HAUP Hauppague Digital Inc (CE)

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

Net sales for the three months ended June 30, 2013 decreased $3,628,071 compared to the three months ended June 30, 2012 as shown in the table below.

Increased competition, tepid economic conditions in Europe and a greater sales decline in our seasonally slow third fiscal quarter had a negative impact on sales.

Gross profit

Gross profit decreased $1,165,122 for the three months ended June 30, 2013 compared to the same quarter in the prior fiscal year. The decrease in gross profit was due to:

The decrease in the gross profit percentage was due to:

The factors contributing to the gross profit percentage decrease of 2.16% for the three months ended June 30, 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 third quarter of fiscal 2013 decreased $285,195 from the prior year’s third fiscal quarter as follows:

Sales and marketing expenses decreased $246,197, driven primarily by $207,792 in lower commission and co-operative advertising expense, which declined due to lower sales, and $36,661 in lower sales office expense due to reduction in personnel.

The decrease in technical support of $1,911 was primarily due to lower personnel expenses. The decrease in general and administrative expenses of $35,242 was due mainly to lower depreciation expense and lower credit card processing fees due to the issuing of credit lines to certain customers who previously purchased product with credit cards. 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 June 30, 2013 increased slightly by $3,223 from the same quarter in the prior fiscal year. The increase was mainly due to lower compensation and compensation related expenses offset by higher product development costs. 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 three months ended June 30, 2013 and 2012 is as follows:

Deferred tax benefit for the three months ended June 30, 2013 and 2012 was primarily due to increases in net operating losses.

Summary of operations

We recorded a net loss of $1,800,398 for the three months ended June 30, 2013, which resulted in basic and diluted net loss per share of $0.18 on weighted average basic and diluted shares of 10,122,344, compared to a net loss of $1,026,983 for the three months ended June 30, 2012, which resulted in basic and diluted net loss per share of $0.10 on weighted average basic and diluted shares of 10,122,344.

Options to purchase 1,478,125 and 1,531,567 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 June 30, 2013 and 2012, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive.

Net sales for the nine months ended June 30, 2013 decreased $8,009,973 compared to the nine months ended June 30, 2012 as shown in the table below.

Increased competition, tepid economic conditions in Europe and a greater sales decline in our seasonally slow third fiscal quarter had a negative impact on sales. In addition, 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 fiscal 2012, which did not repeat in fiscal 2013.

Gross profit

Gross profit decreased $837,833 for the nine months ended June 30, 2013 compared to the same period 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 5.98% for the nine months ended June 30, 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 nine months ended June 30, 2013 decreased $681,633 from same period in the prior fiscal year as follows:

Sales and marketing expenses decreased $557,379, driven primarily by $412,461 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 $83,586 in higher compensation expenses related to the addition of sales and marketing resources.

The decrease in technical support of $23,931 was primarily due to lower personnel expenses. The decrease in general and administrative expenses of $93,162 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, lower bad debt expense and lower depreciation. 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 nine months ended June 30, 2013 decreased $118,533 from the same period in the prior fiscal year. The decrease was mainly due to lower compensation expenses of $199,112, primarily due to a change in estimate for unused severance liabilities, offset by $81,314 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 (Benefit)

Our tax provision for the nine months ended June 30, 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 $1,043,704 for the nine months ended June 30, 2013, which resulted in basic and diluted net loss per share of $0.10 on weighted average basic and diluted shares of 10,122,344, compared to a net loss of $930,231 for the nine months ended June 30, 2012, which resulted in basic and diluted net loss per share of $0.09 on weighted average basic and diluted shares of 10,122,344.

Options to purchase 1,478,125 and 1,531,567 shares of common stock, at prices from $0.74 to $7.45 and from $0.77 to $7.45, were outstanding for the nine months ended June 30, 2013 and 2012, respectively, but were not included in the computation of diluted earnings 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

The Company had cash and cash equivalents as of June 30, 2013 of $2,254,689, a decrease of $2,841,164 from September 30, 2012.

The decrease in cash was due to:

Cash used in operating activities of $2,819,615 was due to an increase in inventory of $3,618,079, a decrease in accounts payable and accrued expenses of $760,106 and an increase in prepaid expenses and other current assets of $154,464. Sources of cash came from the net loss adjusted for non cash items of $35,234 and a decrease in accounts receivable of $1,677,800. The increase in inventory was due to a change in the delivery method of product from air shipments to boat shipments and a higher seasonal decline in sales than forecasted. We believe the change in delivery method from air to ocean will save on freight costs but require an additional investment in inventory in recognition of the anticipated four to five week transit time. The decrease in accounts payable and accrued expenses was due to the timing of payment to suppliers. The decrease in accounts receivable was due to cash collections coupled with lower sales in the third fiscal quarter compared to the previous two fiscal quarters. Cash of $30,002 was used to purchase capital equipment. We had a working capital deficit of $1,873,043 as of June 30, 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 to fund our operating and working capital needs. We rely exclusively upon cash generated from our operations to fund these needs. We do not have a working capital line of credit or other borrowing facility in place to draw upon in the event that cash from our operations is insufficient to fund our capital requirements to sustain our operations. Based on our current scale of operating expenses and our new product development schedule, we have evaluated that our cash and cash equivalents as of June 30, 2013 and our internally generated cash may not provide sufficient liquidity to meet our capital needs for the next twelve months, and that additional sources of cash may be required to meet our capital needs.

We have incurred operating losses for the last five fiscal years and in the nine month period ended June 30, 2013. Those losses are primarily attributable to a continuing decline in sales. In the quarter ended June 30, 2013, we experienced an unprecedented and precipitous 46% drop in sales from the quarter ended March 31, 2013. We believe that our sales have declined for reasons which we described in Item 1A of our Annual Report on 10-K for the fiscal year ended September 30, 2012, including, among other things:

Since the fourth quarter of fiscal 2011, we have been implementing expense reduction initiatives. We switched from air to ocean freight to reduce shipping costs, outsourced most of our shipping and logistics to a third party, reduced personel, relocated certain facilities to smaller offices, renegotiated certain existing leases to reduce rent and closed certain sales offices. We believe that it may be increasingly difficult to make further material reductions in costs and maintain a viable operating plan. Additionally , absent a recovery in our business, we may be required to reduce our current expectations of future cash flows and pre-tax operating results, which, in turn, may result in charges for the impairment of our longed lived assets and/or  increase the valuation allowance against our net deferred tax assets. Such charges could be material. 

We are working to develop a strategy to address our continuing operating losses and loss of sales, and we have retained Corporate Fuel Advisors, an investment bank and advisory firm, to assist us in considering and pursuing strategic alternatives, including possible additional financing to fund our capital needs and the restructuring of our business.

We cannot assure that we will be able to develop and implement a plan that will enable us to successfully address our business and financial challenges. Among other things:

If any strategic or restructuring plan that we develop and implement is not successful, there is a substantial risk that that we might not be able to sustain our operations at current levels, which would have a material adverse effect on our business, operating results and financial condition.

Future contractual obligations

The following table shows our contractual obligations related to lease obligations as of June 30, 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.