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, 1999
------------------------------------
( ) 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
HAUPPAGE DIGITAL, INC.
(Name of small business issuer in its charter)
Delaware 11-3227864
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(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
91 Cabot Court, Hauppauge, New York 11788
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (516) 434-1600
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
Check whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15 (d) of the Exchange Act of 1934 during the past twelve (12)
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to the filing requirements for the past
ninety (90) days.
YES X NO
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Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B not contained in this form, and no disclosure will 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: [ ]
State registrant's revenues for its most recent fiscal year: $58,601,611
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of December 17, 1999 was approximately $86,248,337. Non-affiliates
include all shareholders other than officers, directors and 5% shareholders of
the Company. Market value is based upon the price of the Common Stock as of the
close of business on December 17, 1999 which was $23.50 per share as reported by
NASDAQ.
As of December 17, 1999, the number of shares outstanding of the Common Stock
was 4,349,002 shares (exclusive of treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Part III which includes Item 10 (Directors, Executive Officers, Promoters and
Control Persons; Compliance with Section 16(a) of the Exchange Act), Item 11
(Executive Compensation), Item 12 (Security Ownership of Certain Beneficial
Owners and Management), and Item 13 (Certain Relationships and Related
Transactions) will be incorporated in the Company's Proxy Statement to be filed
within 120 days of September 30, 1999 and are incorporated herein by reference.
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PART I
Special Note Regarding Forward Looking Statements
Certain statements in this Report 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 the actual results, performance or achievements of
the Company, 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 other things, the
following: the Company's ability to manage growth; the risks associated with
successfully integrating acquired businesses; the risks associated with
dependence on resellers, contract manufacturers and other third-party
relationships; the uncertainty of continued market acceptance of PC-based video
products; the Company's highly competitive industry and rapid technological
change within the Company's industry; the risks associated with development and
introduction of new products; the need to manage product transitions; the risks
associated with product defects and reliability problems; the risks associated
with single source suppliers; the uncertainty of patent and proprietary
technology protection and reliance on technology licensed from third parties;
the risks of third party claims of infringement; the Company's dependence on
retention and attraction of key employees; the risks associated with future
acquisitions; the risks associated with international licensing and operations;
general economic and business conditions; and other factors referenced in this
Report.
Item 1. BUSINESS
Hauppauge Digital Inc. (the "Company"), through its subsidiaries, develops,
manufactures, markets and sells products for the Personal Computer market which
allow PC users to watch television in a resizable window on their PC screen. The
Company's main product line, called the "WinTV(R)", is sold primarily through
computer retail stores in the United States, in Europe and in Asia.
Management believes the most common reason for using the WinTV is the
entertainment and information value derived by allowing Personal Computer users
to watch either important or otherwise interesting television shows while they
work on their PC's. For example, a stock broker can have a financial television
program in a small window on their PC screen while seeing stock quotes in
another window. An end user who likes to watch music video shows on television
can have the music video television show in one window on their PC screen, while
surfing the Internet, working on e-mail, or performing any other PC activity.
In 1999, the Company shipped its one millionth WinTV board. Management
believes that the Company's sales have grown over the last five years as a
result of personal computer users spending more time working with their PC's on
such activities as Internet surfing and e-mail writing. Management believes that
when a PC user spends time working with their PC, they do not want to miss the
important or entertaining television shows they would typically watch on a
standard television set.
In addition to allowing users to watch television on a PC, the WinTV boards
can also receive certain data that maybe transmitted along with the TV signal.
The transmission of data along with a TV signal is called "Data Broadcasting".
As the United States and Europe transition from analog television to Digital TV,
the data rates supported by Data Broadcasting are expected to increase to well
over 1 million bits per second. With such high data rates, Data Broadcasting has
the ability to create new business opportunities for both television
broadcasters and the Company.
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The United States is in a multi-year transition period from analog to
digital television. Management believes that the demand for the Company's
Digital TV products will grow as: 1) more digital TV stations come "on-line", 2)
the amount of compelling and original digital TV programming increases, and 3)
as new services which use the unique characteristics of digital TV data
broadcasts are introduced. In Europe, similar market dynamics are present,
though the standards and technical characteristics are different from the U.S.
market.
The Company markets its products through computer retailers, computer
products distributors and Original Equipment Manufacturers ("OEMs"). Computer
retailers typically stock the products on their shelves and sell them to end
users for installation in their own . Distributors typically stock and sell the
products to retail stores and value added resellers (VAR's), while OEMs
typically purchase TV and video conferencing boards to incorporate them into
multimedia PCs, which are then ultimately sold to end users.
Company Strategy
Since its entry into the PC digital video market in 1991, Hauppauge Digital
has become a leading provider by focusing on four primary strategic fronts:
innovating and diversifying its product line by developing and exploiting core
technologies; forging strategic relationships with key industry players;
expanding its worldwide sales and distribution channels; and maintaining and
improving profit margins.
Significant product lines include a wide range of analog television
receiver boards covering a 3:1 range in price across most major world television
standards; digital television receiver boards for terrestrial transmissions in
the US and satellite transmissions in Europe; external television products based
on the USB (Universal Serial Bus); video capture boards for origination and
editing of video streams for Internet and other uses; and an overall software
architecture with a human interface that unites all of the product lines.
Strategic relationships with key suppliers, OEMs, broadcasters, and
internet and e-commerce solutions providers give Hauppauge important advantages
in developing new technologies and marketing its products. Working with a
variety of other companies allows Hauppauge to leverage its investment in
research and development and minimize time to market.
Hauppauge's sales organization cultivates a variety of distribution
channels, including retail stores, distributors and other resellers, as well as
OEMs which incorporate Hauppauge's products into their own. Rapidly developing
and growing its worldwide presence gives Hauppauge an important strategic
position, allows it to benefit many times over from investments in product
development, and more firmly establishes the WinTV brand name in the global
market.
Maintaining and improving Hauppauge's profit margins involves
outsourcing production for each geographic region to subcontractors best suited
for the type and volume of work, as well as leveraging worldwide supplier
relationships to ensure being the lowest cost producer in the category.
Engineering products for low cost and high flexibility in production is another
important way that technology leadership contributes to the bottom line.
Products
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The WinTV products are designed so that a PC user can watch television in a
resizable window on a PC video monitor during normal computer use. This activity
requires operating software to control functions such as channel change, volume
adjustment, freeze frame, and channel scan. All required functions, such as
video digitizing, windowing, color space conversion and chroma keying, are
performed on the WinTV board, in the external WinTV- USB, or in the operating
software. WinTVs include audio functions so that sound can be heard while
watching TV or video. The audio can be connected to speakers or to a PC's sound
card.
In 1999, the Company furthur diversified the WinTV product line with the
introduction of several new products. Also in 1999 the Company added two
completely new product lines: external TV tuners and digital TV tuners. WinTV
products introduced in 1999 were:
- - - WinTV-USB - which brings WinTV capabilities to desktop and laptop computers
by connecting externally through a PC's USB port
- - - WinTV-DVBsat - a digital broadcast receiver for the European market
- - - WinTV-D - the first PC-based digital broadcast receiver in the U.S. market
- - - WinTV-Theater and WinTV-Theater with Wave - which brings 5-speaker Dolby
ProLogic surround audio to TV reception
- - - WinTV-Go - a very low cost WinTV, for the mass consumer market
- - - WinTV 2000 - A single, easy-to-use human interface that unites all of
Hauppauge's products, allowing the consumer to learn and use one "look and
feel" for all TV-in-a-PC needs, be they analog, digital, or for external
devices such as the WinTV-USB.
- - - Your Video on the Web - which uses the WinTV video digitizer to allow
consumers to host their video tapes on the Internet
Current production models
With the line of analog WinTV boards still generating the bulk of the
Company's revenues, the Company has, as of the end of fiscal 1999, roughly 30
different products in the marketplace, ranging from the VCB for video capture
and videoconferencing applications, to WinTV-D, the Company's new digital
television receiver board. The Company normally sells between 3 and 6 models
into each geographic market.
Internal PCI-based WinTV boards for analog TV reception:
The WinTV-pci products are single slot PCI boards which enable a user to
bring TV and broadcast data to their PC. The WinTV has a 125 channel cable
ready TV tuner with automatic channel scan and a video digitizer. The video
digitizer allows the user to capture still and motion video images to a
hard disk, creating high impact presentations, and to videoconference over
the Internet (using the supplied Microsoft NetMeeting software). In the
U.S., the WinTV can be used to receive Intel's Intercast(TM) data
broadcasts of Intercast(TM) Web pages in a window alongside the live TV
window. The WinTV can also be used to
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receive WaveTop data broadcasts. In Europe, the WinTV products can be used
to receive teletext broadcasts.
The WinTV-GO is a low cost TV receiver, which has all of the features
mentioned above. The WinTV-GO has mono audio, and retails in the United
States for $49. There are models for the U.S., European and Asian markets.
The WinTV-dbx model offers high quality dbx-TV for stereo decoding, and is
sold primarily in the U.S. In Europe, the WinTV-pci offers high quality
NICAM stereo audio.
The WinTV-Radio has all the features of the WinTV-pci stereo models, in
addition to an FM stereo radio tuner. There are models for the U.S.,
European and Asian markets.
The WinTV-Theater has all the features of the WinTV-Radio stereo models,
plus adds a built-in Dolby ProLogic Surround sound decoder. Many prime time
TV shows, as well as many sporting events, are broadcast using Dolby
ProLogic Surround sound. The WinTV-Theater can be connected to 5 speakers
so that the user can get a complete home theater experience while working
at their PC. There are WinTV- Theater models for the U.S. and European
markets.
The WinTV-Theater with Wave is a version of the WinTV-Theater which adds
the Wave Systems Embassy E-Commerce chip. This configuration allows the
WinTV-Theater to enable fee-based Wave transactions, such as the single use
purchase of games and music.
External WinTV products for analog TV reception:
The WinTV-USB brings TV-in-a-window to both desktop and laptop PC's
equipped with a USB port. WinTV-USB connects to a PC via a USB port and is
an external device, so the user does not have to open up the PC during
installation. This will increase the overall market for the Company's
products by making installation easier.
Internal WinTV boards for digital TV reception:
The WinTV-D and the WinTV-DVB are PC-based Digital TV receivers. They can
decode digital TV transmissions and format the video portion of the
transmission into a window on the PC screen. Simultaneously, the WinTV-D
and WinTV-DVB can extract data from the digital TV transmission and send
this data to an application which is running in the PC. For example, there
are Data Broadcast services in Europe which send internet web pages in a
digital TV transmission. The WinTV-DVB can extract this data and send it to
a Web browser such as Internet Explorer for display.
The ongoing transition to digital broadcast signals in the United States
will enable networks and broadcasters to package - or datacast, as it is
called -- along with a DTV signal, a range of information formats for at
speeds several times faster than cable modems. With over 100 stations
currently broadcasting a digital TV signal, and more signing on throughout
the year 2000, customers will be offered a wide range of digital content,
from television programming to datacasted music, video games and e-commerce
content. In Europe, the growth in digital television will provide similar
opportunities to mix television and data.
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ImpactVCB boards for OEM video capturing applications:
The Hauppauge Impact Video Capture Board ("ImpactVCB") is a low cost PCI
bus card for high performance access to digitized video. Designed for PC
based video conferencing and video capturing in industrial applications,
the ImpactVCB features live video in a window, still image capture and a
Microsoft Video for Windows compatible AVI motion video capture driver.
There are currently 8 different ImpactVCB models in production, each with
different video input and power configurations. Most of these models have
been developed for specific customers under OEM arrangements.
WinTV-CinemaPro board for financial workstation use:
The WinTV-CinemaPro board ("CinemaPro") was introduced in fiscal 1997. Due
to its lower manufacturing costs, the CinemaPro has essentially replaced
its predecessor, the WinTV Celebrity. The CinemaPro is a high end solution
for financial service customers as well as distribution and retail
channels. The CinemaPro is normally equipped with a cable ready tuner, and
uses a proprietary Company designed technology called "SmartLock". The
SmartLock feature allows synchronizing of the WinTV video to the VGA
display, eliminating connection problems between the VGA card and the WinTV
board.
VideoWizard-pci for desktop video editing of home video tapes:
The VideoWizard-pci digitizes full frame live video from a video camera or
VCR and stores it to the hard disk so that it can be digitally edited on a
PC. VideoWizard-pci uses Motion-JPEG compression technology which increases
performance and reduces the storage space required for digital video clips.
The compression technology allows the board to capture 60 fields per
second, resulting in more accurate frame- by-frame video editing and more
realistic video playback. The VideoWizard-pci can also play back full
screen video clips from a hard disk, which can be recorded on tape or
displayed on a video monitor.
The VideoWizard-pci was designed to be used to edit home video tapes, and
to add flair to home videos. The VideoWizard-pci is also used for corporate
marketing communication departments, training video developers, trade show
demonstration creators, video hobbyists, CD-ROM title producers and
creators of corporate product literature on CD-ROM.
The Company currently has a next generation VideoWizard-pci product under
development, for introduction in Fiscal 2000. The VideoWizard products are
aimed at the lower cost but higher quality market, with particular
attention to ease of installation.
WinTV products which are for sale to the computer retail market are
essentially the same as those which are available to the OEM market. The
differences are in the packaging and in the sophistication of the operating
software. The Company's WinTV boards are primarily sold to the retail market but
are also sold in the OEM market, the CinemaPro is typically sold to the retail
market, and VCB video capture boards are typically sold in the OEM market.
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For the international market, the Company has developed a capability for
most WinTV models called teletext decoding. This capability allows the reception
of digital data which is transmitted along with the live television signal.
Though relatively unknown in the United States, teletext is standard on most
European TV sets. Examples of teletext data transmitted by TV stations include
weather information, travel schedules, stock market data and home shopping
services. In addition to many teletext services, the Intercast data broadcast
service was introduced in Germany in 1997.
Teletext, Intercast and several newer services are all forms of data
broadcasting. The Company believes that, due to the capability of its products
to receive digital information in PC's, data broadcasting represents a key
growth opportunity.
Technology
Hauppauge has developed four generations of WinTV since first introducing
the products in 1991. The first generation of ISA-bus based WinTVs put the TV
image on the PC screen using chroma keying, requiring a dedicated "feature
connector cable" between the WinTV and the VGA board. Despite issues with screen
resolution, for the first time a PC user could watch television in a resizable
window on their PC screen. Initial customers were mostly professional PC users
who spent many hours on their PC's and found having television in a window on
their desktop useful and entertaining. For example, Management believes PC users
involved in financial markets need to be able to see stock market related TV
shows while they work on their PC's. Video clip capture and capabilities, valued
features in today's models, can also trace their origins to the first WinTV
products.
In 1993 the Company invented a technique called "smartlock", which
eliminated the need for, and the installation problems associated with, the
"feature connector cable." In 1994 the Company introduced its "WinTV- Celebrity"
generation of TV tuner boards based on this "smartlock" technology, greatly
improving customer satisfaction. The CinemaPro series of WinTV boards then used
smartlock and other techniques to further reduce the cost and improve
performance. The CinemaPro is still used in some high end WindowsNT systems.
In June of 1996, the Company introduced the WinCast/TV line (also called
the "WinTV-pci" outside of the U.S.) of TV tuner boards for PC's. These boards
were developed to eliminate the relatively expensive "smartlock" circuitry and
memory used on the WinTV-Celebrity and CinemaPro boards. The WinCast/TV used a
technique called "PCI Push" and was designed to be used in the emerging Intel
Pentium market. These Pentium based PC's had a new type of system expansion
"bus", called the PCI bus, which allowed data to be moved at a much higher rate
then the older ISA bus, which the previous WinTV generations used. The "PCI
Push" technique moves the video image 30 times per second (in Europe the image
is moved 25 times a second) over the PCI bus.
In addition to being less expensive to manufacture, the WinCast/TV 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 WinCast/TV found new uses in video
conferencing, video surveillance and internet streaming video applications.
The fourth and latest generation of WinTV boards are digital TV receivers.
The United States and Europe are in a transition period from analog television
to digital television. The Company's WinTV-D board, developed during the 1999
fiscal year but not delivered to the market until the beginning of fiscal 2000,
is the first digital TV receiver for the U.S. market which allows personal
computers to receive and display Digital TV signals, in addition to conventional
analog TV signals The software to control the Digital TV reception is based on
the Company's
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"WinTV-2000" software, which was developed during 1999.
The Company also introduced in Fiscal 1999 the WinTV-DVB board for the
European market. This board brings Digital TV to PC's, and is based on the
European Digital Video Broadcast standard.
Both the WinTV-D and the WinTV-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. The Company has
developed proprietary software which can decode and display some of these
special data broadcasts, and intends to work on standardized reception and
display software, if such broadcasts become standardized.
Research and Development
Hauppauge's development efforts are currently focused on digital television
products, externally attached television products, and new video compression
technologies. The Company is also developing more highly integrated versions of
its hardware products to further improve performance and cost points, and new
versions of its software to add features, improve ease of use, and provide
support for new operating systems. The Company is also developing additional
capabilities in the data broadcasting field, in the e-commerce area, and
exploring the application of its products to the Apple Macintosh market. The
Company's Singapore R&D team is mainly focused on external television products,
and on Asian-language adaptations of the Company's products.
The technology underlying the Company's 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 the Company's business. The Company will need to
maintain an ongoing research and development program, and the Company's success,
of which there can be no assurances, will depend in part on its 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. The Company continues to increase it
research and development expenditures. The Company expended approximately
$1,257,000, $808,000 and $560,000 for research and development expenses for the
years ended September 30, 1999, 1998 and 1997. There can be no assurance that
the Company's research and development will be successful or that the Company
will be able to foresee and respond to such 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 the Company's products or technologies
non-competitive or obsolete. See Item 7 Management's Discussion and Analysis-
Risks and Forward Looking Statements.
Product Production and Suppliers
Hauppauge designs the WinTV products and also writes the operating software
to be used in conjunction with the popular Microsoft(R) WindowsO operating
system and the WindowsNT operating system. The Company subcontracts the
manufacturing, assembly, and sometimes the packaging of the WinTV boards to
independent third parties at facilities in various countries. The Company
monitors the quality of the completed product at its facility in Hauppauge, New
York before shipping to customers to ensure the quality of its products.
The Company purchases components such as tuners from reliable manufacturers
such as Philips and Temic, and video digitizers from companies such as Conexant
and Philips. If the foregoing companies do not supply their products to the
Company, the business of the Company might be adversely affected because the
Company would
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have to find alternative suppliers of tuners and video digitizers, which may
result in additional costs and delays and therefore adversely affect the
Company's production and profitability. See Item 7 Management's Discussion and
Analysis-Risks and Forward Looking Statements.
Manufacturing is performed by a selected group of contract manufacturers.
Product design specifications are provided to insure proper assembly. Contract
manufacturing is either done on a consignment basis, in which the Company
provides all the component parts and pays an assembly charge for each board
produced, or on a turnkey basis, in which all components and labor are provided
by the contract manufacturer, and the manufacturing price the Company is charged
includes parts and assembly costs. The Company continuously monitors the quality
of its selected manufacturers. The Company has five contract manufacturers
qualified to assemble various products, three located in the United States, one
in Scotland and one in Malaysia. These contract manufacturers are presently
being utilized to handle the majority of production. If demand were to increase
dramatically, the Company believes additional production could be absorbed by
the other contract manufacturers.
In fiscal 1998, the Company began producing boards for the majority of its
European sales through a subcontractor in Scotland. The production is done on a
turnkey basis with assembly, testing and rework being handled in Scotland. The
packaging and shipping of the product to customers is also being performed at
the subcontractor's location. By shifting its European production to Scotland,
the Company anticipates savings on the production costs and shipping costs of
the boards, in addition to the elimination of duties charged on boards entering
Europe from the United States. In fiscal 1999, the Company added a subcontractor
in Malaysia, who is equipped to assemble domestic and international products.
Customers and Markets
The primary use for the WinTV is in the Consumer Market to allow PC users
to watch their favorite television shows while they work on their PC's. To reach
this consumer market, the Company has expanded its sales through computer
retailers in the U.S. and in Europe to over 3000 outlets. The Company uses both
direct sales to retailers and sales through computer products distributors to
service this market. To attract new PC users in the Consumer Market, the Company
advertises with and runs special promotions with computer retailers. The company
actively participates in trade shows to educate and train key computer retail
marketing personal. Most of the Company's sales and marketing budget is aimed at
the Consumer Market. The WinTV runs under the Microsoft Windows95 and Windows98
operating systems, which are popular operating systems in the Consumer Market.
The WinTV-D, the Companys' Digital TV receiver, incorporates the same
analog TV capabilities and sells into the same markets as described for the
WinTV above. In addition to allowing PC users to watch their favorite television
shows, both analog and digital television shows, while they work on their PC's,
the WinTV-D has the ability to output a decoded Digital TV show to a large
screen TV monitor. With this feature, and with the WinTV- D's 5-speaker Dolby
Digital Surround sound decoder, the WinTV-D can also be used in a home theater
system.
In addition to the Consumer Market, the Company has sales into the
professional stock brokerage market, where the WinTV is used to display
financial television shows in a window on a stock brokers workstation while they
continue to operate their financial applications. The WinTV also runs under
Microsoft's WindowsNT and Windows2000 operating systems, which are popular in
professional stock brokerage market. The Company sells its WinTV products to two
large financial services information providers for incorporation into their
workstations,
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and several independent financial institutions. This market segment is typically
project based.
The Company also sells products to PC OEM's, who either sell the WinTV as
an accessory to their PC's or as a standard feature on a particular model of PC.
Distribution to the Retail Market
During fiscal 1999, net sales to distributors and retailers of the Company
totaled approximately $52,398,000 or 89% of the Company's net sales
compared to approximately $33,008,000 or 85% and $19,006,000 or 74% for the
years ended September 30, 1998 and 1997. The Company has no exclusive
distributor or retailer and sells through a multitude of retailers and
distributors, no one of which accounted for more than 10% of the Company's
net sales. The Company either sells direct to retailers or utilizes
distributors, who sell to a variety of retailers and value added resellers.
Sales to Original Equipment Manufacturers ("OEMs")
The OEM business is one where a PC manufacturer incorporates the Company's
WinTV board or Impact video conferencing board into a product sold under
the OEM's label. Although no assurances can be made, the Company's OEM
business is expected to increase in the next few years. Factors which could
impact the expansion of the Company's OEM business include, among other
things, the ability to successfully negotiate and implement agreements with
original equipment manufactures. It is anticipated, but there can be no
assurances, that new FCC regulations mandating the digital broadcasting TV
signals by the year 2006 will attract consumer interest in devices, such as
the Company's WinTV(R) boards, which are equipped to receive digital TV
broadcasts.
The Company's OEM business totaled approximately $6,203,000, $ 5,749,000
and $6,607,000 for 1999, 1998 and 1997 For fiscal 1999 and 1998, the
Company sold product to a variety of OEM customers, none of which accounted
for more than 10% of total sales in 1999 and 1998. In 1997, a computer
peripheral company accounted for 11% of net sales and a company providing
news service accounted for 12% of net sales. Sales to OEM customers
accounted for approximately 11 %, 15% and 26% of the Company's net sales
for 1999, 1998 and 1997.
Video Conferencing Market
During fiscal 1997, the Company, on an OEM project basis, began selling a
video conferencing board, (the Impact VCB) to a large computer peripheral
company, who targeted the product through nationwide retail outlets. In
fiscal 1999, the company developed a new generation of ImpactVCB's,
primarily to lower cost and to increase system performance. Video
conferencing allows PC users to see and hear each other through a video
window on their computer monitor. Using Hauppauge's video conferencing
board, a modem, camera and the applicable software,. users can visually
share information with each other.
The Company believes that PC based video conferencing will be a growth
market as software products, such as White Pine's CUSEEME and Microsoft's
NetMeeting, gain in popularity.
Marketing and Sales
The Company sells both domestically and internationally through Company
sales offices in New York, California
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, Germany, the United Kingdom , France and Singapore, plus through independent
sales representative offices in Sweden, Italy, the Netherlands, Spain and
Beijing, China. For the fiscal years ended September 30, 1999, 1998 and 1997,
approximately 27%, 28% and 34% of the Company's net sales were made within the
United States, respectively, while approximately 73%, 72% and 66% were outside
the United States (predominately in Germany, the United Kingdom , France and the
Netherlands) respectively. Hauppauge Computer Works, LTD, a foreign sales
corporation, handles all sales outside of the United States.
The Company advertises its products in a number of U.S. and international
PC magazines. The Company also participates extensively in retailers' market
promotion programs, such as store circulars, promotions and end cap displays.
These in store promotional programs, magazine advertisements plus a public
relations program aimed at editors of key personal computer magazines and an
active web site on the Internet, are the principal means of getting the product
introduced to end users. The sales rate in the computer retail market is closely
related to the effectiveness of these programs, along with the technical
capabilities of the product itself. The Company also lists its products in
catalogs of various mail order companies and attends various worldwide trade
shows.
The Company currently has 8 sales persons located in Europe, two
salespersons in the Far East and 6 sales persons in the United States, located
in New York and California. The Company also has 4 manufacturer representatives
retained by it on a non-exclusive basis, who work with customers in certain
domestic geographic areas.
See Management's Discussion and Analysis- results of operations-years ended
September 30, 1999, 1998 and 1997 with reference to a discussion on the impact
seasonality has on the Company's sales.
Foreign Currency Fluctuations
Since the Company has extensive sales to European customers, the Company is
exposed to market risks resulting from the fluctuations in the foreign currency
exchange rates to the dollar. The Company attempts to reduce these risks by
utilizing foreign exchange hedging contracts. The value of the Euro and British
Pound against the dollar can affect the Company's financial results. Changes in
exchange rates may positively or negatively affect the Company's revenues (as
expressed in U.S. dollars), gross margins, operating income and retained
earnings. Where it deems prudent, the Company engages in hedging programs aimed
at limiting, in part, the impact of currency fluctuations. Primarily selling
foreign currencies through window contracts, the Company attempts to hedge its
foreign sales against currency fluctuations.
As of September 30, 1999, the Company has foreign currency forward
contracts outstanding of approximately $4.0 million for the Euro. The contracts
expire through January 2000. As of September 30, 1999, the Company had deferred
gains from foreign currency forward contracts of under $2,000.
These hedging activities provide only limited protection against currency
exchange risks. Factors that could impact the effectiveness of the Company's
programs include volatility of the currency markets and availability of hedging
instruments. The contracts the Company procures are specifically entered into to
as a hedge against existing or anticipated exposure. The Company does not enter
into contracts for speculative purposes. Although the Company maintains these
programs to reduce the impact of changes in currency exchange rates, when the
U.S. dollar sustains a strengthening position against the currencies in which
the Company sells it products, the Company's revenues can be adversely affected.
<PAGE>
Competition
The Company's business is subject to significant competition. Competition
exists from larger companies that possess substantially greater technical,
financial, sales and marketing resources than that which the Company has. The
dynamics of competition in this market involve short product life cycles,
declining selling prices, evolving industry standards and frequent new product
introductions. The Company competes in this emerging market against companies
such as ATI Technologies Inc., 3dfx Interactive Inc. Pinnacle Systems and
AVerMedia Technologies among others. The Company believes that competition from
new entrants will increase as the market for digital video in a PC expands.
There can be no assurances that the Company will not experience increased
competition in the future. Such increased competition may have a material
adverse effect on the Company's ability to successfully market its products.
However, the Company believes that through research and development, reduction
of manufacturing costs and aggressive marketing it can compete in this very
competitive market, although there can be no assurances of such.
Patents, Copyrights and Trademarks
Even though the Company independently develops its hardware and software
products, the Company's success will depend, in large part, on its ability to
innovate, obtain or license patents, protect trade secrets and operate without
infringing on the proprietary rights of others. The Company maintains copyrights
on its designs and software programs, but currently has no patent on the
WinTV(R) board and the Company believes that such technology cannot be patented.
In the course of its business, the Company may receive and has received
communications asserting that the Company's products may or in fact infringe
patents or other intellectual property rights of third parties. The Company's
policy is to investigate the factual basis and/or the frivolousness of such
communications, with the advice from legal counsel, and to negotiate licenses
where appropriate. While it may be necessary or desirable in the future to
obtain licenses relating to one or more of its products, or relating to current
or future technologies, there can be no assurance that the Company will be able
to do so on commercially reasonable terms or at all. There can be no assurance
that such communications can be settled on commercially reasonable terms or that
they will not result in protracted and costly litigation. There has been
substantial industry litigation regarding patent, trademark and other
intellectual property rights involving technology companies. In the future,
litigation may be necessary to enforce any patents issued to the Company, to
protect its trade secrets, trademarks and other intellectual property rights
owned by the Company, or to defend the Company against claimed infringement. Any
such litigation could be costly and a diversion of management's attention,
either of which could have material adverse effect on the Company's business,
financial condition and results of operations. Adverse determinations in such
litigation could result in the loss of the Company's proprietary rights, subject
the Company to significant liabilities, require the Company to seek licenses
from third parties or prevent the Company from manufacturing or selling its
products, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
On December 27, 1994, the Company's mark, "WinTV(R)", was registered with
the United States Patent and Trademark Office. The Company's "Hauppauge" name
logo is also registered.
See "Legal Proceedings" for a discussion of certain litigation.
Employees
<PAGE>
As of September 30, 1999, the Company had 94 employees worldwide, including
its executive officers, all of which are full-time. None of the Company's
employees are represented by a union, and management considers its relationship
with its employees to be excellent.
Corporate Structure
Hauppauge Digital, Inc. (the "Company") was incorporated in the state of
Delaware on August 2, 1994 and has four wholly owned subsidiaries, Hauppauge
Computer Works, Inc., which was incorporated in the state of New York on
December 14, 1982, HCW Distributing Corp., which was incorporated in the state
of New York on September 13, 1984, Hauppauge Digital Asia Pte. Ltd., which is
incorporated in Singapore and Hauppauge Digital Europe SARL, which is
incorporated in Luxembourg. Hauppauge Computer Works, Inc. is the owner of all
the outstanding shares of Hauppauge Computer Works, GmbH, a German corporation
responsible for directing European marketing efforts, Hauppauge Computer Works,
LTD, a Virgin Islands corporation responsible for handling sales outside of the
United States, Hauppauge Computer Works SARL, a French Corporation responsible
for sales and marketing efforts in France. Hauppauge Computer Works GMBH is the
owner of Hauppauge Computer Works LTD, an English corporation which directs the
Company's sales and marketing efforts in the United Kingdom. All references
herein to the Company include the Company, its wholly owned subsidiaries and
their subsidiaries, unless otherwise indicated or the context otherwise
requires.
In 1999, the Company established a new sales, warehousing, packing and R&D
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 Asia market, and to expand the Company's Research and
Development capacity.
The Company is currently restructuring and consolidating its European
operations to lower distribution and warehousing costs, and anticipated to bring
into effect a lower overall corporate tax rate. This restructuring will continue
throughout Fiscal 2000. The Company expects this restructuring to result in
higher operating margins for products sold into the European market.
The Company's executive offices are located at 91 Cabot Court, Hauppauge,
New York 11788, its telephone number at that address is (516) 434-1600 and its
internet address is http://www.hauppauge.com.
Item 2 DESCRIPTION OF PROPERTY
The Company occupies a 25,000 square foot facility at 91 Cabot Court,
Hauppauge, New York which it uses as its executive offices and for the testing,
storage, and shipping of its products. The Company considers the premises to be
suitable for all its needs. The building is owned by a partnership consisting of
Messrs. Aupperle and Plotkin and their wives and is leased to the Company under
a lease agreement expiring on January 31, 2006 with an option of the Company to
extend the lease for an additional three years. Rent is currently at the annual
rate of $354,959, and will increase to $372,707 per year on February 1, 2000.
The rent is payable in equal monthly installments and increases at a rate of 5%
per year on February 1 of each year thereafter including during the option
period. The premises are subject to two mortgages which have been guaranteed by
the Company upon which the outstanding principal amount due as of September 30,
1999 was $978,655. The Company pays the taxes and operating costs of maintaining
the premises.
The Company also occupies, in Fremont, California, approximately 1,600
square feet. This office operates
<PAGE>
as the Company's western region sales office. The lease, which expires on May
18, 2000, requires the Company to pay monthly rent of approximately $2,300 per
month, with the rent increasing 3.8 percent on May 19 1998 and May 19, 1999. On
December 1, 1999, the Company leased an additional 1,642 square feet. Monthly
rent for the combined space is approximately $ 4,900 per month. The lease on
both the locations expires on May 31, 2000. The Company is also responsible for
a portion of common area maintenance charges based on the space it occupies.
The Company, through Hauppauge Computer Works, Inc., GmbH, maintains an
office in Germany, which consists of approximately 6,000 square feet. This
facility contains a sales office, customer support area, a demonstration room
and a storage facility. The Company pays a monthly rent of approximately $3,700
per month for this facility pursuant to a rental agreement which expires on
October 31, 2006.
In fiscal 1999 the Company, through a wholly owned subsidiary, opened an
office in Singapore. The office in Singapore leases about 6,400 square feet of
office and warehouse space. The lease, which expires on November 30, 2002, calls
for a monthly rent of $ 4,700. The rent includes an allocation for common area
maintenance charges.
Item 3. LEGAL PROCEEDINGS.
In January 1998, Advanced Interactive Incorporated ("AII") contacted the
Company and attempted to induce the Company to enter into a patent license or
joint venture agreement with AII relative to certain of the Company's products.
AII alleged that such products infringe U.S. Patent No. 4, 426, 698 (the "AII
Patent"). At such time, the Company's engineering staff analyzed the AII Patent
and determined that the Company's products did not infringe any such patent.
Accordingly, the Company rejected AII's offer.
On October 6, 1998, the Company received notice that AII had commenced an
action against it and multiple other defendants in the United States District
Court for the Northern District of Illinois, alleging that the certain of the
Company's products infringe on certain patent rights allegedly owned by the
plaintiff. The complaint seeks unspecified compensatory and statutory damages
with interest. The Company denies such allegations and intends to vigorously
defend this action. On December 22, 1998, the Company filed its Answer (the
"Answer").
Among other things, pursuant to the answer, the Company denies that its
products infringe AII's patent rights and asserts certain affirmative defenses.
In addition, the Answer contains a counterclaim challenging the validity of
AII's alleged patent rights.
Notwithstanding the foregoing, because of the uncertainties of litigation,
no assurances can be given as to the outcome of the AII litigation. In the event
that the Company were not to prevail in this litigation, the Company could be
required to pay significant damages to AII and could be enjoined from further
use of such technology as it presently exists. Although a negative outcome in
the AII litigation would have a material adverse affect on the Company,
including, but not limited to, its operations and financial condition, the
Company believes that, if it is held that the Company's products infringe AII's
patent rights, the Company would attempt to design components to replace the
infringing components or would attempt to negotiate with AII to utilize its
system, although no assurances can be given that the Company would be successful
in these attempts. At the present time, the Company can not assess the possible
cost of designing and implementing a new system or obtaining rights from AII.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
<PAGE>
Not Applicable.
<PAGE>
Executive Officers of Registrant
First Elected
Offices and an Officer of
Name Age(1) Positions Held the Company
Kenneth R. Aupperle 42 President, chief 1982
operating officer and
Director
Kenneth Plotkin 48 Chairman of the board of 1982
directors, chief executive
officer, vice-president,
secretary and Director
Gerald Tucciarone 44 Chief financial officer 1995
and treasurer
John Casey 43 Vice-president - technology 1987
-------------
(1) Age as of September 30, 1999.
All of the above Executive Officers have been elected to serve until the next
annual meeting of the Board of Directors or until their respective successors
are elected and qualified.
There are no family relationships between any Executive Officers.
Except for Gerald Tucciarone, each of the Executive Officers listed above has
served the Company in the above executive capacities on a full time basis for
the past five years.
Gerald Tucciarone, prior to his employment with the Company in January, 1995,
served as a 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.
<PAGE>
PART II
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) The principal market on which the common stock of the Company (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. Quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions.
Fiscal Year Ended
September 30, 1999 High Low
- - ------------------ ---- ---
First Quarter 10 5/8 5 5/8
Second Quarter 11 1/2 7 3/4
Third Quarter 30 3/8 9 13/16
Fourth Quarter 32 1/8 21 3/8
Fiscal Year Ended
September 30, 1998 High Low
- - ------------------ ---- ---
First Quarter 6 3 15/16
Second Quarter 10 3/8 4 7/16
Third Quarter 15 9 5/8
Fourth Quarter 13 3/4 6
(b) The approximate number of holders of record of the Common Stock as of
December 9, 1999 was 263. The Company believes there are in excess of 2,000
beneficial holders of the Common Stock.
No dividends have been paid during the past two years. The Company has no
present intention of paying any cash dividends in its foreseeable future and
intends to use its net income, if any, in its operations.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data with respect to the Company's
financial position and its results of operations for each of the five years in
the period ended September 30, 1999 set forth below has been derived from the
Company's audited consolidated financial statements. The selected financial
information presented below should be read in conjunction with the Consolidated
Financial Statements and related notes thereto in item 8 and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
item 7.
<TABLE>
<CAPTION>
Years ended September 30, 1999 1998 1997 1996 1995
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
(in thousands, except for per share amounts)
Net Sales $ 58,602 $ 38,757 $ 25,613 $ 14,695 $ 11,551
Cost of sales 42,435 28,643 19,962 11,014 9,244
------ ------ ------ ------ -----
Gross Profit 16,167 10,114 5,651 3,681 2,307
Selling, General and Administrative
Expenses 10,458 7,244 4,283 3,022 3,151
Research & Development Expenses 1,256 808 560 448 269
----- --- --- --- ---
Income (loss) from operations 4,453 2,062 808 211 (1,113)
Other Income (Expense):
Interest Income 201 236 243 82 29
Other , net (61) 184 (9) 16 (439)
--- --- -- -- ----
Income (loss) before taxes on income 4,593 2,482 1,042 309 (1,523)
Income tax provision 1,602 1,027 150 30 -
Reduction in deferred tax valuation allowance (127) (503) (94) - -
---- ---- ---
Net tax provision 1,475 524 56 30 -
----- --- -- --
Net income, (loss) $ 3,118 $ 1,958 $ 986 $ 279 $ (1,523)
========== ======== ======== ============== ========
Net income, (loss) per share:
Basic $ 0.72 $ 0.44 $ 0.22 $ 0.09 $ (0.64)
Diluted $ 0.66 $ 0.42 $ 0.22 $ 0.09 $ (0.64)
Weighted average shares outstanding:
Basic 4,316 4,403 4,427 3,261 2,383
Diluted 4,740 4,677 4,435 3,261 2,383
Balance Sheet Data (at period end):
Working capital $ 12,533 $ 9,536 $ 8,689 $ 7,969 $ 1,472
Total assets 27,728 22,897 14,471 11,931 4,946
Stockholders' equity 13,322 10,037 8,966 8,174 1,675
</TABLE>
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations
Years ended September 30, 1999 and 1998
Sales for the year ended September 30, 1999 were $58,601,611 compared to
$38,757,443 for the year ended September 30, 1998, resulting in an increase of
$19,844,168 or 51%, comprised of an increase in domestic sales of 44% and an
increase in international sales of 54%. The primary forces driving the sales
growth were:
- - - The full year effect of the increase in the Company's domestic distribution
and retail channel to approximately 3,000 locations.
- - - Increased European sales due to the Company's expansion into new geographic
markets combined with increased sales to the Company's existing European
customers.
- - - Growth in sales to direct corporate customers.
Unit sales for the year ended September 30, 1999 increased 62% to
approximately 670,000 as compared to approximately 413,000 for the prior year.
Domestic sales were 27% of net sales for the current year compared to 28% for
the prior year. International sales were 73% of net sales for the current year
compared to 72% for the prior year.
Gross profit increased to $16,166,999 from $10,113,600, an increase of
$6,053,399 or 60% over the prior year. The gross profit percentage was 27.6% for
the year ended September 30, 1999 compared to 26.1% for the year ended September
30, 1998.
The increase in gross profit was primarily due to:
- - - Shifting the majority of the Company's production to subcontractors in
Scotland and Malaysia, resulting in a reduction of import duties and lower
unit manufacturing costs.
- - - A reduction in material, labor and other subcontractor production costs due
to the benefits of increased production volume, which resulted in improved
material prices and allocation of fixed production overhead spread over a
larger volume of boards.
The chart below illustrates the components of Selling, General and
Administrative expenses:
<TABLE>
<CAPTION>
Twelve months ended September 30,
----------------------------------
Dollar Costs Percentage of Sales
------------ -------------------
Increase/
1999 1998 Increase 1999 1998 (Decrease)
---- ---- ----------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Sales & Promotional $ 6,073,732 $4,603,989 $ 1,469,743 10.4% 11.9% (1.5%)
Customer Support 447,860 301,860 146,000 .8% .8% -
Product Handling 592,494 449,999 142,495 1.0% 1.2% ( .2%)
General & Admin 3,343,627 1,887,970 1,455,657 5.7% 4.9% .8%
------------- ---------- ----------- ----- ----- ------
Total $10,457,713 $7,243,818 $ 3,213,895 17.9% 18.8% ( .9%)
</TABLE>
<PAGE>
As a percentage of sales, Selling, General and Administrative expenses for the
year ended September 30, 1999 declined by .9% when compared to the prior year.
Sales and Promotional expenses and Product Handling expenses declined 1.5% and
.2% respectively. General and Administrative expenses increased by .8%.
Represented in dollars, Selling General and Administrative expenses increased
$3,213,895 compared to the prior year.
The increase in Sales and Promotional expenses of $1,469,743 was primarily due
to:
- - - Increase in marketing and promotional programs to support product
visibility at a greater number of retail locations.
- - - Higher commissions resulting from the 51% net sales increase.
- - - The opening of sales offices in the United Kingdom and France
- - - Additional marketing personnel required to handle expanded market locations.
Customer Support and Product Handling expenses increased $146,000 and
$142,495 respectively. Customer Support costs increased due to the additional
staff required to maintain a high level of customer service to support the
Company's expanding domestic and international customer base. Increased Product
Handling costs was a function of greater shipment volume to customers.
The increase in General and Administrative costs of $1,455,657 was primarily due
to:
- - - Contractual wage increases for senior executives.
- - - Retaining professional services for public relations and investment banking
advice.
- - - Fees for legal and accounting services, primarily for tax consultation,
patent issues and acquisition advice.
- - - Larger incentive bonus accruals based on increased profitability.
- - - Increased bad debt expense, due primarily to a
customer filing for bankruptcy
Research and Development expenses increased $448,448 or approximately 56%. The
increase was due to the initiation and completion of several projects in fiscal
1999 which led to the introduction of several new products in the USB and
digital video areas.
The Company had net other income for the twelve months ended September 30,
1999 of $139,878 compared to net other income for the prior year of $420,796.
The decrease in net other income was primarily due to lower returns on monies
invested throughout the year and foreign currency exchange losses due to the
decline of the Euro.
Provision for income taxes was $1,475,000, or an effective tax rate of 32%
for the year ended September 30, 1999 compared to $523,937 or an effective tax
rate of 21% for the year ended September 30, 1998. The net effective rate for
fiscal 1999 and 1998 was reduced by a reduction in the deferred tax valuation
allowance of $127,000 and $503,131, recorded during the fourth quarters of
fiscal 1999 and 1998, respectively. The reduction lowered the effective rate tax
rate from 35% to 32% in fiscal 1999 and 41% to 21% in fiscal 1998, respectively.
The reduction in the effective tax rate, before the reduction of the
deferred tax valuation allowance, for 1999 to 35% from 41% for 1998, was due to
the tax benefits derived primarily from the allocation of income to a foreign
sales corporation.
As a result of the above, the Company recorded net income after taxes for
the year ended September 30, 1999 of $3,117,628, or an increase of 59%, when
compared to $1,958,553 for the year ended September 30, 1998.
<PAGE>
Earnings per share, on a basic and diluted basis were, $0.72 and $0.66,
respectively, for 1999, on weighted average basic and diluted shares outstanding
of 4,316,216 and 4,739,874, respectively. Earnings per share, on a basic and
diluted basis for 1998 were $0.44 and $0.42, respectively for 1998 on weighed
average basic and diluted shares outstanding of 4,403,357 and 4,676,747,
respectively.
Results of Operations
Years ended September 30, 1998 and 1997
Sales for the year ended September 30, 1998 were $38,757,443 compared to
$25,613,252 for the prior fiscal year, resulting in an increase of $13,144,191
or 51%. The increase in sales was primarily due to the expansion of the
Company's domestic distribution and retail channels from approximately 300
retail locations carrying the Company's product to approximately 3,000 retail
locations, promotions and increases in inventory at the retail level leading up
to the launch of Windows98, continued sales growth in Europe due to expanding
sales from existing customers plus expansion to new geographic markets in
Europe, plus strong sales to direct corporate customers.
Unit sales for the year ended September 30, 1998 increased 47% to
approximately 413,000 as compared to approximately 281,000 for the prior year.
Sales to domestic customers were 28% of net sales for the current year compared
to 34% for the prior year. Sales to international customers were 72% of net
sales for the current year compared to 66% for the prior year.
Gross profit increased to $10,113,600 from $5,651,217, an increase of
$4,462,383 or 79% over the prior fiscal year. The gross profit percentage was
26.1% for the year ended September, 1998 compared to 22.1% for the prior year.
The increase in gross profit was primarily due to the absorption of
manufacturing overhead over a greater number of units, a program of hedging
foreign sales currency exposure, primarily for German Marks and British
Sterling, which has stabilized the effect of foreign currency fluctuations, and
the shifting of production for most of the Company's European sales to a
subcontractor in Scotland, which resulted in lower unit production costs, the
elimination of duty on completed boards and reduced shipping costs.
The chart below illustrates the components of selling, general and
administrative expenses:
<TABLE>
<CAPTION>
Dollars Costs Percentage of Sales
1998 1997 Increase 1998 1997 Increase/
---- ---- -------- ---- ---- (Decrease)
<S> <C> <C> <C> <C> <C>
Sales & Promotional $4,603,989 $2,082,782 $2,521,207 11.9% 8.1% 3.8%
Customer Support 301,860 232,740 69,120 .8% .9% ( .1%)
Product Handling 449,999 311,961 138,038 1.2% 1.2% -
General & Admin 1,887,970 1,655,847 232,123 4.9% 6.5% (1.6%)
----------- ---------- ----------- ----- -------- ----------
Total $7,243,818 $4,283,330 $2,960,488 18.8% 16.7% 2.1%
</TABLE>
Although Customer Support and General and Administrative expenses as a
percentage of sales declined in total by 1.7 percent compared to last year,
Sales and Promotional expense as a percentage of sales increased 3.8 percent
compared to the prior year, resulting in an overall increase in Selling, General
and Administrative expenses as a percentage of sales of 2.1 percent. Represented
in dollars, Selling General and Administrative expenses increased $2,960,488
over fiscal 1997. The largest component of this increase was Sales and
Promotional expenses whose increase of $2,521,207 over the prior year represents
about 85% of the total increase. The increase in sales and promotional expenses
was primarily due to the Company allocating approximately $1 million of
additional marketing funds to participate, as a Microsoft Windows98 launch
partner, in the marketing, promotional and media campaign associated with the
introduction of Windows98. In addition, the Company during fiscal 1998 embarked
on a commitment to increase its domestic market presence. To achieve this goal,
the Company has increased its outside sales staff, paid higher commissions
resulting from the 51% net sales increase, and incurred higher marketing and
promotional costs in support of increased distribution and retail locations. As
a result of this program, the number of retail stores carrying the Company's
products increased from approximately 300 retail locations at the start of the
year to approximately 3,000 as of September 30, 1998.
<PAGE>
Customer Support, Product Handling, and General and Administrative
expenses, which represents about 15% of the increase over the prior year,
increased $69,120, $138,038 and $232,123 respectively. Additional staff required
to consistently maintain a high level of customer support in light of the
Company's expanding customer base caused the Customer Support costs to increase.
Increased Product Handling costs was a function of greater shipment volume to
customers. The increase in General and Administrative costs was mainly for
contractual wage increases, higher rent, utilities and building costs for the
Company's sales office in California, which opened in June 1997, higher
communication costs due to increased voice and data traffic, and approximately
$60,000 in listing fees related to the Company's move to the NASDAQ National
Market from the NASDAQ Small Cap Market.
Research and development expenses increased $247,721 or approximately 44%.
The increase was due to the strategic addition of personnel which is in line
with the Company's commitment to expand its engineering research and development
resources to continually enhance current products and further develop future
product lines.
The Company had net other income of $420,796 compared to net other income
for the prior fiscal year of $234,291. The increase in net other income was
primarily foreign currency exchange rate gains as a result of favorable foreign
rates.
Provision for income taxes was $523,937, or an effective tax rate of 21% in
fiscal 1998 compared to $56,003 or an effective tax rate of 5% for fiscal 1997.
The 16% increase in the effective tax rate is due primarily to the utilization
of all the remaining unrestricted net operating loss carry forwards in fiscal
1997 and the tax benefit realized in the fourth quarter of fiscal 1997 for the
disposal of approximately $400,000 of obsolete inventory.
During the fiscal years prior to 1997, the Company, due to unpredictable
sales, new product introduction, rapid product change and the limited track
record of profitability, had recorded full valuation allowances against deferred
tax assets. At September 30, 1997, the company had $513,798 in deferred tax
assets offset by a valuation allowance of $419,798, resulting in a net deferred
tax asset of $94,000. At the end of fiscal 1998, in recognition of the continued
profitability of the Company, the ability to carry back deferred tax benefits to
offset prior year taxable income and projected profitability, the Company
decided to not only substantially reduce the existing valuation, but to forego
recording a valuation on deferred tax assets recorded in fiscal 1998. In
recognition of this, the Company reduced the valuation allowance by $292,798
during the fourth quarter. Also in the fourth quarter, the Company recognized a
net addition to deferred tax assets of $210,333. The reduction of the valuation
allowance and the increase in 1998 deferred tax assets without any corresponding
valuation allowance resulted in a reduction in the tax provision of $503,131. As
of September 30, 1998, the company had deferred tax assets of $ 724,131 offset
by a valuation allowance of $127,000, resulting in a net deferred tax asset of
$597,131.
<PAGE>
As a result of the above, the Company recorded net income after taxes for
the year ended September 30, 1998 of $1,958,553, which resulted in basic and
diluted earnings per share of $0.44 and $0.42 respectively, on weighed average
basic and diluted shares outstanding of 4,403,357 and 4,676,747, respectively,
compared to net income after taxes of $985,808 for the year ended September 30,
1997, which resulted in basic and diluted earnings per share of $0.22 on
weighted average basic and diluted shares of 4,427,440 and 4,434,598,
respectively.
Since the Company sells primarily to the consumer market, the Company has
experienced certain revenue trends. The sales of the Company's products, which
are primarily sold through distributors and retailers, has historically recorded
stronger sales results 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 73%, 72 % and 66% of sales for the years ended September
30, 1999, 1998 and 1997, 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.
To offset the above cycles, the Company continues to target a wide a range
of customer types in order to moderate the seasonality of retail sales.
Liquidity and Capital Resources
The Company's cash, working capital and stockholders' equity position is
disclosed below:
As of September 30,
1999 1998 1997
---- ---- ----
Cash $ 6,122,922 $ 6,281,852 $ 5,602,412
Working Capital 12,533,310 9,536,450 8,689,914
Stockholders' Equity 13,322,091 10,036,898 8,966,772
The significant items of cash provided by and cash (consumed ) for the fiscal
year ended September 30, 1999 are detailed below:
<TABLE>
<CAPTION>
<S> <C>
Net income (adjusted for non cash items), excluding deferred tax benefits $ 3,349,994
Changes to deferred tax assets 120,057
Increase in investment for current assets ( 4,855,784)
Operations funded by current liabilities-net 1,544,937
Purchase of Property, Plant & Equipment ( 431,288)
Other 113,154
--------------
Net Cash Consumed ( 158,930)
</TABLE>
Net cash of $ 159,204 provided by operating activities was primarily due to
cash generated from net income (adjusted for non cash items) of $3,349,994, a
net decrease in deferred tax assets of $ 120,057 and operations funded by the
increase in current liabilities of $1,544,937, offset partially by cash invested
in current assets of $4,855,784.
Cash of $431,288 was used to purchase fixed assets. The exercise of
employee options provided additional cash of $192,691. The purchase of treasury
shares consumed $63,525 in additional cash.
<PAGE>
The Company's asset based credit facility expired on February 28, 1998. The
Company has chosen not to renew the loan facility. The Company feels it is in a
position to obtain new financing at more competitive rates, and is currently
negotiating with new institutions to replace the expired loan facility.
On November 8, 1996, the Company approved a stock repurchase program for
the repurchase of up to 300,000 shares of its own stock. The Company will use
the repurchased shares for certain employee benefit programs. On December 17,
1997, the stock repurchase program was extended by a resolution of the Board of
Directors. Through September 30, 1999, the Company had repurchased 214,300
shares for $1,267,129 at an average purchase price of approximately $5.91 per
share.
The Company believes that its current cash position and its internally
generated cash flow will be sufficient to satisfy the Company's anticipated
operating needs for at least the ensuing twelve months.
Inflation
While inflation has not had a material effect on the Company's operations
in the past, there can be no assurance that the Company will be able to continue
to offset the effects of inflation on the costs of its products or services
through price increases to its customers without experiencing a reduction in the
demand for its products; or that inflation will not have an overall effect on
the computer equipment market that would have a material affect on the Company.
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.
Effective January 1, 1999, the Company began invoicing its customers,
located in the eleven member countries, in Euros. The benefits to the Company
were twofold:
- - - The Company's foreign currency hedging program was streamlined to two
currencies, the Euro and the British Pound.
- - - The pricing from country to country was harmonized, eliminating price
differences between countries due to the fluctuating local currencies.
The conversion to the Euro was handled by the Company without any material
disruptions to the Company's operations.
Effect of New Accounting Pronouncements
Investment Derivatives and Hedging Activities Income
<PAGE>
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
("SFAS 133"), Accounting for Derivative Investments and Hedging Activities
Income. SFAS 133 is effective for transactions entered into after June 15, 2000.
SFAS 133 requires that all derivative instruments be recorded on the balance
sheet at fair value. Changes in the fair value of the derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designed as part of the hedge transaction and the type
of hedge transaction. The ineffective portion of all hedges will be recognized
in earnings. The Company is in the process of determining the impact that the
adoption of SFAS 133 will have on its results of operations and financial
position.
Year 2000
Many computer systems were not designed to handle dates beyond the year
1999. The Company evaluated the effect of Year 2000 issues relating to its
internal computer systems and has concluded that its system was not Year 2000
compliant. In recognition of this, the Company purchased and installed new
software and upgraded its computer hardware during fiscal 1999. Testing was
performed in house by Company personnel, with assistance from an outside
consultant. The hardware upgrades and the implementation of new software began
in January 1999. The new system was fully operational on October 1, 1999. The
cost to the Company to become Year 2000 compliant was approximately $150,000,
which was funded through internally generated cash flow, capitalized to fixed
assets and will be amortized over a period as prescribed by generally accepted
accounting principles.
The Company has been advised by its vendor that the Company's phone system,
installed during fiscal 1998, is Year 2000 compliant. The Company's facility
security system was upgraded during fiscal 1999 and the Company has been advised
by its vendor that such system is Year 2000 compliant.
During fiscal 1999, the company sent Year 2000 questionnaires to third
parties the Company does business with in order to identify, if possible, the
status of the third parties' Year 2000 readiness. The Company received a
majority of responses back by the close of the 1999 fiscal year. Although the
responses showed that these third parties were either Year 2000 compliant or
working to resolve their Year 2000 compliance issues, the Company has limited or
no control over the actions taken by these third parties. Accordingly, there can
be no assurance that all the third parties the Company does business with will
successfully resolve all of their Year 2000 issues. The failure of these third
parties to resolve their Year 2000 issues could have a potentially adverse
affect on the Company. The Company continues to monitor the readiness of third
parties we currently due business with and look to procure new third parties who
are year 2000 compliant in an effort minimize the risk to the Company.
The Company has a contingency plan to respond to the possible effects the
Year 2000 problem has on third parties that are important to the Company's
operations. The Company has communicated with its critical suppliers, vendors,
customers, utilities, financial institutions and telecommunication providers
with whom it does significant business to identify any Year 2000 issues. The
Company will continue to communicate with and review the progress of these third
party enterprises in resolving their Year 2000 issues. The ability to accurately
assess the Company's third parties' readiness is dependent in large part upon
the reliability and completeness of their representations.
Risk Factors
From time to time, information provided by the company, statements made by
its employees or information provided in its Securities and Exchange Commission
filings, including information contained in this Form 10-K, may contain forward
looking information.
<PAGE>
The Company's 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 its digital video processing chips, non-availability of management,
government regulation, currency fluctuations and the inability of the Company to
profitably sell its products. The market price of the Company's common stock may
be volatile at times in response to fluctuation in the Company's 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 factors external to the Company.
Item 7A. Market Risks
Since the Company has extensive sales to European customers, the Company is
exposed to market risks resulting from the fluctuations in the foreign currency
exchange rates to the dollar. The Company attempts to reduce these risks by
utilizing foreign exchange hedging contracts.
The value of the Euro and British Pound against the dollar can affect the
Company's financial results. Changes in exchange rates may positively or
negatively affect the Company's revenues (as expressed in U.S. dollars), gross
margins, operating income and retained earnings. Where it deems prudent, the
Company engages in hedging programs aimed at limiting, in part, the impact of
currency fluctuations. Primarily selling foreign currencies through window
contracts, the Company attempts to hedge its foreign sales against currency
fluctuations.
As of September 30, 1999, the Company has foreign currency forward
contracts outstanding of approximately $4.0 million for the Euro. The contracts
expire through January 2000. As of September 30, 1999, the Company had deferred
gains from foreign currency forward contracts of under $2,000.
These hedging activities provide only limited protection against currency
exchange risks. Factors that could impact the effectiveness of the Company's
programs include volatility of the currency markets and availability of hedging
instruments. The contracts the Company procures are specifically entered into to
as a hedge against existing or anticipated exposure. The Company does not enter
into contracts for speculative purposes. Although the Company maintains these
programs to reduce the impact of changes in currency exchange rates, when the
U.S. dollar sustains a strengthening position against the currencies in which
the Company sells it products, the Company's revenues can be adversely affected.
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
Not applicable
<PAGE>
PART III
Item 10 (Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act), Item 11 (Executive
Compensation), Item 12 (Security Ownership of Certain Beneficial Owners and
Management), and Item 13 (Certain Relationships and Related Transactions) will
be incorporated in the Company's Proxy Statement to be filed within 120 days of
September 30, 1999 and are incorporated herein by reference.
<PAGE>
PART IV
Item 14. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit
Number
1.1 Form of Underwriting Agreement with Lew Lieberbaum & Co., Inc.
3.1 Certificate of Incorporation, as amended to date (1)
3.2 By-laws, as amended to date (1) (3)
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)
4.4 1998 Incentive Stock Option Plan (5)
10.1 Form of Employment Agreement with Kenneth R. Aupperle
10.2 Form of Employment Agreement with Kenneth Plotkin
10.3 Lease dated February 7, 1990 between Ladokk Realty Company and
Hauppauge Computer Works, Inc.(1)
10.3.1 Modification made February 1, 1996 to lease dated 1990 between
LADOKK Realty and Hauppauge Computer Works, Inc. (2)
10.8 Long Island Development Corporation ("LIDC") Mortgage Loan
Agreements (1)
10.9 The Company's Guaranty of LIDC Loan Agreements (1)
10.10 Shawmut Mortgage Loan Agreements (1)
10.11 The Company's Guaranty of the Shawmut Mortgage Loan Agreements (1)
10.12 Master Purchase Agreement between Reuters Ltd. and Hauppauge
Computer Works Inc. (1)
10.13 Credit Agreement between MTB Bank and Hauppauge Computer Works,
Inc. dated March 28, 1996 (1)
22 Subsidiaries of the Company
23 Consent of BDO Seidman LLP
(1) Denotes document filed as an exhibit to the Company's 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 10-KSB for
September 30, 1996 and incorporated herein by reference.
(3) With respect to Article X of the By-Laws, denotes document filed as an
exhibit to the company's Form 10-KSB for September 30, 1997 and incorporated
herein by reference.
(4) Denotes document filed as an Exhibit to the company's definitive Proxy
Statement pursuant to Section 14 (a) of the Securities Exchange Act of 1934, as
filed on January 27, 1998, and incorporated herein by reference.
(5) Denotes document filed as an Exhibit to the Company's definitive Proxy
Statement pursuant to Section 14 (a) of the Securities Exchange Act of 1934,
as filed on January 27, 1998 and incorporated herein by reference.
(b) Reports on form 8K
No report on form 8K was filed by the company during the fourth
quarter of the fiscal year ended September 30, 1999.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
endorsed.
HAUPPAUGE DIGITAL INC.
By:/s/ Kenneth Plotkin Date: 12/29/99
------------------------------ --------
KENNETH PLOTKIN
Chief Executive Officer, Vice-
President, and Secretary
By:/s/ Gerald Tucciarone Date: 12/29/99
------------------------------ --------
GERALD TUCCIARONE
Treasurer and Chief Financial Officer
Pursuant to the requirements of the Exchange Act, this report has been
signed below by the following persons on behalf of the Company and in the
capacities and as of the date indicated.
By:/s/ Kenneth R. Aupperle Date: 12/29/99
----------------------------- --------
KENNETH R. AUPPERLE
Director
By:/s/ Kenneth Plotkin Date: 12/29/99
----------------------------- --------
KENNETH PLOTKIN
Director
By:/s/ Steven J. Kuperschmid Date: 12/29/99
---------------------------- --------
STEVEN J. KUPERSCHMID
Director
By:/s/ Bernard Herman Date: 12/29/99
----------------------------- --------
BERNARD HERMAN
Director
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page(s)
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets as of September 30,
1999 and 1998 F-3
Consolidated Statements of Income for the
years ended September 30, 1999, 1998 and 1997 F-4
Consolidated Statements of Stockholders' Equity
for the years ended September 30, 1999, 1998 and 1997 F-5
Consolidated Statements of Cash Flows for the years
ended September 30, 1999, 1998 and 1997 F-6
Notes to Consolidated Financial Statements F-7 - F-18
Report of Independent Certified Public Accountants F-19
Schedule II-Valuation and Qualifying Accounts F-20
F-1
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Shareholders 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, 1999 and 1998 and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years ended September 30, 1999. 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 generally accepted auditing
standards. 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, 1999 and 1998 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1999 in conformity with generally accepted accounting principles.
/s/ BDO Seidman, LLP
- - ----------------------------
BDO Seidman, LLP
Melville, New York
December 10, 1999
F-2
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30,
ASSETS 1999 1998
---- ----
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 6,122,922 $ 6,281,852
Accounts receivable, net of allowance for doubtful
accounts of $135,000 and $100,000 6,973,452 6,497,163
Inventories 12,957,439 8,552,097
Prepaid expenses and other current assets 407,916 468,763
Deferred tax assets 477,074 597,131
-------- -------
Total current assets 26,938,803 22,397,006
Property, plant and equipment, net 718,562 443,610
Security deposits and other non current assets 70,219 56,838
------ -------
$27,727,584 $22,897,454
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY :
Current Liabilities:
Accounts payable $11,208,777 $ 9,497,003
Accrued expenses 2,698,161 2,342,380
Income taxes payable 498,555 1,021,173
------- ---------
Total current liabilities 14,405,493 12,860,556
---------- ----------
Commitments and Contingencies (Notes 5, 8 and 9)
Stockholders' Equity
Common stock $.01 par value; 10,000,000 shares authorized, 4,560,302
and 4,501,402 issued, respectively 45,603 45,014
Additional paid-in capital 10,696,208 10,465,707
Retained earnings 3,847,409 729,781
Treasury stock, at cost, 214,300 and 207,200 shares, respectively (1,267,129) (1,203,604)
----------- -----------
Total stockholders' equity 13,322,091 10,036,898
----------- -----------
$27,727,584 $22,897,454
========== ============
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE>
HAUPPAUGE DIGITAL, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years ended September 30,
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Net sales $58,601,611 $38,757,443 $25,613,252
Cost of sales 42,434,612 28,643,843 19,962,035
---------- ---------- ----------
Gross profit 16,166,999 10,113,600 5,651,217
Selling , general and administrative expenses 10,457,713 7,243,818 4,283,330
Research & development expenses 1,256,536 808,088 560,367
--------- ------- -------
Income from operations 4,452,750 2,061,694 807,520
Other income (expense):
Interest income 201,392 236,441 243,235
Other, net (61,514) 184,355 (8,944)
------- ------- ------
Income before taxes on income 4,592,628 2,482,490 1,041,811
Taxes on income 1,475,000 523,937 56,003
--------- ------- ------
Net income $3,117,628 $1,958,553 $ 985,808
========== ========== ===========
Net income per share-basic $ 0.72 $ 0.44 $ 0.22
========== ========== ===========
Net income per share-diluted $ 0.66 $ 0.42 $ 0.22
========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
Common Stock
------------ Retained
Additional Earnings
Number Paid-In (Accumulated Treasury
Of shares Amount Capital Deficit) Stock Total
----------- -------- ---------- ------------ ------------- -------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT OCTOBER 1, 1996 4,465,302 $44,653 $10,344,844 ($2,214,580) $ - $8,174,917
Net income 985,808 - 985,808
Purchase of treasury stock - - - (193,953) (193,953)
----------- ---------- ---------- -------------- ------------- ----------
BALANCE AT SEPTEMBER 30, 1997 4,465,302 $44,653 $10,344,844 ($1,228,772) $(193,953) $ 8,966,772
Net income 1,958,553 1,958,553
Purchase of treasury stock (1,009,651) (1,009,651)
Exercise of stock options 29,600 296 91,272 91,568
Stock issued to pay bonuses 6,500 65 29,591 29,656
----------- --------- ---------- -------------- -------------- ----------
BALANCE AT SEPTEMBER 30, 1998 4,501,402 $ 45,014 $10,465,707 $ 729,781 $(1,203,604) $10,036,898
Net income 3,117,628 3,117,628
Purchase of treasury stock (63,525) (63,525)
Exercise of stock options 58,600 586 192,105 192,691
Compensation in options for consulting services - - 36,000 36,000
Stock issued to pay bonuses 300 3 2,396 2,399
---------- ----------- ---------- ----------- ----------- ------------
BALANCE AT SEPTEMBER 30, 1999 4,560,302 $ 45,603 $ 10,696,208 $ 3,847,409 $(1,267,129) $ 13,322,091
========== ========= ============= =========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended September 30,
1999 1998 1997
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 3,117,628 $ 1,958,553 $ 985,808
------------ ------------ ----------
Adjustments to reconcile net income to net cash
provided by (used in) operating
activities:
Depreciation and amortization 158,967 88,138 50,783
Provision for doubtful accounts 35,000 50,000 24,367
Compensation paid in stock and options 38,399 29,656 -
Deferred income taxes 120,057 (503,131) (94,000)
Changes in current assets and liabilities:
Accounts receivable (511,289) (3,353,030) (1,382,610)
Inventories (4,405,342) (3,707,731) (1,705,405)
Prepaid expenses and other current assets 60,847 (9,223) (268,379)
Accounts payable 1,711,774 5,093,216 1,584,954
Accrued expenses (166,837) 2,262,808 163,894
-------- --------- -------
(2,958,424) (49,297) (1,626,396)
----------- ------- ----------
Net cash provided by (used in) operating activities 159,204 1,909,256 (640,588)
Cash flows from investing activities:
Purchases of property, plant and equipment (431,288) (311,733) (120,002)
Security deposits and other (16,012) - (2,220)
------- -------- ------
Net cash used in investing activities (447,300) (311,733) (122,222)
Cash flows from financing activities:
Purchase of treasury stock ( 63,525) (1,009,651) (193,953)
Proceeds from the exercise of stock options 192,691 91,568 -
------- ------ -------
Net cash provided by (used in) financing activities 129,166 (918,083) (193,953)
------- -------- --------
Net (decrease) increase in cash and cash equivalents (158,930) 679,440 (956,763)
Cash and cash equivalents, beginning of period 6,281,852 5,602,412 6,559,175
--------- --------- ---------
Cash and cash equivalents, end of period $ 6,122,922 $ 6,281,852 $5,602,412
============ =========== ==========
Cash and Cash Equivalents, end of period
Supplemental disclosure:
Income taxes paid $ 1,971,561 $ 148,522 $ 66,895
============ =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE>
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., Hauppauge Digital Asia, PTE, and Hauppauge Digital SARL,
as well as Hauppauge Computer Works, GMBH and Hauppauge Computer Works, Ltd.,
both wholly owned subsidiaries of Hauppauge Computer Works, Inc. (collectively,
the "Company"). All inter company accounts and transactions have been
eliminated.
Nature of Business
The Company is primarily engaged in the design, manufacture and marketing
of WinTV(R) video computer boards and video conferencing boards. Win/TV boards
convert moving video images from cable TV, video cameras or a VCR to a digital
format which is displayed in a sizable window on a PC monitor. These video
images can be viewed simultaneously with normal PC operations such as word
processing programs and spreadsheet applications. The WinTV(R) board is marketed
worldwide through retailers, distributors, original equipment manufacturers and
manufacturers' representatives. Net sales to international and domestic
customers were approximately 73% and 27%, 72% and 28%, and 66% and 34% of total
sales for the years ended September 30, 1999, 1998 and 1997, respectively. The
Company operates in only one segment. The Company maintains sales offices in
both Europe and Asia. Long lived assets of the foreign operations are immaterial
and therefore not separately disclosed.
Net sales to customers by geographic location consist of:
Years ended September 30,
Sales to: 1999 1998 1997
- - --------- ---- ---- ----
United States 27% 28% 34%
Germany 43% 38% 28%
United Kingdom 13% 19% 20%
France 6% 2% -
Netherlands 2% 3% 5%
Other Countries 9% 10% 13%
---- ---- ----
Total 100% 100% 100%
Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, 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.
F-7
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 7). 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.
Revenue Recognition
The Company records revenue when its products are shipped. Provisions for
estimated sales allowances and returns are accrued at the time revenues are
recognized.
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 an 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.
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.
F-8
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Long-Lived Assets
Long-lived assets, such as property and equipment, 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.
Foreign Currency Transactions and Operations
The Company sells products and services to foreign customers through local
sales offices. Revenues and expenses are recorded in U.S. dollars at the current
exchange rate at the time of the transaction. Gains due to the changes in
exchange rate totaling approximately $184,000 for fiscal 1998 and losses
totaling approximately $ 62,000 and $ 16,000 for fiscal 1999 and 1997 were
included as a component of Other, net, in the statement of income.
Financial Instruments
The Company uses forward exchange contracts to hedge certain firm
commitments denominated in foreign currencies. Gains and losses on these
positions are deferred and included in the Statement of Income as part of Other,
net, when the transaction is completed.
Fair Value of Financial Instruments
The carrying amounts of certain financial instruments, including cash,
accounts receivable and accounts payable, approximate fair value as of September
30, 1999 because of the relatively short term maturity of these instruments.
Net income per share
Basic earnings per share includes no dilution and is computed by dividing
net income by the weighted average number of common shares outstanding for the
period. Diluted earnings 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 per share follows:
<TABLE>
<CAPTION>
Years ended September 30,
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Weighted average shares outstanding-basic 4,316,216 4,403,357 4,427,440
Common stock equivalents-stock options 423,658 273,390 7,158
------- ------- -----
Weighted average shares outstanding-diluted 4,739,874 4,676,747 4,434,598
========= ========= =========
</TABLE>
Options to purchase approximately 47,500 shares of common stock at exercise
prices of $17.50 to $20.00 per share were outstanding during a portion of 1999,
but were not included in the computation of diluted earnings per share because
they are anti-dilutive. These options expire through 2004.
F-9
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company repurchased 7,100, 148,000 and 59,200 shares in fiscal 1999,
1998 and 1997, respectively, for treasury purposes (see note 6a). These shares,
on a weighted average basis, have been excluded in calculating weighted average
shares outstanding.
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" (see note
6c).
Prospective Accounting Changes
Investment Derivatives and Hedging Activities Income
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
("SFAS 133"), Accounting for Derivative Investments and Hedging Activities
Income. SFAS 133 is effective for transactions entered into after June 15, 2000.
SFAS 133 requires that all derivative instruments be recorded on the balance
sheet at fair value. Changes in the fair value of the derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designed as part of the hedge transaction and the type
of hedge transaction. The ineffective portion of all hedges will be recognized
in earnings. The Company is in the process of determining the impact that the
adoption of SFAS 133 will have on its results of operations and financial
position.
2. Inventories
Inventories consist of the following:
September 30,
1999 1998
Component Parts $ 4,875,940 $1,445,811
Work in Process 494,285 511,640
Finished Goods 7,587,214 6,594,646
--------- ---------
$12,957,439 $8,552,097
=========== ==========
F-10
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
3. Property, Plant and Equipment
The following is a summary of property, plant and equipment:
September 30,
1999 1998
---- ----
Office Equipment and Machinery $1,178,805 $773,384
Leasehold Improvements 58,436 32,569
---------- ----------
1,237,241 805,953
Less: Accumulated depreciation and amortization 518,679 362,343
------- -------
$ 718,562 $443,610
======= =======
4. Income Taxes
The income tax provision consists of the following:
<TABLE>
<CAPTION>
Years ended September 30,
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Current tax expense:
Federal income taxes $ 1, 125,234 $ 932,653 $ 120,284
State income taxes 129,709 94,415 29,719
Foreign income taxes 100,000 - -
------------- ---------- ----------
Total current $ 1,354,943 $1,027,068 $ 150,003
------------- ---------- ----------
Deferred tax expense (benefit)
Federal 107,417 (450,170) (84,105)
State 12,640 (52,961) (9,895)
------ ------- ------
Total deferred 120,057 (503,131) (94,000)
------- -------- -------
Total taxes on income $ 1,475,000 $ 523,937 $ 56,003
============= ========== =========
</TABLE>
Components of deferred taxes are as follows:
Years ended September 30,
1999 1998
---- ----
Deferred tax assets:
Net operating loss carry forwards $ 47,612 $ 152,259
Inventory obsolescence reserve 125,400 101,853
Warranty reserve 27,550 27,550
Allowance for doubtful accounts 66,107 33,807
Deferred rent payments 39,632 41,632
Capitalized inventory costs 92,109 74,129
Sales return reserve 65,189 272,141
Other reserves 13,475 20,760
------ ------
Total deferred assets 477,074 724,131
Valuation allowance - (127,000)
------- ---------
Net deferred tax assets $ 477,074 $ 597,131
========= ==========
F-11
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prior to 1997 , due to new products, the relative volatility of the
industry the Company operates in and the limited track record of profitability,
the Company had recorded a full valuation allowance against the deferred tax
assets. In recognition of market acceptance of the Company's product as
evidenced by the expansion of sales, along with consecutive years of
profitability, the Company reduced the valuation allowance by $127,000, $292,798
and $282,408, primarily in the fourth quarter of fiscal 1999, 1998 and 1997,
respectively, which resulted in the recognition of deferred tax benefits of
$127,000, $503,131 and $94,000, respectively.
As of September 30, 1999, the Company had net operating losses, (which
expire in the years through 2010), of $125,295 available to offset future
taxable income. Due to the change in control which resulted from the Company's
January 10, 1995 initial public offering of stock, all of the remaining unused
net operating losses are subject to limitations per Internal Revenue code
section 382. The Company's carry forward utilization of these restricted net
operating losses is limited to $275,386 per year. In 1999 and 1998, the Company
utilized $275,386 in restricted tax loss carry forwards.
The difference between the actual income tax provision and the tax
provision computed by applying the Federal statutory income tax rate of 34% to
the income before income tax is attributable to the following:
<TABLE>
<CAPTION>
Years ended September 30,
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Income tax at federal statutory rate $1,561,494 $ 844,047 $ 354,816
Reduction in deferred income tax
Valuation allowance (see above) (127,000) (292,798) (282,408)
Permanent differences 48,356 21,250 -
Income taxed at lower than statutory rates (159,219) ( 104,995) ( 36,020)
State income taxes, net of federal benefit 85,608 62,040 19,615
Foreign income taxes 100,000 - -
Research and Development credit (100,000) (75,000) -
Other 65,761 69,393 -
------ ------ --------
Taxes on income $1,475,000 $ 523,937 $ 56,003
========== ========= ==========
</TABLE>
5. Line of Credit
On March 28, 1996, Hauppauge Computer Works, Inc, a wholly owned subsidiary
of Hauppauge Digital, Inc., entered into a Credit Agreement with a bank which
expired on February 28, 1998. The Credit Agreement provided for, among other
things, a two year asset based line of credit, whereby the Company may borrow up
to $1,600,000. The loan required the Company to maintain certain financial
covenants and the Company was prohibited from paying cash dividends during the
term of the Credit Agreement. The line expired on February 28, 1998, and the
Company chose not to renew the line. The Company is now seeking to replace this
loan facility and believes it can replace this credit facility at more favorable
rates.
F-12
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Shareholders' Equity
a. Treasury Stock
On November 8, 1996, the Company approved a stock repurchase program for
the repurchase of up to 300,000 shares of its own Common Stock. The repurchased
shares will be used by the Company for certain employee benefit programs. The
total shares purchased as of September 30, 1999 were 214,300 for $1,267,129, at
an average price of $5.91. As of September 30, 1998 the Company had repurchased
207,200 shares for $ 1,203,604, at an average price of $5.81. As of September
30, 1997, the Company had repurchased 59,200 for $193,953, at an average price
of $3.28.
b. Exercise of Stock Options
During fiscal 1999 and 1998, 58,600 and 29,600 options from the Company's
incentive stock option plans were exercised at an average prices of $3.29 and
$3.09. The Company realized $ 192,691 and $91,568 in proceeds for the exercise
of options for fiscal 1999 and 1998, respectively.
c. 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,
200,000 options may be granted for up to ten years with exercise prices during
the first two years subsequent to the IPO being the greater of the IPO offering
price per unit ($3.15) or the fair market value of the common stock at the date
of the grant. After the initial two year period, the option price shall be no
less than the fair market value of the stock on the date the options are
granted.. As of September 30, 1999, 1998 and 1997, 110,800, 167,200 and 160,000
options were outstanding, respectively, ranging in prices from $2.69 to $5.09.
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 Non-Qualified Plan
authorizes the grant of 250,000 shares. 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, 1999, 1998 and 1997, 159,000. 110,000 and
40,000 options ranging in prices from $2.69 to $20 have been granted to
employees 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 ("ISO") pursuant to section 422A of
the Internal Revenue Code. This plan was approved by the Company's shareholders
at the Company's March 12, 1998 annual shareholder meeting. The plan as adopted
authorizes the grant of 350,000 shares of common stock, subject to adjustment as
provided in the plan. The plan terminates on December 16, 2007. The options
terms may not exceed ten years. Options can not be granted at less than 100% of
the market value at the time of grant. Options granted top employees who own
more the 10% of the Company's outstanding common stock will be granted options
at not less than 100% of the market value of the stock at the date of grant. As
of September 30, 1999 and 1998, 334,950 and 148,150 were outstanding with
exercise prices from $4.50 to $ 17.50.
F-13
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
c. Stock Compensation Plans-continued
On September 30, 1999, 1998 and 1997, in connection with employment
contracts the Company had with the Chief Executive Officer and President, 60,000
non qualified stock options for each year became exercisable.
The Company accounts for its stock option awards under the intrinsic value
based method, as prescribed by APB Opinion 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations. Under APB 25, because the
exercise price of the employees stock options equals the market price of the
underlying stock at the date of the grant, no compensation is cost is
recognized.
SFAS Statement 123, "Accounting for Stock Based Compensation,"("SFAS 123")
requires the Company to provide pro forma information regarding net income and
earnings 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 1999, 1998 and 1997: risk free interest rates of 4.25%, 4.25%
and 5.92% for 1999, 1998 and 1997, volatility factor of the expected market
price of the Company's stock 35%, 37 % and 35% for 1999, 1998 and 1997, and
expected lives of either five or ten years. The weighted average fair value of
options granted in 1999, 1998 and 1997 were $1.71 to $6.66, $1.63 to $2.58 and
$1.15 to $1.75, respectively.
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,
1999 1998 1997
---- ---- ----
Net income:
As reported $ 3,117,628 $ 1,958,553 $ 985,808
Pro forma 2,749,697 1,724,754 843,123
Net income, per share:
As reported
Basic $ 0.72 $ 0.44 $ 0.22
Diluted $ 0.66 $ 0.42 $ 0.22
Pro Forma
Basic $ 0.64 $ 0.39 $ 0.19
Diluted $ 0.58 $ 0.37 $ 0.19
F-14
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the status of the Company's fixed options plans as of September 30,
1999, 1998 and 1997 and changes during the years ending those dates is presented
below:
<TABLE>
<CAPTION>
Weighted Weighted
Average Average
Exercise Non Exercise
ISO Price Qualified Price
-------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Balance at September 30, 1996 87,000 $3.68 30,000 $3.00
Granted 91,100 2.78 70,000 3.08
Exercised - - - -
Forfeited (20,600) 3.70 - -
-------- ------ ------- ----------
Balance at September 30, 1997 157,500 $2.95 100,000 $3.06
Granted 190,650 4.74 130,000 4.10
Exercised (29,600) 3.10 - -
Forfeited (3,200) 3.10 - -
---------- ------ ------ ----------
Balance at September 30, 1998 315,350 $4.10 230,000 $3.64
Granted 197,000 8.63 109,000 8.02
Exercised (58,600) 3.29 - -
Forfeited ( 8,000) 3.96
=========== ===== ========= ==========
Balance at September 30, 1999 445,750 $6.24 339,000 5.05
Options exercisable at year end 52,350 $4.65 267,000 $3.70
</TABLE>
The following table summarizes information about stock options outstanding at
September 30, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- - ------------------- -------------------
Range of Weighted Average Weighted
Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise
- - ------ ----------- ------------------ --------------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 2.69 40,900 3.4 years $2.69 10,800 $2.69
3.00 30,000 6.4 3.00 24,000 3.00
3.15 180,000 5.3 3.15 180,000 3.15
2.93 800 3.8 2.93 - 2.93
3.37 4,500 3.9 3.37 - 3.37
3.75 34,600 2.6 3.75 10,600 3.75
4.13 7,500 4.0 4.13 1,500 4.13
5.09 90,000 3.3 5.09 30,000 5.09
4.63 60,000 8.3 4.63 24,000 4.63
4.50 80,450 3.4 4.50 9,450 4.50
6.44 10,000 3.5 6.44 10,000 6.44
7.50 4,000 1.0 7.50 4,000 7.50
7.75 15,000 4.3 7.75 15,000 7.75
20.00 25,000 4.8 20.00 - 20.00
7.88 149,500 4.5 7.88 - 7.88
5.63 30,000 4.0 5.63 - 5.63
17.50 22,500 4.7 17.50 - 17.50
------ ------
784,750 319,350
======= =======
</TABLE>
F-15
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Significant Customer Information
For the years ended September 30, 1999 and 1998 the Company had no single
customer who accounted for more that 10% of net sales. As of September 30, 1999
and 1998 the Company had five and four customers who accounted for 66% and 51%,
respectively of the net accounts receivable. For the year ended September 30,
1997, the Company had two customers who accounted for 12% and 11% of net sales,
respectively.
8. Related Party Transactions
The Company rents its principal office and warehouse space in Hauppauge,
New York from a real estate partnership owned by the two principal shareholders
of the Company. 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. On December 17, 1997 in connection with a
re-negotiation of the lease term, the Company granted 60,000 options to a real
estate partnership owned by the principal shareholders at an exercise price of
$3.81 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 indebtedness incurred by the two principal shareholders to purchase the
building is also guaranteed by the Company and totaled $978,655 at September 30,
1999.
Minimum annual lease payments to related parties and third parties are as
follows:
Year ended September 30,
2000 505,507
2001 493,474
2002 514,413
2003 489,372
2004 503,000
Thereafter 745,702
--------
$3,251,468
Rent expense totaled approximately $432,196, $399,166 and $373,704 for the
years ended September 30, 1999, 1998 and 1997, respectively. The Company pays
the real estate taxes and is responsible for normal building maintenance.
9. Commitment and Contingencies
a. Litigation
In the normal course of business, the Company is a party to various claims
and/or litigation. Management and the Company's 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.
F-16
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
a. Litigation-continued
In January 1998, Advanced Interactive Incorporated ("AII") contacted the
Company and attempted to induce the Company to enter into a patent license or
joint venture agreement with AII relative to certain of the Company's products.
AII alleged that such products infringe U.S. Patent No. 4, 426, 698 (the "AII
Patent"). At such time, the Company's engineering staff analyzed the AII Patent
and determined that the Company's products did not infringe any such patent.
Accordingly, the Company rejected AII's offer.
On October 6, 1998, the Company received notice that AII had commenced an
action against it and multiple other defendants in the United States District
Court for the Northern District of Illinois, alleging that the certain of the
Company's products infringe on certain patent rights allegedly owned by the
plaintiff. The complaint seeks unspecified compensatory and statutory damages
with interest. The Company denies such allegations and intends to vigorously
defend this action. On December 22, 1998, the Company filed its Answer (the
"Answer").
Among other things, pursuant to the answer, the Company denies that its
products infringe AII's patent rights and asserts certain affirmative defenses.
In addition, the Answer contains a counterclaim challenging the validity of
AII's alleged patent rights.
Notwithstanding the foregoing, because of the uncertainties of litigation,
no assurances can be given as to the outcome of the AII litigation. In the event
that the Company were not to prevail in this litigation, the Company could be
required to pay significant damages to AII and could be enjoined from further
use of such technology as it presently exists. Although a negative outcome in
the AII litigation would have a material adverse affect on the Company,
including, but not limited to, its operations and financial condition, the
Company believes that, if it is held that the Company's products infringe AII's
patent rights, the Company would attempt to design components to replace the
infringing components or would attempt to negotiate with AII to utilize its
system, although no assurances can be given that the Company would be successful
in these attempts. At the present time, the Company can not assess the possible
cost of designing and implementing a new system or obtaining rights from AII.
b. Employment Contracts
On January 10, 1998, upon the expiration of prior employment agreements,
the Company's chief executive officer and president entered into new employment
agreements with the Company. The term of the employment agreements is for three
years which is automatically renewed each year unless otherwise not authorized
by the Board of Directors. The agreements provide each executive with an annual
base salary of $125,000, $150,000 and $180,000 for the first, second and third
year of the contract. For each annual year thereafter, compensation shall be
mutually determined, but can not be less that the preceding year.
The contract also provides for a bonus of 2% of operating income (income
from operations but before interest and other income) to be paid if the
operating income exceeds the prior year's operating earnings by 120%. A 1% bonus
on operating income will be paid if the operating income exceed the prior year's
operating by less than 120%. The agreement also obligates the Company to provide
certain disability, medical and life insurance, and other benefits. In the event
of a change of control as defined in the employment agreement, a
F-17
<PAGE>
HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
one time bonus shall be paid equal to the executive's average annual
compensation, including base compensation, bonus and benefits, received by him
during the thirty six month period preceding the change in control.
Pursuant to the January 10, 1998 employment agreements, on January 21,
1998, incentive stock options to acquire 45,000 shares each, exercisable in
increments of 33 1/3 % per year at $5.0875 for a period of five years from the
date the options first become exercisable, were granted to the chief executive
officer and the president. In addition, options to purchase 30,000 non qualified
options were issued to the chief executive officer and president, exercisable
for a period of ten years at $4.625.
c. Forward Exchange Contracts
The Company, in an effort to manage the volatility that exchange rates have
upon foreign sales, maintains a program of selling forward foreign currencies
based on future estimated revenue. The amount of window contracts open, at
September 30, 1999, was approximately $4 million Euros, ranging in prices from
1.066 to 1.0717, which expire through January 2000. As of September 30, 1999,
the Company has deferred foreign gains of approximately $2,000, based on the
September 30, 1999 Euro exchange rate of 1.066 dollars to 1 Euro. The Company
will continue this strategy of hedging projected future revenues invoices in
foreign currency in an effort to control the impact of foreign currency
fluctuations.
F-18
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Shareholders of
Hauppauge Digital, Inc. and Subsidiaries
Hauppauge, New York
The audits referred to in our report dated December 10, 1999 relating to
the consolidated financial statements of Hauppauge Digital, Inc. included the
audits of the financial statement Schedule II-Valuation and Qualifying Accounts
for each of the three years in the period ended September 30, 1999. This
financial statement schedule is the responsibility of management. Our
responsibility is to express an opinion on this schedule based on our audits.
In our opinion, such financial statement Schedule-Valuation and Qualifying
Accounts, presents fairly, in all material respects, the information set forth
therein.
/s/ BDO Seidman, LLP
- - ----------------------------
BDO Seidman, LLP
Melville, New York
December 10, 1999
F-21
<PAGE>
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions
Balance at Charged to Costs Charged to Other Balance at
Description Beginning of Period and Expenses Accounts Deductions(1) End of Period
- - ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED SEPTEMBER 30, 1999
Reserve and allowances deducted
from asset accounts 100,000 585,000 550,000 135,000
Allowance for doubtful accounts
YEAR ENDED SEPTEMBER 30, 1998
Reserve and allowances deducted
from asset accounts 100,000 50,000 50,000 100,000
Allowance for doubtful accounts
YEAR ENDED SEPTEMBER 30, 1997
Reserve and allowances deducted
from asset accounts 75,000 25,000 - 100,000
Allowance for doubtful accounts
</TABLE>
(1) Doubtful accounts written off net of collections
F-20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
(Replace this text with the legend)
</LEGEND>
<CIK> 0000930803
<NAME> Hauppauge Digital, Inc.
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 6,122,922
<SECURITIES> 0
<RECEIVABLES> 6,973,452
<ALLOWANCES> 135,000
<INVENTORY> 12,957,439
<CURRENT-ASSETS> 26,938,803
<PP&E> 1,237,241
<DEPRECIATION> 518,679
<TOTAL-ASSETS> 27,727,584
<CURRENT-LIABILITIES> 14,405,493
<BONDS> 0
0
0
<COMMON> 45,603
<OTHER-SE> 13,276,488
<TOTAL-LIABILITY-AND-EQUITY> 27,727,584
<SALES> 58,601,611
<TOTAL-REVENUES> 58,601,611
<CGS> 42,434,612
<TOTAL-COSTS> 11,714,249
<OTHER-EXPENSES> (139,878)
<LOSS-PROVISION> 135,000
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,952,628
<INCOME-TAX> 1,475,000
<INCOME-CONTINUING> 3,117,628
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,117,628
<EPS-BASIC> 0.72
<EPS-DILUTED> 0.66
</TABLE>
