursuant to stock options grants or other awards, subject to adjustment
for any merger, reorganization, consolidation, recapitalization, stock dividend,
stock split or any other changes on corporate structure affecting the common
stock. All of the Common Stock which may be awarded under the 2003 Plan may be
subject to delivery through Incentive Stock Option Plans. The 2003 Plan will be
administered by the Board of Directors or a Committee thereof composed of two or
more members who are non-employee Directors (the "Committee"). Grants of awards
under the 2003 Plan to non-employee Directors require the approval of the Board
of Directors.
The Board or the Committee may amend, suspend or discontinue the 2003 Plan or
any portion thereof at any time, but no amendment, suspension or discontinuation
shall be made which would impair the right of any holder without the holder's
consent. Subject to the foregoing, the Board or the Committee has the authority
to amend the 2003 Plan to take into account changes in law and tax and
accounting rules, as well as other developments. The Board or the Committee may
institute loan programs to assist participants in financing the exercise of
options through full recourse interest bearing notes not to exceed the cash
consideration plus all applicable taxes in connection with the acquisition of
shares.
F-19
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
This plan allows the granting of options as either incentive stock options or
non-qualified options. Non-employee directors and non-employee consultants may
only be granted Non-Qualified Stock Options. Incentive stock options are priced
at the market value at the time of grant and shall be exercisable no more than
ten years after the date of the grant. Incentive stock options granted to
employees who own 10% or more of the Company's combined voting power cannot be
granted at less than 110% of the market value at the time of grant.
Non-qualified options shall be granted at a price determined by the Board of
Directors and shall be exercisable no more than 10 years and one month after the
grant. The aggregate fair market value of shares subject to an incentive stock
option granted to an optionee in any calendar year shall not exceed $100,000. As
of September 30, 2003, no stock options have been granted under the 2003 Plan.
The Board or the Committee may grant options with a reload feature. A reload
feature shall only apply when the option price is paid by delivery of Common
Stock held by the optionee for at least 12 months. The agreement for options
containing the reload feature shall provide that the option holder shall
receive, contemporaneously with the payment of the option price in Common Stock,
a reload stock option to purchase the number of Common Stock equal to the number
of Common Stock used to exercise the option, and, to the extent authorized by
the Board or the Committee, the number of Common Stock used to satisfy any tax
withholding requirement incident to the underlying Stock Option. The exercise
price of the reload options shall be equal to the fair market value of the
Common Stock on the date of grant of the reload option and each reload option
shall be fully exercisable six months from the effective date of the grant of
such reload option. The term of the reload option shall be equal to the
remaining term of the option which gave rise to the reload option. No additional
reload options shall be granted to optionees when Stock Options are exercised
following the termination of the optionee's employment. Subject to the
foregoing, the terms of the 2003 Plan applicable to the option shall be equally
applicable to the reload option.
Stock Appreciation Rights may be granted in conjunction with all or part of any
stock option granted under the 2003 Plan or independent of a stock option grant.
Stock Appreciation Rights shall be subject to such terms and conditions as shall
be determined by the Board or the Committee. Upon the exercise of a Stock
Appreciation Right, a holder shall be entitled to receive an amount in cash,
Common Stock, or both, equal in value to the excess of the fair market value
over the option exercise price per Common Stock
Shares of Restricted Stock may also be issued either alone or in addition to
other amounts granted under the 2003 Plan. The Board or the Committee shall
determine the officers, key employees and non-employee consultants to whom and
the time or times at which grants of Restricted Stock will be made, the number
of shares to be awarded, the time or times within which such awards may be
subject to forfeiture and any other terms and conditions of the award.
Long term performance awards (or "Award) may be awarded either alone or in
addition to other awards granted under the 2003 Plan. The Board or the Committee
shall determine the nature, length, and starting date of the performance period
which shall generally be at least two years. The maximum award for any
individual with respect to any one year of any applicable performance period
shall be 100,000 Common Stock.
Upon a Change in Control as defined in the 2003 Plan, but only to the extent
determined by the Board or the Committee, stock options, stock appreciation
rights and Long term performance awards (the "Award") will vest, provided that
no award granted to an employee of the Company shall vest or be exercisable
unless the employee's employment is terminated within 24 months from the date of
the Change in Control, (as defined in
F-20
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the 2003 Plan) unless the employee is terminated for Cause, as defined in the
2003 Plan or if the employee resigns his employment without Good Reason, as
defined in the 2003 Plan. Otherwise, the Award shall not vest and be exercisable
upon a Change in Control, unless otherwise determined. The employee shall have
30 days from after his employment is terminated due to a Change in Control to
exercise all unexercised Awards. However, in the event of the death or
disability of the employee, all unexercised Awards must be exercised within
twelve (12) months after the death or disability of the employee.
The Company's Board of Directors on May 9, 2000 adopted the Employee Stock
Purchase Plan. This plan was approved by the stockholders at its July 18, 2000
annual stockholders' meeting. This plan is intended to provide the Company's
full-time employees an opportunity to purchase an ownership interest in the
Company through the purchase of Common Stock. The Company has reserved 100,000
Common Stock for issuance under the plan. This plan is to be administered by the
Board of Directors. Employees who have completed six months of employment and
who work more than 20 hours per week for more than five months in the year are
eligible to participate in the plan. The employee may elect to payroll
deductions up to 10% per pay period. The purchase price shall either be the
lower of 85% of the closing price on the offering commencement date or the
offering termination date. No employee will be granted an option to purchase
Common Stock if such employee would own shares or holds options to purchase
shares which would cause the employee to own more than 5% of the combined voting
power of all classes of stock. Non-employees are not eligible to participate.
This plan terminates on December 31, 2003. The maximum number of shares that may
be issued in any quarterly offering is 10,000, plus unissued shares from prior
offerings whether offered or not. At our September 6, 2002 stockholders'
meeting, our stockholders' approved an increase in shares reserved under this
plan to 180,000, and extended the plan termination date to December 31, 2004. As
of September 30, 2003 and 2002, 97,937 and 67,786 Common Stock were purchased
under this plan.
A summary of the status of the Company's fixed options plans as of September 30,
2003, 2002 and 2001 and changes during the years ending those dates is presented
below:
Weighted Weighted
Average Average
Exercise Non Exercise
ISO Price Qualified Price
--- ----- --------- -----
Balance at September 30, 2000 848,922 $3.40 641,304 $2.71
Granted 194,500 1.38 47,500 3.99
Exercised (11,000) 1.43 - -
Forfeited (13,900) 4.73 - -
--------- ---- -------- -----
Balance at September 30, 2001 1,018,522 $3.02 688,804 $2.80
Granted 123,000 1.36 - -
Exercised - - - -
Forfeited (142,100) 3.21 (273,400) 1.81
--------- ---- -------- -----
Balance at September 30, 2002 999,422 $2.79 415,404 $3.45
Granted 272,600 1.08 111,075 2.50
Exercised (3,000) 1.16 - -
Forfeited (19,400) 1.22 - 1.81
--------- ---- ------- -----
Balance at September 30, 2003 1,249,622 $2.45 526,479 $3.25
========= ===== ======= =====
Options exercisable at September 30, 2003 715,976 $2.82 421,675 $2.40
========= ===== ======== =====
F-21
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about stock options outstanding at
September 30, 2003:
Options Outstanding
Range of Weighted Average Weighted Options Exercisable Weighted
Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
------ ----------- ---------------- -------------- ------------------- --------------
$ 1.35 44,204 0.2 years $ 1.35 42,204 $ 1.35
1.50 30,000 2.4 1.50 30,000 1.50
1.58 180,000 2.3 1.58 180,000 1.58
1.47 1,600 0.6 1.47 1,600 1.47
1.87 33,200 0.2 1.87 33,200 1.87
2.07 9,000 0.5 2.07 9,000 2.07
2.54 90,000 0.2 2.54 90,000 2.55
2.32 60,000 4.3 2.32 60,000 2.32
2.25 124,500 0.2 2.25 122,500 2.25
3.87 10,000 0.3 3.87 10,000 3.87
10.00 50,000 0.8 10.00 40,000 10.00
3.94 250,322 0.5 3.94 166,322 3.94
2.82 60,000 0.2 2.82 60,000 2.82
8.75 20,000 0.7 8.75 16,000 8.75
10.06 10,000 1.3 10.06 6,000 10.06
5.25 59,400 1.8 5.25 43,740 5.25
5.78 34,600 1.8 5.78 20,760 5.78
3.99 47,500 2.1 3.99 44,166 3.99
1.38 167,100 3.3 1.38 64,324 1.38
1.05 50,000 4.6 1.05 12,500 1.05
1.81 71,000 3.0 1.81 8,500 1.81
3.05 80,000 4.7 3.05 20,000 3.05
1.08 293,675 5.0 1.08 56,835 1.08
--------- ---------
1,776,101 1,137,651
========= =========
c. Stockholders' Rights Agreements
On July 19, 2001, the Company's Board of Directors adopted a stockholder rights
plan, as set forth in the Rights Agreement, dated as of July 20, 2001 (the
"Rights Agreement") between the Company and North American Transfer Company as
Rights Agent. Pursuant to the Rights Agreement, one Right will be issued for
each share of common stock, par value $0.01 per share, of the Company ("Common
Stock") outstanding as of August 5, 2001. Each of the Rights will entitle the
registered holder to purchase from the Company one share of Common Stock at a
price of $11.00 per share, subject to adjustment. The Rights generally will not
become exercisable unless and until, among other things, any person acquires 10%
to 12% or more of the outstanding Common Stock or makes a tender offer to
acquire 10% or more of the outstanding Common Stock. The 10% threshold will not
be applicable to institutional investors who stay below a 20% ownership level
and who report their ownership on a Schedule 13G under the Securities Exchange
Act of 1934. In addition, stockholders of more than 10% of the Common Stock as a
of July 19, 2001 will be grandfathered at a their current level plus 1% unless
they later fall below the 10% threshold. The Rights are redeemable under certain
circumstances at $0.001 per Right and will expire, unless earlier redeemed or
extended, on July 19, 2011.
8. Significant Customer Information
For the years ended September 30, 2003 and 2002 the Company had no single
customer who accounted for more than 10% of net sales. As of September 30, 2003
and 2002, the Company had fourteen customers who accounted for 74% and 79% ,
respectively of the net accounts receivable.
F-22
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Related Party Transactions
The Company rents its principal office and warehouse space in Hauppauge, New
York from a real estate partnership owned by certain of the Company's principal
stockholders. The lease term expires on January 31, 2006 and includes an option
to extend for three additional years. The lease provides for rent increases of
5% per year. Rent is currently at the annual rate of $431,454 and will increase
to $453,027 annually as of February 1, 2004. On December 17, 1995 in connection
with a re-negotiation of the lease term, the Company granted options to purchase
120,000 shares to a real estate partnership partially owned by the principal
stockholder at an exercise price of $1.905 per share, which are exercisable
through the lease term. The market price of the option equaled the exercise
price at the date of the grant. The effect of imputing the fair value of the
options granted was immaterial. The options were still outstanding as of
September 30, 2003.
The Company had amounts payable to this related party for unpaid rent of
$302,128 as of September 30, 2003 and 2002.
The indebtedness partially incurred by the principal stockholder to purchase the
building is also guaranteed by the Company and totaled $745,567 at September 30,
2003.
Minimum annual lease payments to related parties and third parties are as
follows:
Year September 30,
- ------------------
2004 679,272
2005 673,673
2006 239,803
-------
Total $1,592,748
==========
Rent expense to related parties and third parties totaled approximately
$622,000, $619,000 and $623,000 for the years ended September 30, 2003, 2002 and
2001 respectively. The Company pays the real estate taxes and it is responsible
for normal building maintenance.
10. Commitments and Contingencies
a. Litigation
In the normal course of business, the Company is party to various claims and/or
litigation. Management and its legal counsel believe that the settlement of all
such claims and or/litigation, considered in the aggregate, will not have a
material adverse effect on the Company's financial position and results of
operations.
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.
F-23
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
b. Employment Contract
As of January 10, 1998, after the expiration of a prior employment agreement
with the Company, Kenneth Plotkin entered into an employment agreement (the
"1998 Employment Agreement") with the Company to serve in certain offices of the
Company. The 1998 Employment Agreement provided for a three-year term, which
term automatically renews from year to year thereafter unless otherwise
terminated by the Board of Directors or the executive. The 1998 Employment
Agreement provided for an annual base salary of $125,000 during the first year,
$150,000 during the second year, and $180,000 during the third year. For each
Annual Period (as defined in the 1998 Employment Agreement) thereafter, the 1998
Employment Agreement provides that compensation shall be as mutually determined
between the Company and the executive, but not less than that for the preceding
Annual Period. In addition, the 1998 Employment Agreement provides for a bonus
to be paid as follows: an amount equal to 2% of the Company's earnings,
excluding earnings that are not from operations and before reduction for
interest and income taxes ("EBIT"), for each fiscal year starting with the year
ended September 30, 1998, provided that the Company's EBIT for the applicable
fiscal year exceeds 120% of the prior fiscal year's EBIT, and if not, then 1% of
the Company's EBIT. The determination of EBIT shall be made in accordance with
the Company's audited filings with the Securities and Exchange Commission on its
Form 10-KSB or Form 10-K. Pursuant to the 1998 Employment Agreement, on January
21, 1998, incentive stock options to acquire a total of 90,000 Common Shares
each were granted to Mr. Plotkin, exercisable, beginning on January 21, 1999, in
increments of 33 1/3% per year at $2.544 per share. Each increment of these
options expires five (5) years after it first becomes exercisable. Also on
January 21, 1998, pursuant to the 1998 Employment Agreement, non-qualified
options to acquire a total of 60,000 Common Shares each were granted to Mr.
Plotkin, exercisable immediately for a period of ten (10) years. These options
expire as of January 20, 2008. Options granted under the 1998 Incentive Stock
Option Plan shall become immediately vested and exercisable in the event of a
Change in Control (as defined in the 1998 Incentive Stock Option Plan). The 1998
Employment Agreement further provides for disability benefits, the obligation of
the Company to pay the premiums on a term life insurance policy or policies in
the amount of $500,000 on the life of Mr. Plotkin owned by Mr. Plotkin or his
spouse, or a trust for his respective benefit or for the benefit of his family,
a car allowance of $500 per month, reasonable reimbursement for automobile
expenses, and medical insurance as is standard for executives of the Company.
The 1998 Employment Agreement further provides that the Company may apply for
and own life insurance on the life of Mr. Plotkin for the benefit of the
Company, in such amounts as the Board of Directors of the Company may from time
to time determine. As set forth in the 1998 Employment Agreement, the Company
shall pay the premiums as they become due on any such insurance policies, and
all dividends and any cash value and proceeds on such insurance policies shall
belong to the Company. In the event of a termination of employment associated
with a Change in Control of the Company (as defined in the 1998 Employment
Agreements), a one-time bonus shall be paid to the executive equal to three
times the amount of the executive's average annual compensation (including
salary, bonus and benefits, paid or accrued) received by him for the thirty-six
month period preceding the date of the Change of Control.
F-24
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of May 1, 2002, Dean Cirielli entered into an Employment Agreement with the
Company (the "Cirielli Employment Agreement"). The Cirielli Employment Agreement
provides for a two-year term, unless terminated earlier by either Mr. Cirielli
or the Company. The Cirielli Employment Agreement provides that Mr. Cirielli
shall be paid an annual salary of $175,000 for the first year of the Cirielli
Employment Agreement, with annual performance evaluations and upward adjustments
as determined by the Compensation Committee of the Board of Directors, based on
his performance. In addition, the Cirielli Employment Agreement provides that he
shall also receive a yearly bonus totaling one percent of the operating income
of the Company, provided that earnings are at least 120% of the prior fiscal
year's earnings. Pursuant to the Cirielli Employment Agreement, Mr. Cirielli was
granted an option to purchase 50,000 shares of Common Stock of the Company, on
May 1, 2002 at an exercise price of $1.81 per share (for the purposes of the
Company's 2000 Performance and Equity Incentive Plan, the fair market value of
the Company's Common Stock as May 1, 2002) was $1.81 per share. Such options are
exercisable to the extent of 12,500 shares on each of May 1, 2003, 2004, 2005
and 2006, with each installment being exercisable over a ten year period
commencing on the date of grant of the options; and that such options are not
intended to qualify as incentive stock options, as defined in section 422 of the
Internal Revenue Code, as amended. All outstanding options as of the date such
Change in Control (as defined in the Company's 2000 Performance and Equity
Incentive Plan) shall become fully exercisable and vested, unless the terms of
the award provide otherwise. Pursuant to the Cirielli Employment Agreement, the
Company and Mr. Cirielli entered into a Relocation Package Agreement providing
for, amongst other things, a relocation reimbursement of no more than $100,000.
Such relocation reimbursement shall be paid as follows:
(i) 50% of the Relocation Costs (as defined in his Relocation Package
Agreement) or $50,000 (whichever is the lower) on or before he
physically and permanently relocates to Long Island, NY, such date to
be the date of signing a definitive sale and purchase agreement to
either sell his existing residence or buy a house in the Long Island
area, NY, whichever is the earlier (the "Relocation Date"),
(ii) 25% of the Relocation Costs or $25,000 (whichever is the lower) on the
first anniversary of the Relocation Date and
(iii)25% of the Relocation Costs or $25,000 (whichever is the lower) on the
second anniversary of the Relocation Date.
c. Forward Exchange Contracts
Due to extensive sales to European customers denominated in local currencies
(primarily the Euro and Great British Pound), the Company is a net receiver of
currencies other than the U.S. dollar and as such, benefit from a weak dollar
and are adversely affected by a strong dollar relative to the major worldwide
currencies, especially the Euro and Great British Pound. Consequently, changes
in exchange rates expose the Company to market risks resulting from the
fluctuations in the foreign currency exchange rates to the U.S. dollar. The
Company attempts to reduce these risks by entering into foreign exchange forward
contracts with financial institutions to protect against currency exchange
risks.
As of September 30, 2003, the Company has foreign currency forward contracts
outstanding of $3,560,000 against delivery of the Euro. The contracts expire
through December, 2003.
F-25
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended September 30, 2003 and 2002, the Company recorded
approximately $1,395,200 and $408,000 as a decrease to net sales related to the
changes in the fair value of the Company's derivative contracts.
11. Business Acquisition
On June 1, 2000 the Company acquired certain assets of Eskape Labs Inc.
("Eskape"), a California-based company specializing in designing and
manufacturing TV and video products for Apple(R) Macintosh(R) computers. The
purchased assets expand and complement the Company's product line into the
Apple(R) Macintosh(R) market. The cash price for the acquisition, which was
accounted for under the purchase method, was approximately $900,000, including
$100,000 for direct transactions costs and a restrictive covenant totaling
$50,000. The excess of the acquisition cost over the fair value of identifiable
assets acquired totaled approximately $810,000 and was amortized on a straight
line basis over 10 years and the restrictive covenant on a straight line basis
over two years.
In connection with the acquisition the Company had recorded goodwill of
approximately $810,000. Due to changing conditions that occurred during the
second half of fiscal 2001, such as declining sales, lost market share and the
market changes caused by the introduction of a new Macintosh operating system,
the following events and circumstances indicated to the Company that its
goodwill asset has been impaired and is not likely to be recovered:
o The Eskape(TM) Labs division was not profitable during fiscal 2001 and
did not contribute, nor is to expected to contribute, any positive
cash flow stream
o The asset value was greater than the estimated future cash flows
o Eskape(TM) Labs division did not fulfill its internal sales forecast
for fiscal 2001
o At the time of the acquisition, the Company hired approximately 10 of
the EsKape(TM) Labs' employees, including three from senior
management. Only four employees remain.
o Certain Eskape(TM) Labs products have been deemed by management as
slow moving products
In recognition of the above events, the Company recognized an impairment loss
during the fourth quarter of fiscal 2001 for the entire remaining goodwill
balance of $701,919.
The Company recorded the impairment loss as a component of income (loss) from
operations for fiscal 2001.
12. Life Insurance Proceeds
On January 29, 2001 the Company's President unexpectedly passed away. Pursuant
to key man life insurance policies the Company had on its President, it
collected life insurance proceeds in the aggregate of $2 million from these
policies, $1 million of which was recorded in the quarter ended June 30, 2001,
while the other $1 million was recorded during the quarter ended September 30,
2001. The proceeds were reported on the Company's statement of operations in
"Other income (expense)" under the caption "Life insurance proceeds".
F-26
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Quarterly Information (Unaudited)
The following presents certain unaudited quarterly financial data:
(In thousands, except per share data)
Quarters ended
December 31, March 31, June 30, September 30,
2002 2003 2003 2003
---- ---- ---- ----
Net Sales $15,520 $13,919 $10,011 $11,506
Gross Profit 3,920 3,369 2,254 2,696
Operating income (loss) 721 197 (872) (604)
Net income (loss) 656 261 (855) (876)
Net income (loss) per share:
Basic and diluted $ .07 $ .03 $( 0.10) $ (.09)
======= ======= ======= =======
Quarterly Information (Unaudited)
(In thousands, except per share data)
Quarters ended
December 31, March 31, June 30, September 30,
2001 2002 2002 2002
---- ---- ---- ----
Net Sales $12,062 $10,748 $10,113 $9,872
Gross Profit 2,919 2,824 2,669 2,724
Operating income (loss) 393 165 74 (157)
Net income (loss) 284 217 26 (179)
Net income (loss) per share:
Basic and diluted $ .03 $ .02 $ 0.00 $ (.01)
======= ======= ======= ======
Since the Company sells primarily to the consumer market, it has experienced
certain revenue trends. The sales of the Company's products, which are primarily
sold through distributors and retailers, have historically been stronger during
the Company's first fiscal quarter (October to December), which due to the
holiday season, is a strong quarter for computer equipment sales. In addition,
the Company's international sales, mostly in the European market, were 68%, 73%
and 77% of sales for the years ended September 30, 2003, 2002 and 2001,
respectively. Due to this, the Company's sales for its fourth fiscal quarter
(July to September) can be potentially impacted by the reduction of activity
experienced with Europe during the July and August summer holiday period.
During the 4th quarter of the fiscal year ended September 30, 2001, the Company
recorded the following adjustments:
o Due to the decline in sales during the third and fourth quarters of
the current fiscal year, the Company deemed it necessary to increase
its reserve for obsolete and slow moving inventory. An additional
reserve of approximately $1,863,000 was recognized during the fourth
fiscal quarter of fiscal 2001 and charged to cost of sales (see Note
2)
o The Company analyzed the future realization of the deferred tax asset
during the fourth quarter of fiscal 2001 as a result of the operating
losses incurred in the third and fourth quarters of 2001, and it
concluded that under the present circumstances, it would be
appropriate for the Company to record a valuation allowance against
the deferred tax asset and reduce certain income tax liabilities. The
net result was a charge to the Company's tax provision for $1,082,000
(see Note 4)
F-27
o Due to changing conditions that occurred during the second half of
fiscal 2001, such as declining sales, lost market share and the market
changes caused by the introduction of a new Macintosh operating
system, the Company deemed it necessary to write off approximately
$701,000 of goodwill related to its June 2000 acquisition of Eskape
Labs (see Note 10)
During the 4th quarter of the fiscal year ended September 30, 2003, the Company
recorded the following adjustments:
o 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 change of $198,425.
F-28
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
Hauppauge Digital, Inc. and Subsidiaries
Hauppauge, New York
The audits referred to in our report dated December 4, 2003, relating to
the consolidated financial statements of Hauppauge Digital, Inc. and
Subsidiaries included the audits of the financial statement schedules for each
of the three years in the period ended September 30, 2003. These financial
statement schedules are the responsibility of management. Our responsibility is
to express an opinion on these schedules based on our audits.
In our opinion, such financial statement schedules presents fairly, in all
material respects, the information set forth therein.
/s/ BDO Seidman, LLP
- ----------------------------
BDO Seidman, LLP
Melville, New York
December 4, 2003
F-29
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts
- -------------------------------
Balance at Charged to Costs Charged to Other Bad Debt Balance at
Description Beginning of Year and Expenses Accounts Deductions(1) Recoveries(2) End of Year
- ----------- ----------------- ---------------- ---------------- ------------- ------------- ----------
YEAR ENDED SEPTEMBER 30, 2003
Reserve and allowances deducted from
asset accounts
Allowance for doubtful accounts $202,244 - - - - $202,244
YEAR ENDED SEPTEMBER 30, 2002
Reserve and allowances deducted from
asset accounts
Allowance for doubtful accounts $182,244 $ 20,000 - - - $202,244
YEAR ENDED SEPTEMBER 30, 2001
Reserve and allowances deducted from
asset accounts
Allowance for doubtful accounts $165,000 $ 10,000 - $77,187 $84,431 $182,244
(1) Doubtful accounts written off net of collections
(2) Recovery of accounts previously written off
F-30
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Reserve for Obsolete and Slow Moving Inventory
- ----------------------------------------------
Balance at Charged to Costs Charged to Other Balance at
Description Beginning of Year And Expenses Accounts Disposals (1) End of Year
- ----------- ----------------- ---------------- ---------------- ------------- -----------
YEAR ENDED SEPTEMBER 30, 2003
Reserve and allowances deducted from asset accounts
Reserve for obsolete and slow moving inventory $2,732,445 $ 593,442 - ($531,809) $2,794,078
YEAR ENDED SEPTEMBER 30, 2002
Reserve and allowances deducted from asset accounts
Reserve for obsolete and slow moving inventory $3,300,000 $ 386,409 - ($181,146) $2,732,445
YEAR ENDED SEPTEMBER 30, 2001
Reserve and allowances deducted from asset accounts
Reserve for obsolete and slow moving inventory $1,509,325 $1,862,786 - ($72,111) $3,300,000
(1) Obsolete inventory disposed of
F-31
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Reserve for sales returns
- -------------------------
Balance at Charged to Costs Charged to Other Balance at
Description Beginning of Year and Expenses Accounts Adjustments(1) End of Year
- ----------- ----------------- ------------ -------- -------------- -----------
YEAR ENDED SEPTEMBER 30, 2003
Sales reserve deducted from sales and
receivables account
Reserve for sales returns $2,684,940 $ - - $ - $2,684,940
YEAR ENDED SEPTEMBER 30, 2002
Sales reserve deducted from sales and
receivables account
Reserve for sales returns $2,684,940 $ - - $ - $2,684,940
YEAR ENDED SEPTEMBER 30, 2001
Sales reserve deducted from sales and
Reserve for sales returns $3,984,940 $ - - $1,300,000 $2,684,940
(1) Sales reserve adjusted per historical evaluation
F-32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HAUPPAUGE DIGITAL INC.
By:/s/ Kenneth Plotkin Date: December 22, 2003
--------------------------
KENNETH PLOTKIN
Chief Executive Officer, Chairman of the Board,
Vice President of Marketing (Principal Executive Officer)
By:/s/ Gerald Tucciarone Date: December 22, 2003
--------------------------
GERALD TUCCIARONE
Treasurer and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
By:/s/ Kenneth Plotkin Date: December 22, 2003
---------------------------
KENNETH PLOTKIN
Chief Executive Officer, Chairman of the Board,
Vice President of Marketing (Principal Executive Officer)
and Director
By:/s/ Gerald Tucciarone Date: December 22, 2003
---------------------------
GERALD TUCCIARONE
Treasurer and Chief Financial Officer
By:/s/ Seymour G. Siegel Date: December 22, 2003
---------------------------
SEYMOUR G. SIEGEL
Director
By:/s/ Steven J. Kuperschmid Date: December 22, 2003
---------------------------
STEVEN J. KUPERSCHMID
Director
By:/s/ Bernard Herman Date: December 22, 2003
---------------------------
BERNARD HERMAN
Director
By:/s/ Robert S. Nadel Date: December 22, 2003
---------------------------
ROBERT S. NADEL
Director
By:/s/ Neal Page Date: December 22, 2003
---------------------------
NEAL PAGE
Director
By:/s/ Christopher G. Payan Date: December 22, 2003
---------------------------
CHRISTOPHER G. PAYAN
Director