HAUP Hauppague Digital Inc (CE)

Notes To Consolidated Financial Statements

(Unaudited)

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial statements for Hauppauge Digital Inc. and subsidiaries (collectively, the “Company”) included herein have been prepared in accordance with generally accepted accounting principles for interim period reporting in conjunction with the instructions to Form 10-Q. Accordingly, these statements do not include all of the information required by generally accepted accounting principles for annual financial statements. In the opinion of management, all known adjustments (consisting of normal recurring accruals and reserves) necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows as of and for the interim periods have been included. It is suggested that these interim statements be read in conjunction with the financial statements and related notes included in the Company's September 30, 2012 Form 10-K.

The operating results for the three months and six months ended March 31, 2013 are not necessarily indicative of the results to be expected for the fiscal year ending September 30, 2013.

Note 2. Trade Accounts and Other Non-Trade Receivables

Trade receivables consist of:

Other non trade receivables consist of:

Trade receivables and other non-trade receivables as of March 31, 2013 and September 30, 2012 consisted of:

HAUPPAUGE DIGITAL INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(Unaudited

Note 4. 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 shares of common stock outstanding for the period. Diluted net income (loss) per share reflects, in the periods in which they have a dilutive effect, the dilution which would occur upon the exercise of stock options. A reconciliation of the shares used in calculating basic and diluted net income per share is as follows:

Options to purchase 1,478,125 and 1,535,567 shares of common stock, at prices from $0.74 to $7.45 and from $0.77 to $7.45, were outstanding for the three months and six months ended March 31, 2013 and 2012, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive.

Note 5. Product segment and geographic information

The Company operates primarily in one business segment, which is the development, marketing and manufacturing of analog and digital TV receiver and video recorder products for the personal computer and Apple iPad ® and iPhone ® market. Most of the Company’s products are similar in function and share commonality of component parts and manufacturing processes. The Company’s products are either sold, or can be sold, by the same retailers and distributors in the Company’s marketing channel. The Company also sells its TV receiver products directly to PC manufacturers. The Company evaluates its product lines under the functional categories of TV receiver products, video recorder products and other non TV receiver products.

HAUPPAUGE DIGITAL INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(Unaudited)

The Company’s products fall under three product categories:

The Company’s TV receiver products enable, among other things, a PC user to watch TV in a resizable window on a PC. The Company’s video recorder products allow consumers to record high definition video from a cable TV or satellite set top box or a game console such as a Xbox 360 or Sony Playstation 3. The Company’s other non TV receiver products enable, among other things, the ability to watch and listen to PC based videos, music and pictures on a TV set through a home network.

Sales by functional category are as follows:

The Company sells its products through a North American and international network of distributors and retailers. It maintains sales offices in the United Stated, Europe and Asia. Sales percentages by geographic region are as follows:

HAUPPAUGE DIGITAL INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(Unaudited)

Note 6. Tax provision

The Company’s tax provision for the three and six months ended March 31, 2013 and 2012 is as

follows:

The deferred tax expense was primarily due to the utilization of net operating losses and the utilization of deferred timing differences related to our United States subsidiary.

Note 7. Accrued expense-fees

The Company uses various software and technologies in certain of its products.  In certain cases, the Company purchases or licenses these software and technologies from third parties. The related purchase or license agreements provide for payment of royalty and other fees associated with the Company's sale of the related products. Such fees are estimated and get accrued and reflected as a component of cost of sales when those sales occur.  In certain circumstances, such fees are not specifically covered by contractual arrangements but are nonetheless potentially due to the third party sellers or owners of the software and technologies.  The Company uses all available applicable information in determining these estimates and thus the accrued amounts are subject to change as new information is made available to the Company. Occasionally, third parties audit the Company's historical determination of fees and adjustments are made.  Accrued fees are subject to elimination after three to seven years if not billed by or requested from the third parties.

Based on new information obtained during fiscal 2013, including the completion of a significant third party audit, the Company reduced its September 30, 2012 accrued expenses - fees balance by $2,108,030. This estimate change resulted in an improved gross margin during fiscal 2013.  As of March 31, 2013 and September 30, 2012, the amount of accrued expense-fees amounted to $12,405,608 and $12,943,022, respectively.

Note 8. Accrued Expenses

Accrued expenses are for costs incurred for goods and services which are based on estimates, charged as incurred to operations as period costs and for which no invoice has been rendered. Accrued expenses as of March 31, 2013 and September 30, 2012 were $3,175,581 and $3,668,491, respectively. Included in accrued expenses are accruals for product costs, accruals for sales costs relating to sales rebate programs, accruals for freight and duty expenses, accruals for compensation, accruals for warranty repair costs and accruals for advertising and marketing costs. For the six months ended March 31, 2013, the Company, using the most recent information available, reviewed its estimates for accruals for which no invoice has been rendered. As a result of this review, the Company recorded a change in estimate of $400,697 as a reduction in operating expenses related to unused severance accruals.

HAUPPAUGE DIGITAL INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(UnAUDITED)

Note 9. Fair Value Measurements

ASC Topic 820, “Fair Value Measurements and Disclosures”, establishes a framework for measuring fair value, and expands the related disclosure requirements. The ASC indicates, among other things, that a fair value measurement assumes a transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The Company also adopted the provisions of ASC 820-10 with respect to its non-financial assets and liabilities during the first quarter of fiscal 2010. In order to increase consistency and comparability in fair value measurements, ASC 820-10 establishes a hierarchy for observable and unobservable inputs used to measure fair value into three broad Levels, which are described below:

• Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities . The fair value hierarchy gives the highest priority to Level 1 inputs.

• Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

• Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.

Additionally, on a nonrecurring basis, the Company uses fair value measures when analyzing asset impairment. Long-lived assets and certain identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization periods, their carrying values are reduced to estimated fair value. Measurements based on undiscounted cash flows are considered to be Level 3 inputs.

The carrying amount of cash, accounts receivables and accounts payables and other short-term financial instruments approximate their fair value due to their short-term nature.   

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Net sales for the three months ended March 31, 2013 decreased $885,053 compared to the three months ended March 31, 2012 as shown in the table below.

Increased competition and tepid economic conditions in Europe had a negative impact on sales for the second fiscal quarter. In addition, sales for the second quarter of fiscal 2012 included the product rollout of the MY TV 2 Go TV application for the PC, Apple iPad and iPhone product. The rollout of this product resulted in a concentration of sales in the second quarter of fiscal 2012.

Gross profit

Gross profit decreased $54,889 for the three months ended March 31, 2013 compared to the same quarter in the prior fiscal year. The decrease in gross profit was due to:

The increase in the gross profit percentage was due to:

The factors contributing to the gross profit percentage increase of 2.17% for the three months ended March 31, 2013 were primarily:

Selling, general and administrative expenses

The chart below illustrates the components of selling, general and administrative expense.

Selling, general and administrative expense for the second quarter of fiscal 2013 increased $28,523 from the prior year’s second fiscal quarter as follows:

Sales and marketing expenses increased $1,662, driven primarily by $22,846 in higher compensation expenses related to addition of personnel resources and $25,575 in higher sales office expense. The increase was offset by $48,759 in lower commission and co-operative advertising expense, which declined due to lower sales.

The decrease in technical support of $11,813 was primarily due to lower personnel expenses. The increase in general and administrative expenses of $42,309 was due primarily to higher legal fees for legal consultation required during the second quarter of fiscal 2013. The decrease in stock compensation expense was due to fewer non vested options outstanding issued at a lower fair value price.

Research and development expenses

Research and development expenses for the three months ended March 31, 2013 decreased $16,300 from the same quarter in the prior fiscal year. The decrease was mainly due to lower material consumed during the product development cycle in the second quarter of fiscal 2013. The decrease in stock compensation expense was due to lower option grants issued at a lower fair value.

Tax provision

Our tax provision for the three months ended March 31, 2013 and 2012 is as follows:

The deferred tax expense was primarily due to the utilization of net operating losses and the utilization of deferred timing differences related to our United States subsidiary.

Summary of operations

We recorded a net loss of $533,392 for the three months ended March 31, 2013, which resulted in basic and diluted net loss per share of $0.05 on weighted average basic and diluted shares of 10,122,344, compared to a net loss of $347,181 for the three months ended March 31, 2012, which resulted in basic and diluted net loss per share of $0.03 on weighted average basic and diluted shares of 10,122,344.

Options to purchase 1,478,125 and 1,535,567 shares of common stock, at prices from $0.74 to $7.45 and from $0.77 to $7.45, were outstanding for the three months ended March 31, 2013 and 2012, respectively, but were not included in the computation of diluted earnings (loss) per share because they were anti-dilutive.

Net sales for the six months ended March 31, 2013 increased $4,381,902 compared to the six months ended March 31, 2012 as shown in the table below.

Increased competition and tepid economic conditions in Europe had a negative impact on sales for the first six months of fiscal 2013. In addition, sales for the first six months of fiscal 2012 included the product rollouts of the DCR-2650 cable card, the Broadway, the HD-PVR gaming unit and the MY TV 2 Go TV application for the PC, Apple iPad and iPhone product. The rollout of these products resulted in a concentration of sales for the first six months of fiscal 2012.

Gross profit

Gross profit increased $327,289 for the six months ended March 31, 2013 compared to the same period in the prior fiscal year. The increase in gross profit was due to:

The increase in the gross profit percentage was due to:

The factors contributing to the gross profit percentage increase of 7.76% for the six months ended March 31, 2013 were primarily:

Selling, general and administrative expenses

The chart below illustrates the components of selling, general and administrative expense.

Selling, general and administrative expense for the six months ended March 31, 2013 decreased $396,440 from same period in the prior fiscal year as follows:

Sales and marketing expenses decreased $311,182, driven primarily by $202,490 in lower commission and co-operative advertising expense, which declined due to lower sales and a reduction in expenses of $213,783 for a change in estimate for unused severance liabilities. The decrease in expenses was offset somewhat by $84,438 in higher compensation expenses related to addition of sales resources.

The decrease in technical support of $22,020 was primarily due to lower personnel expenses. The decrease in general and administrative expenses of $57,921 was due primarily to decreases in rent and utilities due to the relocation of offices to smaller spaces, lower credit card processing fees due to the issuing lines of credit to certain customers who previously purchased product with credit cards and lower bad debt expense. This was offset by to higher legal fees for consultation required during fiscal 2013. The decrease in stock compensation expense was due to fewer non vested options outstanding issued at a lower fair value price.

Research and development expenses

Research and development expenses for the six months ended March 31, 2013 decreased $121,755 from the six months ended March 31, 2012. The decrease was mainly due to lower compensation expenses of $173,575, primarily due to a change in estimate for unused severance liabilities offset by $54,809 in higher product development related expenses. The decrease in stock compensation expense was due to fewer non vested options outstanding issued at a lower fair value price.

Tax provision

Our tax provision for the six months ended March 31, 2013 and 2012 is as follows:

The deferred tax expense was primarily due to the utilization of net operating losses and the utilization of deferred timing differences related to our United States subsidiary.

Summary of operations

We recorded a net income of $756,694 for the six months ended March 31, 2013, which resulted in basic and diluted net income per share of $0.07 on weighted average basic and diluted shares of 10,122,344, compared to a net income of $96,751 for the six months ended March 31, 2012, which resulted in basic and diluted net income per share of $0.01 on weighted average basic and diluted shares of 10,122,344.

Options to purchase 1,478,125 and 1,535,567 shares of common stock, at prices from $0.74 to $7.45 and from $0.77 to $7.45, were outstanding for the six months ended March 31, 2013 and 2012, respectively, but were not included in the computation of diluted earnings (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. Historically, our peak sales quarter due to holiday season sales 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 44% of sales for fiscal year ended September 30, 2012 and 41% for the fiscal year ended September 30, 2011. Part of our third and fourth quarters (April through June and July to September) can be potentially impacted by the reduction of activity experienced in Europe during the summer holiday period.

We target a wide range of customer types to attempt to moderate the seasonal nature of our retail sales.

Liquidity and capital resources

We had cash and cash equivalents as of March 31, 2013 of $3,132,059, a decrease of $1,963,794 from September 30, 2012.

The decrease in cash was due to:

 Cash used in operating activities of $1,946,677 was due to an increase in accounts receivable of $1,904,970, an increase in inventory of $1,177,010, a decrease in accounts payable and accrued expenses of $751,007 and an increase in prepaid expenses and other current assets of $62,303. The increase in accounts receivable was due to an increase in sales of approximately 20.28% between the second quarter of fiscal 2013 and the fourth quarter of fiscal 2012. The increase in inventory was due to a change in the delivery method of product from air shipments to boat shipments. We believe we will save on freight costs but need to invest more in inventory in recognition of the anticipated four week travel time on the boat. The decrease in accounts payable and accrued expenses was due to the timing of payment to suppliers. Sources of cash came from net income adjusted for non cash items of $1,948,613. Cash of $29,383 was used to purchase capital equipment. We had working capital of $19,169 as of March 31, 2013 compared to a working capital deficit of $1,433,704 as of September 30, 2012.

Our cash requirements for the next twelve months will include, among other things, the cash needed to fund our operating and working capital needs. With the proper execution of our business and operating plan, we believe that our cash and cash equivalents as of March 31, 2013 and our internally generated cash will provide us with sufficient liquidity to meet our capital needs for the next twelve months. Failure to meet the business and operating plan could require the need for additional sources of capital. In light of the current economic and credit conditions there can be no assurances that we will be able to find external sources of financing to fund our additional capital needs. In addition, if we are able to obtain financing, there can be no assurances that it will be on financially reasonable terms.

Future contractual obligations

The following table shows our contractual obligations related to lease obligations as of March 31, 2013:

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 effect on us.

Recent Accounting Pronouncements

In October 2012, the FASB issued ASU 2012-04, “Technical Corrections and Improvements.” ASU 2012-04 contains amendments to clarify the ASC, correct unintended application of guidance, or make minor improvements to the ASC that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Additionally, the amendments are intended to make the ASC easier to understand and the fair value measurement guidance easier to apply by eliminating inconsistencies and providing needed clarifications. The amendments that do not have transition guidance were effective upon issuance. The amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2012-04 is not anticipated to have a material impact on our results of operations or our financial position.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about these amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. Early adoption is permitted.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 305 of Regulation S-K “Quantitative and Qualitative Disclosures About Market Risk” is not required for Smaller Reporting Companies.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure .

As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this Quarterly Report, with the participation of our principal executive officer and principal financial officer, we evaluated the effectiveness of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of March 31, 2013.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting , identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Special note regarding forward-looking statements

This Quarterly Report on Form 10-Q contains forward-looking statements as that term is defined in the federal securities laws. The events described in forward-looking statements contained in this Quarterly Report on Form 10-Q may not occur. Generally these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, financing plans, projected or anticipated benefits from acquisitions that we may make, or projections involving anticipated revenues, earnings or other aspects of our operating results or financial position, and the outcome of any contingencies. Any statements contained herein that are not historical facts are forward-looking statements. Any such forward-looking statements are based on current expectations, estimates and projections of management. We intend for these forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements. Words such as “may,” “will,” “expect,” “believe,” “anticipate,” “project,” “plan,” “intend,” “estimate,” and “continue,” and their opposites and similar expressions are intended to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, that may influence the accuracy of the statements and the projections upon which the statements are based. Factors that could cause actual results to differ materially from those set forth or implied by any forward-looking statement include, but are not limited to, the mix of products sold and the profit margins thereon, order cancellation or a reduction in orders from customers, competitive product offerings and pricing actions, the availability and pricing of key raw materials, dependence on key members of management, successful integration of acquisitions, economic conditions in the United States and abroad, fluctuation of the value of the Euro versus the U.S. dollar, continued operating losses, our ability to obtain financing, our ability to make timely filings of the required periodic reports and other reports with the Securities and Exchange Commission, issues relating to our ability to maintain effective internal control over financial reporting and disclosure controls and procedures, our failure to maintain compliance with Nasdaq’s continued listing requirements or our failure to maintain our Nasdaq listing, as well as other risks and uncertainties discussed in our reports filed with the Securities and Exchange Commission, including, but not limited to, our Annual Report on Form 10-K for the fiscal year ended September 30, 2012, this Quarterly Report on Form 10-Q, the Quarterly Report on Form 10-Q for the three months ended December 31, 2012 , and the risk of litigation or governmental investigations or proceedings relating to any of the foregoing matters . Copies of these filings are available at www.sec.gov . Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. All cautionary statements made in this Quarterly Report on Form 10-Q should be read as being applicable to all related forward-looking statements wherever they appear.