UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549





FORM
10-Q





(Mark
One)


x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934





For
the quarterly period ended  June 30,
2010





OR





 ̈
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934





For
the transition period from _______ to ________





Commission
file number          1-13550





HAUPPAUGE DIGITAL
INC.


(Exact
name of  registrant as specified in its charter)





Delaware
              
              11-3227864(State
      or other jurisdiction of
              
              (I.R.S.
      Employerincorporation
      or organization)
              
              Identification
      No.)





91 Cabot Court, Hauppauge,
New York  11788


(Address
of principal executive offices)





(631)
434-1600


(Registrant’s
telephone  number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.





x
YES           ̈
NO





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).





 ̈
YES             ̈
NO





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  (See definitions of “large accelerated filer”, “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act).





 ̈  LARGE
      ACCELERATED FILER
             ̈  ACCELERATED  FILER ̈
      NON-ACCELERATED FILER
            x  SMALLER
      REPORTING COMPANY


(Do not
check if a smaller reporting company)





Indicate
by check mark whether the registrant is a shell company (as defined
in  Rule12b-2 of the Exchange Act).





 ̈
YES              x  NO





As of
July 30, 2010, 10,069,170 shares of .01 par value Common Stock of the issuer
were outstanding.







HAUPPAUGE DIGITAL INC. AND
SUBSIDIARIES




INDEX





Page no.PART I. FINANCIAL
    INFORMATIONItem
      1. Financial StatementsConsolidated
      Balance Sheets – June 30, 2010 (unaudited) and September 30,
      2009
                        
                        4Consolidated
      Statements of Operations - Three Months ended June 30, 2010 (unaudited)
      and 2009 (unaudited)
                        
                        5Consolidated
      Statements of Operations - Nine Months ended June 30, 2010 (unaudited) and
      2009 (unaudited)
                        
                        6Consolidated
      Statements of Other Comprehensive Loss Three Months and nine Months ended
      June 30, 2010 (unaudited) and 2009 (unaudited)
                        
                        7Consolidated
      Statements of Cash Flows - Nine Months ended June 30, 2010 (unaudited) and
      2009 (unaudited)
                        
                        8Notes
      to Consolidated Financial Statements
                        
                        9-17Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                        
                        18-27Item
      3. Quantitative and Qualitative Disclosures about Market
    Risks
                        
                        27Item
      4. Controls and Procedures
                        
                        27-28




2





PART II. OTHER INFORMATIONItem
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                    28-29Item
      6. Exhibits
                    29Signatures
                    30




3


PART I. FINANCIAL
INFORMATION




Item
1. Financial Statements


HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





June 30,
                              2010
                            
                            
                            September 30 ,
                              2009(unaudited)Assets:Cash
      and cash equivalents
                            
                            $
                            8,166,507
                            
                            
                            $
                            8,368,342Trade
      receivables, net of various allowances
                            
                            
                            5,002,355
                            
                            
                            
                            9,770,584Other
      non trade receivables
                            
                            
                            2,457,288
                            
                            
                            
                            4,116,392Inventories
                            
                            
                            12,189,968
                            
                            
                            
                            8,616,800Deferred
      tax asset-current
                            
                            
                            966,974
                            
                            
                            
                            1,297,574Prepaid
      expenses and other current assets
                            
                            
                            1,153,919
                            
                            
                            
                            928,680Total
      current assets
                            
                            
                            29,937,011
                            
                            
                            
                            33,098,372Intangible
      assets, net
                            
                            
                            4,129,975
                            
                            
                            
                            4,696,102Property,
      plant and equipment, net
                            
                            
                            591,531
                            
                            
                            
                            757,488Security
      deposits and other non current assets
                            
                            
                            122,401
                            
                            
                            
                            108,088Deferred
      tax asset-non current
                            
                            
                            887,611
                            
                            
                            
                            887,611Total
      assets
                            
                            $
                            35,668,529
                            
                            
                            $
                            39,547,661Liabilities
      and Stockholders’ Equity:Current
      Liabilities:Accounts
      payable
                            
                            $
                            9,931,085
                            
                            
                            $
                            12,478,625Accrued
      expenses fees
                            
                            
                            4,669,691
                            
                            
                            
                            5,753,546Accrued
      expenses
                            
                            
                            9,841,621
                            
                            
                            
                            8,131,263Note
      payable
                            
                            
                            0
                            
                            
                            
                            625,045Income
      taxes payable
                            
                            
                            229,560
                            
                            
                            
                            224,316Total
      current liabilities
                            
                            
                            24,671,957
                            
                            
                            
                            27,212,795Stockholders'
      Equity:Common
      stock, $.01 par value; 25,000,000 shares authorized,10,829,649
      and 10,814,042 issued, respectively
                            
                            
                            108,297
                            
                            
                            
                            108,140Additional
      paid-in capital
                            
                            
                            17,615,594
                            
                            
                            
                            17,276,651Retained
      earnings
                            
                            
                            473,466
                            
                            
                            
                            795,674Accumulated
      other comprehensive loss
                            
                            
                            (4,795,237
                            )
                            
                            
                            (3,441,262
                            )Treasury
      Stock, at cost, 760,479 and 759,579 shares, respectively
                            
                            
                            (2,405,548
                            )
                            
                            
                            (2,404,337
                            )Total
      stockholders' equity
                            
                            
                            10,996,572
                            
                            
                            
                            12,334,866Total
      liabilities and stockholders' equity
                            
                            $
                            35,668,529
                            
                            
                            $
                            39,547,661





See
accompanying notes to consolidated financial statements


4





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(UNAUDITED)





Three months ended June 30,2010
                    
                    
                    2009Net
      sales
                    
                    $
                    13,593,518
                    
                    
                    $
                    13,067,124Cost
      of sales
                    
                    
                    7,653,058
                    
                    
                    
                    9,845,438Gross
      profit
                    
                    
                    5,940,460
                    
                    
                    
                    3,221,686Selling,
      general and administrative expenses
                    
                    
                    3,705,827
                    
                    
                    
                    3,954,536Research
      and development expenses
                    
                    
                    1,083,489
                    
                    
                    
                    1,122,911Income
      (loss) from operations
                    
                    
                    1,151,144
                    
                    
                    
                    (1,855,761
                    )Other
      income (expense):Interest
      income
                    
                    
                    1,442
                    
                    
                    
                    1,707Interest
      expense
                    
                    
                    -
                    
                    
                    
                    (20,832
                    )Foreign
      currency gain
                    
                    
                    152,142
                    
                    
                    
                    25,532Total
      other income
                    
                    
                    153,584
                    
                    
                    
                    6,407Income
      (loss) before tax provision
                    
                    
                    1,304,728
                    
                    
                    
                    (1,849,354
                    )Tax
      provision
                    
                    
                    389,512
                    
                    
                    
                    38,028Net
      income (loss)
                    
                    $
                    915,216
                    
                    
                    $
                    (1,887,382
                    )Net
      income (loss) per share:Basic
      and diluted
                    
                    $
                    0.09
                    
                    
                    $
                    (0.19
                    )





See
accompanying notes to consolidated financial statements


5





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(UNAUDITED)





Nine months ended June 30,2010
                    
                    
                    2009Net
      sales
                    
                    $
                    45,318,955
                    
                    
                    $
                    43,089,233Cost
      of sales
                    
                    
                    30,290,307
                    
                    
                    
                    34,305,007Gross
      profit
                    
                    
                    15,028,648
                    
                    
                    
                    8,784,226Selling,
      general and administrative expenses
                    
                    
                    11,816,087
                    
                    
                    
                    11,655,103Research
      and development expenses
                    
                    
                    3,258,661
                    
                    
                    
                    3,236,401Loss
      from operations
                    
                    
                    (46,100
                    )
                    
                    
                    (6,107,278
                    )Other
      income (expense):Interest
      income
                    
                    
                    4,336
                    
                    
                    
                    11,332Interest
      expense
                    
                    
                    (4,340
                    )
                    
                    
                    (49,478
                    )Foreign
      currency gain
                    
                    
                    213,770
                    
                    
                    
                    669,209Total
      other income
                    
                    
                    213,766
                    
                    
                    
                    631,063Income
      (loss) before tax provision
                    
                    
                    167,666
                    
                    
                    
                    (5,476,215
                    )Tax
      provision
                    
                    
                    489,874
                    
                    
                    
                    115,550Net loss
                    
                    $
                    (322,208
                    )
                    
                    $
                    (5,591,765
                    )Net
      loss per share:Basic
      and diluted
                    
                    $
                    (0.03
                    )
                    
                    $
                    (0.56
                    )





See
accompanying notes to consolidated financial statements


6





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)


(UNAUDITED)





Three months ended June
      30,2010
                  
                  
                  2009Net
      income (loss)
                  
                  $
                  915,216
                  
                  
                  $
                  (1,887,382
                  )Foreign
      currency translation gain (loss)
                  
                  
                  (690,333
                  )
                  
                  
                  494,085Forward
      exchange contracts marked to market loss
                  
                  
                  (16,117
                  )
                  
                  
                  (57,808
                  )Other
      comprehensive income (loss)
                  
                  $
                  208,766
                  
                  
                  $
                  (1,451,105
                  )





Nine months ended June
      30,2010
                  
                  
                  2009Net
      loss
                  
                  $
                  (322,208
                  )
                  
                  $
                  (5,591,765
                  )Foreign
      currency translation gain (loss)
                  
                  
                  (1,359,345
                  )
                  
                  
                  1,449Forward
      exchange contracts marked to market gain (loss)
                  
                  
                  5,370
                  
                  
                  
                  (20,134
                  )Other
      comprehensive loss
                  
                  $
                  (1,676,183
                  )
                  
                  $
                  (5,610,450
                  )





See
accompanying notes to consolidated financial statements


7


HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)





Nine months ended June
    30,2010
                        
                        
                        2009Net loss
                        
                        $
                        (322,208
                        )
                        
                        $
                        (5,591,765
                        )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                        
                        
                        206,730
                        
                        
                        
                        206,594Amortization
      of intangible assets
                        
                        
                        566,127
                        
                        
                        
                        377,418Stock
      compensation expense
                        
                        
                        326,350
                        
                        
                        
                        401,936Deferred
      tax expense
                        
                        
                        330,600
                        
                        
                        
                        -Sales
      reserve, net
                        
                        
                        259,240
                        
                        
                        
                        -Bad
      debt reserve
                        
                        
                        40,000
                        
                        
                        
                        -Inventory
      reserve
                        
                        
                        60,000
                        
                        
                        
                        -Other
      items
                        
                        
                        (14,313
                        )
                        
                        
                        (5,800
                        )Changes
      in current assets and liabilities, net of effects of
      acquisition:Accounts
      receivable
                        
                        
                        5,350,574
                        
                        
                        
                        (1,186,810
                        )Inventories
                        
                        
                        (2,855,649
                        )
                        
                        
                        2,301,900Prepaid
      expenses and other current assets
                        
                        
                        (225,239
                        )
                        
                        
                        (18,694
                        )Accounts
      payable
                        
                        
                        (2,547,540
                        )
                        
                        
                        (1,236,820
                        )Accrued
      expenses and other current liabilities
                        
                        
                        518,034
                        
                        
                        
                        3,356,714Total
      adjustments
                        
                        
                        2,014,914
                        
                        
                        
                        4,196,438Net
      cash provided by (used in) operating activities
                        
                        
                        1,692,706
                        
                        
                        
                        (1,395,327
                        )Cash
      Flows From Investing Activities:PCTV
      acquisition
                        
                        
                        (511,332
                        )
                        
                        
                        (2,490,500
                        )Purchases
      of property, plant and equipment
                        
                        
                        (40,773
                        )
                        
                        
                        (28,319
                        )Purchase
      of treasury shares
                        
                        
                        (1,211
                        )
                        
                        
                        -Net
      cash used in investing activities
                        
                        
                        (553,316
                        )
                        
                        
                        (2,518,819
                        )Cash
      Flows From Financing Activities:Payments
      on note payable
                        
                        
                        -
                        
                        
                        
                        (1,249,998
                        )Proceeds
      from the exercise of stock options and employee stock
      purchases
                        
                        
                        12,750
                        
                        
                        
                        24,133Net
      cash provided by (used in) financing activities
                        
                        
                        12,750
                        
                        
                        
                        (1,225,865
                        )Effect
      of exchange rates on cash
                        
                        
                        (1,353,975
                        )
                        
                        
                        (18,595
                        )Net
      decrease in cash and cash equivalents
                        
                        
                        (201,835
                        )
                        
                        
                        (5,158,606
                        )Cash
      and cash equivalents, beginning of period
                        
                        
                        8,368,342
                        
                        
                        
                        14,191,721Cash
      and cash equivalents, end of period
                        
                        $
                        8,166,507
                        
                        
                        $
                        9,033,115Supplemental
      disclosures:Interest
      paid
                        
                        $
                        4,347
                        
                        
                        $
                        49,478Income
      taxes paid
                        
                        $
                        133,367
                        
                        
                        $
                        54,288Note
      payable to Avid Technology, Inc.
                        
                        $
                        -
                        
                        
                        $
                        2,500,000





See
accompanying notes to consolidated financial statements


8


HAUPPAUGE DIGITAL INC.
AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




Note
1.  Basis of Presentation





The
accompanying unaudited consolidated financial statements for Hauppauge Digital
Inc. and subsidiaries (collectively, the “Company”) included herein have been
prepared in accordance with generally accepted accounting principles for interim
period reporting in conjunction with the instructions to Form 10-Q. Accordingly,
these statements do not include all of the information required by generally
accepted accounting principles for annual financial statements. In the opinion
of management, all known adjustments (consisting of normal recurring accruals
and reserves) necessary to present fairly the Company’s consolidated financial
position, results of operations and cash flows as of and for the interim periods
have been included. It is suggested that these interim statements be read in
conjunction with the financial statements and related notes included in the
Company's September 30, 2009 Form 10-K.





The
operating results for the three and nine months ended June 30, 2010 are not
necessarily indicative of the results to be expected for the September 30, 2010
year end.





Certain
reclassifications have been made to prior consolidated financial statements to
conform to the current classifications.





Management
has evaluated subsequent events after the balance sheet date through the
issuance of the financial statements for appropriate accounting and disclosure
through the filing date of this Form 10-Q.




Note
2.  Trade Accounts and Other Non-Trade Receivables




Trade
receivables consist of:




·
            Trade
      receivables from sales to customers




·
            Allowances,
      consisting of sales and bad debt




Other non
trade receivables consist of:




·
            Receivables
      pertaining to component parts purchased from the Company at cost by the
      Company’s contract manufacturers which are excluded from
    sales




·
            General
      services tax (GST) and value added tax (VAT) reclaimable on goods
      purchased by the Company’s Asian and European
  locations




·
            Other
      minor non-trade receivables




9





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Trade
receivables and other non-trade receivables as of June 30, 2010 and September
30, 2009 consisted of:





June
      30,
                  
                  
                  September
      30,2010
                  
                  
                  2009Trade
      receivables
                  
                  $
                  9,975,806
                  
                  
                  $
                  13,893,804Allowances
      and reserves
                  
                  
                  (4,973,451
                  )
                  
                  
                  (4,123,220
                  )Total
      trade receivables
                  
                  
                  5,002,355
                  
                  
                  
                  9,770,584Receivable
      from contract manufacturers
                  
                  
                  1,898,373
                  
                  
                  
                  2,933,918GST
      and VAT taxes receivables
                  
                  
                  484,415
                  
                  
                  
                  1,134,331Other
                  
                  
                  74,500
                  
                  
                  
                  48,143Total
      non trade receivables
                  
                  $
                  2,457,288
                  
                  
                  $
                  4,116,392




Note
3.  Inventories





Inventories
have been valued at the lower of average cost or market on a first in first out
basis. The components of inventory consist of:





June
      30,
                    
                    
                    September
      30,2010
                    
                    
                    2009Component
      parts
                    
                    $
                    3,675,387
                    
                    
                    $
                    2,799,723Finished
      goods
                    
                    
                    8,514,581
                    
                    
                    
                    5,817,077$
                    12,189,968
                    
                    
                    $
                    8,616,800





Note
4.  Intangible Assets





The
following is a summary of intangible assets as of June 30, 2010:





Net
                  
                  
                  WeightedPurchase
                  
                  
                  Accumulated
                  
                  
                  Book
                  
                  
                  average
      remainingAsset description
                  
                  cost
                  
                  
                  Amortization
                  
                  
                  Value
                  
                  
                  life (in years)Customer
      relationships
                  
                  $
                  1,644,353
                  
                  
                  $
                  (205,544
                  )
                  
                  $
                  1,438,809
                  
                  
                  
                  10.50Value
      of technology
                  
                  
                  1,849,897
                  
                  
                  
                  (396,406
                  )
                  
                  
                  1,453,491
                  
                  
                  
                  5.50Covenant
      not to compete
                  
                  
                  1,767,979
                  
                  
                  
                  (530,304
                  )
                  
                  
                  1,237,675
                  
                  
                  
                  3.50Total
      intangible assets
                  
                  $
                  5,262,229
                  
                  
                  $
                  (1,132,254
                  )
                  
                  $
                  4,129,975
                  
                  
                  
                  7.83





Amortization
expense totaled approximately $566,000 for the nine months ended June 30, 2010.
Amortization expense is expected to be approximately $755,000 for each of the
fiscal years ended September 30, 2010, 2011, 2012 and 2013, respectively, and
$490,000 for the year ended September 30, 2014.


10





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




Note
5.  Net Income (Loss) Per Share





Basic net
income (loss) per share includes no dilution and is computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding for the period. Diluted net income per share reflects, in the
periods in which they have a dilutive effect, the dilution which would occur
upon the exercise of stock options. A reconciliation of the shares used in
calculating basic and diluted net income per share is as follows:





Three
      months ended
                  
                  
                  Nine
      months endedJune 30,
                  
                  
                  June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Weighted
      average shares outstanding-basic
                  
                  
                  10,068,765
                  
                  
                  
                  10,048,771
                  
                  
                  
                  10,064,618
                  
                  
                  
                  10,042,546Number
      of shares issued on the assumed exercise of stock options
                  
                  
                  135,327
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Weighted
      average shares outstanding-diluted
                  
                  
                  10,204,092
                  
                  
                  
                  10,048,771
                  
                  
                  
                  10,064,618
                  
                  
                  
                  10,042,546





Options
to purchase 914,000 and 1,522,394 shares of common stock, at prices from $3.02
to $7.45 and from $1.05 to $8.75, were outstanding for the three months ended
June 30, 2010 and 2009, respectively, but were not included in the computation
of diluted earnings per share because they were anti-dilutive.





Options
to purchase 1,529,442 and 1,522,394 shares of common stock, at prices from $0.95
to $7.45 and from $1.05 to $8.75, were outstanding for the nine months ended
June 30, 2010 and 2009, respectively, but were not included in the computation
of diluted earnings per share because they were anti-dilutive.




Note
6.  Foreign Currency Translations and Transactions





The
Company’s Asian subsidiary reports its financial position and results of
operations in the reporting currency of the Company.





The financial position and
results of operations of the Company’s European subsidiaries are determined
using Euros as the functional currency. Assets and liabilities of these
subsidiaries are translated at the exchange rate in effect at each period end.
Income statement accounts are translated at the average rate during the
year. Translation adjustments arising from the translation to U.S. Dollars
at differing exchange rates are included in the accumulated other comprehensive
income (loss) account in stockholders’ equity. Gains and losses resulting from
transactions that are denominated in currencies other than Euros are included in
earnings as a component of other income. The Company had a translation loss of
$3,441,262 recorded on the balance sheet as of September 30, 2009. For the nine
months
ended June 30, 2010 the Company recorded on the balance sheet translation losses
of $1,359,345, resulting in an accumulated translation loss of $4,800,607
recorded as a component of accumulated other comprehensive income as of June 30,
2010.


11





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




Note
7. Derivatives and Hedging Activities





For each
of the fiscal years ended September 30, 2009 and 2008 and the nine months ended
June 30, 2010, at least 40 % of the Company’s sales were generated by its
European subsidiary and were invoiced and collected in local currency, which was
primarily the Euro. On the supply side, since the Company predominantly deals
with North American and Asian suppliers and contract manufacturers,
approximately 95% of the Company’s inventory required to support its European
sales are purchased and paid in U.S. Dollars. The combination of sales billed in
Euros supported by inventory purchased in U.S. dollars results in an absence of
a natural local currency hedge. Consequently, the Company’s financial results
are subject to market risks resulting from the fluctuations in the Euro to U.S.
Dollar exchange rates.





The
Company attempts to reduce these risks by entering into foreign exchange forward
contracts with financial institutions. The purpose of these forward contracts is
to hedge the foreign currency market exposures underlying the U.S. Dollar
denominated inventory purchases required to support its European
sales.





The
Company does not try to hedge against all possible foreign currency exposures
because of the inherent difficulty in estimating  the volatility of the
Euro. The contracts the Company procures are specifically entered into to as a
hedge against forecasted or existing  foreign currency exposure. The
Company does not enter into contracts for speculative purposes. Although the
Company maintains these programs to reduce the short term impact of changes in
currency exchange rates, long term strengthening or weakening of the U.S. Dollar
against the Euro impacts the Company’s sales, gross profit, operating income and
retained earnings. Factors that could impact the effectiveness of the Company’s
hedging program are:





·
            volatility
      of the currency markets


·
            availability
      of hedging instruments


·
            accuracy
      of the Company’s inventory
forecasts





Additionally,
there is the risk that foreign exchange fluctuations will make the Company’s
products less competitive in foreign markets, which would substantially reduce
the Company’s sales.





As
of June 30, 2010, the Company had foreign currency contracts outstanding of
approximately $1,107,000 against the delivery of the Euro. These contracts
expire each month through September 30, 2010. The Company had no forward
exchange contracts outstanding as of September 30, 2009.





The
Company’s accounting policies for these instruments designate such instruments
as cash flow hedging transactions. The Company does not enter into such
contracts for speculative purposes. The Company records all derivative gains and
losses on the balance sheet as a component of stockholders’ equity under the
caption “Accumulated other comprehensive loss.” For the nine months ended June
30, 2010, the Company recorded on the balance sheet a mark to market deferred
forward exchange gain of $5,370.


12





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




Note
8. Revenue recognition





The
Company sells through a sales channel which is comprised of retailers, PC
manufacturers and distributors. The majority of the Company’s customers are
granted lines of credit. The product is shipped on account with the majority of
customers typically given 30 to 45 day payment terms. Those customers deemed as
large credit risks either pay in advance or issue the Company a letter of
credit.





The
Company requires the customer to submit a purchase order to the Company. The
product price and payment terms are fixed per the terms of the purchase order.
Upon shipment of the order to the customer, the title to the goods is passed to
the customer. The customer is legally obligated to pay for the order within the
payment terms stated on the customer’s purchase order. The obligation to insure
the boards and the cost of any pilferage while in the customer’s possession is
the responsibility of the customer. The Company sells analog, hybrid video
recorders or digital computer boards that are stocked on the shelves of
retailers and are subject to the normal consumer traffic that retail stores
attract. Aside from normal store promotions such as advertisements in the
store’s circular, the Company has no further obligation to assist in the resale
of the products.





The
Company offers some of its customers a right of return. The Company’s accounting
complies with FASB ASC 605-15 (SFAS 48) Revenue Recognition when Right of Return
Exists, as typically at the end of every quarter the Company, based on
historical data, evaluates its sales reserve level based on the previous six
months sales. Due to the seasonal nature of the business coupled with the
changing economic environment, management exercises some judgment with regard to
the historical data when calculating the reserve.





The
Company offers mail-in rebates on certain products at certain times as
determined by the Company. The rebates are recorded as a reduction to sales. The
Company also participates in limited cooperative advertising programs with
retailers and distributors and accounts for these in accordance with FASB ASC
605-50 (EITF 01-09), “Accounting for Consideration Given by a Vendor to a
Customer (Including a Reseller of the Vendor’s Products)”.




Note
9.  Product segment and geographic information





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




13





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





The
Company’s products fall under three product categories:





·
            Analog
      TV tuner products


·
            Digital
      TV tuner, and combination analog and digital TV tuner,
      products


·
            Other
      non-TV tuner products





The
Company’s Analog TV tuner products are TV tuner modules which can be added to a
PC and enable a PC user, among other things, to watch and record analog cable TV
in a resizable window on a PC.





The
Company’s digital TV and combination analog and digital tuner products are TV
tuner modules which enable a PC user, among other things, to watch and record
analog cable TV and digital TV in a resizable window on a PC.





The
Company’s other non-TV tuner products enable a PC user, among other things, to
video conference, watch and listen to PC based videos, music and pictures on a
TV set through a home network, and record TV and other types of video on a PC
for playback on portable video players.





Sales by
functional category are as follows:





Three
      months ended June 30,
                  
                  
                  Nine
      months ended June 30,Product line sales
                  
                  2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Analog
      TV tuner products
                  
                  $
                  253,555
                  
                  
                  $
                  336,030
                  
                  
                  $
                  555,165
                  
                  
                  $
                  2,380,493Digital
      and combination analog and digital TV tuner products
                  
                  
                  10,272,972
                  
                  
                  
                  11,841,827
                  
                  
                  
                  37,989,829
                  
                  
                  
                  37,447,228Other
      non-TV tuner products
                  
                  
                  3,066,991
                  
                  
                  
                  889,267
                  
                  
                  
                  6,773,961
                  
                  
                  
                  3,261,512Total
      sales
                  
                  $
                  13,593,518
                  
                  
                  $
                  13,067,124
                  
                  
                  $
                  45,318,955
                  
                  
                  $
                  43,089,233





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





Three
      months ended June 30,
                      
                      
                      Nine
      months ended June 30,Geographic region
                      
                      2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009The
      Americas
                      
                      
                      46
                      %
                      
                      
                      53
                      %
                      
                      
                      45
                      %
                      
                      
                      50
                      %Europe
                      
                      
                      52
                      %
                      
                      
                      44
                      %
                      
                      
                      53
                      %
                      
                      
                      47
                      %Asia
                      
                      
                      2
                      %
                      
                      
                      3
                      %
                      
                      
                      2
                      %
                      
                      
                      3
                      %Total
                      
                      
                      100
                      %
                      
                      
                      100
                      %
                      
                      
                      100
                      %
                      
                      
                      100
                      %




14





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Note
10. Tax provision





The
Company’s tax provision for the three months and nine months ended June 30, 2010
and 2009 is as follows:





Three
      months ended June 30,
                  
                  
                  Nine
      months ended June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Tax
      expense on international operations
                  
                  $
                  48,912
                  
                  
                  $
                  28,028
                  
                  
                  $
                  129,274
                  
                  
                  $
                  85,550State
      taxes
                  
                  
                  10,000
                  
                  
                  
                  10,000
                  
                  
                  
                  30,000
                  
                  
                  
                  30,000Deferred
      tax expense
                  
                  
                  330,600
                  
                  
                  
                  -
                  
                  
                  
                  330,600
                  
                  
                  
                  -Tax
      provision
                  
                  $
                  389,512
                  
                  
                  $
                  38,028
                  
                  
                  $
                  489,874
                  
                  
                  $
                  115,550





Note
11. Accrued expense- fees





The
Company uses software and technology purchased or licensed from third parties in
certain of the Company’s products.  The Company enters into agreements for
these technologies, and incurs a fee for each product sold that includes
the technology. The Company recognizes and estimates the amount of fees owed to
third parties based on products sold that include software and technology
purchased or licensed from these third parties.  The Company uses all
available applicable information in determining these estimates and thus the
accrued amounts are subject to change as new information is made available to
the Company. During the quarter the Company reduced its Accrued expense fees by
approximately $2,200,000 due to settlements in the quarter plus changes in
estimates.  The Accrued expense fees are accounted for as a component of
product cost and are charged to cost of sales.  As of June 30, 2010 and
September 30, 2009 the amount of Accrued expense fees amounted to $4,669,691 and
$5,753,546, respectively.





Note
12. Fair Value Measurements





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





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


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


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




15





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





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





At
June 30, 2010, the Company had forward contracts whose fair value at quarter end
was determined via inputs that included quoted prices for similar foreign
exchange contracts in active markets and were thus considered to be Level 2
inputs under the ASC 820 hierarchy (see Note 7).





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




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





Note
13. Acquisition of PCTV assets from Avid Technology, Inc.





Effective
December 24, 2008, pursuant to an Asset Purchase Agreement, dated as of October
25, 2008, as amended by that certain Amendment No. 1 to the Asset Purchase
Agreement (the “Amendment”) (together with the Amendment, the “Asset Purchase
Agreement”), PCTV Systems, Sarl, a Luxembourg company (“Buyer”) and the
Company’s wholly-owned subsidiary, acquired certain assets and properties (the
“Acquired Assets”) of Avid Technology, Inc. (“Avid”), a Delaware corporation,
Pinnacle Systems, Inc., a California corporation (“Pinnacle”), Avid Technology
GmbH, a limited


liability
company organized under the laws of Germany, Avid Development GmbH, a limited
liability company organized under the laws of Germany, and Avid Technology
International BV (collectively, the “Sellers”). The Acquired Assets were used by
the Sellers in the business of, among other things, the development, manufacture
and sale of personal devices containing a television tuner for receiving
over-the-air, satellite and/or cable television signals that are used in
conjunction with personal computers for personal television viewing.  The
potential increase in the Company’s customer base, the potential absorption of
the PCTV operations into the existing Hauppauge infrastructure with minimal
incremental costs plus the acquisition of the seller’s technology, reference
designs and product line were among the attributes that were considered in the
Company’s decision to complete the acquisition.





Because
the acquisition was completed on December 24, 2008, results from the operations
of the PCTV business effectively started on January 1, 2009.  The following
unaudited pro forma results assume the acquisition occurred on October 1,
2008.  The pro forma results do not purport to represent what the Company’s
results of operations actually would have been if the transactions set forth
above had occurred on the date indicated or what the Company’s results of
operations will be in future periods.  The financial results for the
periods prior to the acquisition were based on internal financial statements as
provided by the Sellers.


16





HAUPPAUGE
DIGITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





(Unaudited)Nine
      monthsendedJune
      30,Pro forma statements:
                    
                    2009Revenue
                    
                    $
                    54,112,223Net loss
                    
                    $
                    (6,289,775
                    )Net loss
      per shareBasic
      and diluted net loss per share
                    
                    $
                    (0.63
                    )




17





ITEM
2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION


AND
RESULTS OF OPERATIONS





THREE
MONTH PERIOD ENDED JUNE 30, 2010 COMPARED TO THE THREE MONTH


PERIOD
ENDED JUNE 30, 2009





Results
of operations for the three months ended June 30, 2010 compared to June 30, 2009
is as follows:





Three
                    
                    
                    ThreeMonths
                    
                    
                    MonthsEnded
                    
                    
                    Ended
                    
                    
                    Variance
                    
                    
                    Percentage
      of sales6/30/10
                    
                    
                    6/30/09
                    
                    
                    $
                    
                    
                    2010
                    
                    
                    2009
                    
                    
                    VarianceNet
      Sales
                    
                    $
                    13,593,518
                    
                    
                    $
                    13,067,124
                    
                    
                    $
                    526,394
                    
                    
                    
                    100.00
                    %
                    
                    
                    100.00
                    %
                    
                    
                    -Cost
      of sales
                    
                    
                    7,653,058
                    
                    
                    
                    9,845,438
                    
                    
                    
                    (2,192,380
                    )
                    
                    
                    56.30
                    %
                    
                    
                    75.35
                    %
                    
                    
                    -19.05
                    %Gross
      Profit
                    
                    
                    5,940,460
                    
                    
                    
                    3,221,686
                    
                    
                    
                    2,718,774
                    
                    
                    
                    43.70
                    %
                    
                    
                    24.65
                    %
                    
                    
                    19.05
                    %Gross
      Profit %
                    
                    
                    43.70
                    %
                    
                    
                    24.65
                    %
                    
                    
                    19.05
                    %Expenses:Sales
      & marketing
                    
                    
                    2,306,630
                    
                    
                    
                    2,637,961
                    
                    
                    
                    (331,331
                    )
                    
                    
                    16.97
                    %
                    
                    
                    20.19
                    %
                    
                    
                    -3.22
                    %Sales
      & marketing-PCTV
                    
                    
                    98,203
                    
                    
                    
                    115,335
                    
                    
                    
                    (17,132
                    )
                    
                    
                    0.72
                    %
                    
                    
                    0.88
                    %
                    
                    
                    -0.16
                    %Technical
      support
                    
                    
                    109,426
                    
                    
                    
                    127,922
                    
                    
                    
                    (18,496
                    )
                    
                    
                    0.80
                    %
                    
                    
                    0.98
                    %
                    
                    
                    -0.18
                    %General
      & administrative
                    
                    
                    862,150
                    
                    
                    
                    770,359
                    
                    
                    
                    91,791
                    
                    
                    
                    6.34
                    %
                    
                    
                    5.90
                    %
                    
                    
                    0.44
                    %General &
      administrative-PCTV
                    
                    
                    67,358
                    
                    
                    
                    26,144
                    
                    
                    
                    41,214
                    
                    
                    
                    0.50
                    %
                    
                    
                    0.20
                    %
                    
                    
                    0.30
                    %Amortization
      of intangible assets
                    
                    
                    188,709
                    
                    
                    
                    188,709
                    
                    
                    
                    0
                    
                    
                    
                    1.39
                    %
                    
                    
                    1.44
                    %
                    
                    
                    -0.05
                    %Selling,
      general and administrative stock compensation expense
                    
                    
                    73,351
                    
                    
                    
                    88,106
                    
                    
                    
                    (14,755
                    )
                    
                    
                    0.54
                    %
                    
                    
                    0.67
                    %
                    
                    
                    -0.13
                    %Total
      selling, general and administrative expense
                    
                    
                    3,705,827
                    
                    
                    
                    3,954,536
                    
                    
                    
                    (248,709
                    )
                    
                    
                    27.26
                    %
                    
                    
                    30.26
                    %
                    
                    
                    -3.00
                    %Research
      and development
                    
                    
                    653,751
                    
                    
                    
                    608,323
                    
                    
                    
                    45,428
                    
                    
                    
                    4.81
                    %
                    
                    
                    4.66
                    %
                    
                    
                    0.15
                    %Research
      and development-PCTV
                    
                    
                    389,241
                    
                    
                    
                    465,945
                    
                    
                    
                    (76,704
                    )
                    
                    
                    2.86
                    %
                    
                    
                    3.57
                    %
                    
                    
                    -0.71
                    %Research
      and development stock compensation expense
                    
                    
                    40,497
                    
                    
                    
                    48,643
                    
                    
                    
                    (8,146
                    )
                    
                    
                    0.30
                    %
                    
                    
                    0.37
                    %
                    
                    
                    -0.07
                    %Total
      expenses
                    
                    
                    4,789,316
                    
                    
                    
                    5,077,447
                    
                    
                    
                    (288,131
                    )
                    
                    
                    35.23
                    %
                    
                    
                    38.86
                    %
                    
                    
                    -3.63
                    %Income
      ( loss) from operations
                    
                    
                    1,151,144
                    
                    
                    
                    (1,855,761
                    )
                    
                    
                    3,006,905
                    
                    
                    
                    8.47
                    %
                    
                    
                    -14.21
                    %
                    
                    
                    22.68
                    %Other
      income :Interest
      income
                    
                    
                    1,442
                    
                    
                    
                    1,707
                    
                    
                    
                    (265
                    )
                    
                    
                    0.01
                    %
                    
                    
                    0.01
                    %
                    
                    
                    0.00
                    %Interest
      (expense)
                    
                    
                    0
                    
                    
                    
                    (20,832
                    )
                    
                    
                    20,832
                    
                    
                    
                    0.00
                    %
                    
                    
                    -0.16
                    %
                    
                    
                    0.16
                    %Foreign
      currency
                    
                    
                    152,142
                    
                    
                    
                    25,532
                    
                    
                    
                    126,610
                    
                    
                    
                    1.12
                    %
                    
                    
                    0.20
                    %
                    
                    
                    0.92
                    %Total
      other income
                    
                    
                    153,584
                    
                    
                    
                    6,407
                    
                    
                    
                    147,177
                    
                    
                    
                    1.13
                    %
                    
                    
                    0.05
                    %
                    
                    
                    1.08
                    %Income
      (loss) before tax provision
                    
                    
                    1,304,728
                    
                    
                    
                    (1,849,354
                    )
                    
                    
                    3,154,082
                    
                    
                    
                    9.60
                    %
                    
                    
                    -14.16
                    %
                    
                    
                    23.76
                    %Income
      tax provision
                    
                    
                    389,512
                    
                    
                    
                    38,028
                    
                    
                    
                    351,484
                    
                    
                    
                    2.87
                    %
                    
                    
                    0.29
                    %
                    
                    
                    2.58
                    %Net
      income (loss)
                    
                    $
                    915,216
                    
                    
                    $
                    (1,887,382
                    )
                    
                    $
                    2,802,598
                    
                    
                    
                    6.73
                    %
                    
                    
                    -14.45
                    %
                    
                    
                    21.18
                    %




18





Net sales
for the three months ended June 30, 2010 increased $526,394 compared to the
three months ended June 30, 2009 as shown in the table below.





Increase
                  
                  
                  Increase(decrease)
                  
                  
                  (decrease)
                  
                  
                  Percentage
      of sales byThree
      Months
                  
                  
                  Three
      Months
                  
                  
                  Dollar
                  
                  
                  dollar
                  
                  
                  geographic
      regionended 6/30/10
                  
                  
                  ended 6/30/09
                  
                  
                  Variance
                  
                  
                  variance %
                  
                  
                  2010
                  
                  
                  2009The
      Americas
                  
                  $
                  6,276,662
                  
                  
                  $
                  6,834,846
                  
                  
                  $
                  (558,184
                  )
                  
                  
                  -8
                  %
                  
                  
                  46
                  %
                  
                  
                  53
                  %Europe
                  
                  
                  7,075,456
                  
                  
                  
                  5,821,748
                  
                  
                  
                  1,253,708
                  
                  
                  
                  22
                  %
                  
                  
                  52
                  %
                  
                  
                  44
                  %Asia
                  
                  
                  241,400
                  
                  
                  
                  410,530
                  
                  
                  
                  (169,130
                  )
                  
                  
                  -41
                  %
                  
                  
                  2
                  %
                  
                  
                  3
                  %Total
                  
                  $
                  13,593,518
                  
                  
                  $
                  13,067,124
                  
                  
                  $
                  526,394
                  
                  
                  
                  4
                  %
                  
                  
                  100
                  %
                  
                  
                  100
                  %





The
sales increase was attributable to increased European sales due to the addition
of customers acquired in the PCTV acquisition and increased sales to value added
resellers. The weaker Euro exchange rate against the U.S. dollar for the quarter
resulted in lower Euro sales when converted to U.S. dollars. A favorable sales
mix of higher priced product contributed to a 4.95% increase in the average
sales price while unit sales declined by about 0.88%.





Gross
profit





Gross
profit increased $2,718,774 for the three months ended June 30, 2010 compared to
the same period in the prior year.





The
increase in the gross profit is detailed below:





Increase (decrease)Increased
      sales
                  
                  $
                  185,367Decrease
      due to weaker Euro to USD exchange rate
                  
                  
                  (425,052
                  )Higher
      gross profit due to favorable sales mix, including PCTV
      products
                  
                  
                  773,667Change
      in accrued expense fees due to settlements and changes in estimates (See
      Note 11)
                  
                  
                  2,199,167Higher
      production and production related expenses
                  
                  
                  (14,375
                  )Total
      increase in gross profit
                  
                  $
                  2,718,774





Gross
profit percentage for the three months ended June 30, 2010 was 43.70% compared
to 24.65% for the three months ended June 30, 2009, resulting in a gross profit
percentage increase of 19.05%.


The
increase in gross profit percentage is detailed below:





Increase (decrease)Higher
      gross profit due to favorable sales mix, including PCTV
      products
                  
                  
                  4.69
                  %Decrease
      due to weaker Euro to USD exchange rate
                  
                  
                  -2.12
                  %Change
      in accrued expense fees due to settlements and changes in estimates (See
      Note 11)
                  
                  
                  16.18
                  %Production
      and production related expenses
                  
                  
                  0.30
                  %Net
      increase in gross profit percentage
                  
                  
                  19.05
                  %




19





Selling,
general and administrative expenses





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




Three months ended June 30,Dollar Costs
                  
                  
                  Percentage of SalesIncrease
                  
                  
                  
                  
                  
                  
                  
                  
                  Increase2010
                  
                  
                  2009
                  
                  
                  (Decrease)
                  
                  
                  2010
                  
                  
                  2009
                  
                  
                  (Decrease)Sales
      and marketing-HCW
                  
                  $
                  2,306,630
                  
                  
                  $
                  2,637,961
                  
                  
                  $
                  (331,331
                  )
                  
                  
                  16.97
                  %
                  
                  
                  20.19
                  %
                  
                  
                  -3.22
                  %Sales
      and marketing-PCTV
                  
                  
                  98,203
                  
                  
                  
                  115,335
                  
                  
                  
                  (17,132
                  )
                  
                  
                  0.72
                  %
                  
                  
                  0.88
                  %
                  
                  
                  -0.16
                  %Technical
      support
                  
                  
                  109,426
                  
                  
                  
                  127,922
                  
                  
                  
                  (18,496
                  )
                  
                  
                  0.80
                  %
                  
                  
                  0.98
                  %
                  
                  
                  -0.18
                  %General
      and administrative-HCW
                  
                  
                  862,150
                  
                  
                  
                  770,359
                  
                  
                  
                  91,791
                  
                  
                  
                  6.34
                  %
                  
                  
                  5.90
                  %
                  
                  
                  0.44
                  %General
      and administrative-PCTV
                  
                  
                  67,358
                  
                  
                  
                  26,144
                  
                  
                  
                  41,214
                  
                  
                  
                  0.50
                  %
                  
                  
                  0.20
                  %
                  
                  
                  0.30
                  %Amortization
      of intangible assets
                  
                  
                  188,709
                  
                  
                  
                  188,709
                  
                  
                  
                  0
                  
                  
                  
                  1.39
                  %
                  
                  
                  1.44
                  %
                  
                  
                  -0.05
                  %Stock
      compensation
                  
                  
                  73,351
                  
                  
                  
                  88,106
                  
                  
                  
                  (14,755
                  )
                  
                  
                  0.54
                  %
                  
                  
                  0.67
                  %
                  
                  
                  -0.13
                  %Total
                  
                  $
                  3,705,827
                  
                  
                  $
                  3,954,536
                  
                  
                  $
                  (248,709
                  )
                  
                  
                  27.26
                  %
                  
                  
                  30.26
                  %
                  
                  
                  -3.00
                  %





Selling,
general and administrative expense decreased $248,709 from the same period last
year as follows.





Excluding
the PCTV expenses and amortization of intangible assets acquired in the PCTV
acquisition, selling, general and administrative expense decreased $272,791 from
the prior year’s third quarter. Sales and marketing expense for HCW decreased
$331,331, driven by a $112,106 expense decrease resulting from the decrease in
the Euro exchange rate compared to the U.S. dollar, a decrease in sales related
expenses, mainly commissions and co-op advertising expense of $161,467,
reductions in trade show expenses of $15,681 and lower sales office expenses of
38,561, mainly due to personnel and overhead reductions.





Sales and
marketing expenses related to the PCTV product line decreased $17,132, primarily
due to  lower personnel
related expenses.





The
increase in general and administrative expense for HCW of $91,791 was due to
higher professional fees of $31,875, primarily for legal and consulting fees,
and an increase in credit costs of $54,977, due primarily to premiums paid to
purchase Euro denominated option put contracts.





General
and administrative expenses related to the PCTV product line increased $41,214,
primarily due to the overhead expense of the PCTV office in Braunschweig
Germany.





Research
and development expenses





Research
and development expense for the three months ended June 30, 2010 decreased
$39,422 from the three months ended June 30, 2009 as follows:





HCW
                  
                  
                  PCTV
                  
                  
                  TotalResearch
      and development expense-HCW
                  
                  $
                  45,428
                  
                  
                  $
                  0
                  
                  
                  $
                  45,428Research
      and development expense-PCTV
                  
                  
                  0
                  
                  
                  
                  (76,704
                  )
                  
                  
                  (76,704
                  )Stock
      compensation expense
                  
                  
                  (8,146
                  )
                  
                  
                  0
                  
                  
                  
                  (8,146
                  )Total
      research and development expense
                  
                  $
                  37,282
                  
                  
                  $
                  (76,704
                  )
                  
                  $
                  (39,422
                  )




20





Excluding
the expense of the PCTV division, research and development expense increased
$37,282 from the prior year’s third fiscal quarter. The increase was primarily
due to personnel and personnel related increases and the number of development
programs in process.





Offsetting
the expense increases were decreases of $76,704 related to personnel and product
development programs of the PCTV business.




Tax
provision





Our tax
provision for the three months ended June 30, 2010 and 2009 is as
follows:





Three months ended June
      30,2010
                  
                  
                  2009Tax
      expense on international operations
                  
                  $
                  48,912
                  
                  
                  $
                  28,028State
      taxes
                  
                  
                  10,000
                  
                  
                  
                  10,000Deferred
      tax expense
                  
                  
                  330,600
                  
                  
                  
                  -Tax
      provision
                  
                  $
                  389,512
                  
                  
                  $
                  38,028




Summary





We
recorded net income of $915,216 for the three months ended June 30, 2010, which
resulted in basic and diluted net income per share of $0.09 on weighted average
basic and diluted shares of 10,068,765 and 10,204,092, respectively, compared to
a net loss of $1,887,382 for the three months ended June 30, 2009, which
resulted in basic and diluted net loss per share of $0.19 on weighted average
basic and diluted shares of 10,048,771.





Options
to purchase 914,000 and 1,522,394 shares of common stock, at prices from $3.02
to $7.45 and from $1.05 to $8.75, were outstanding for the three months ended
June 30, 2010 and 2009, respectively, but were not included in the computation
of diluted earnings per share because they were anti-dilutive.




21





NINE
MONTH PERIOD ENDED JUNE 30, 2010 COMPARED TO THE NINE MONTH


PERIOD
ENDED JUNE 30, 2009





Results
of operations for the nine months ended June 30, 2010 compared to June 30, 2009
is as follows:





Nine
                
                
                NineMonths
                
                
                MonthsEnded
                
                
                Ended
                
                
                Variance
                
                
                Percentage
      of sales6/30/10
                
                
                6/30/09
                
                
                $
                
                
                2010
                
                
                2009
                
                
                VarianceNet
      Sales
                
                $
                45,318,955
                
                
                $
                43,089,233
                
                
                $
                2,229,722
                
                
                
                100.00
                %
                
                
                100.00
                %
                
                
                0
                %Cost
      of sales
                
                
                30,290,307
                
                
                
                34,305,007
                
                
                
                (4,014,700
                )
                
                
                66.84
                %
                
                
                79.61
                %
                
                
                -12.77
                %Gross
      Profit
                
                
                15,028,648
                
                
                
                8,784,226
                
                
                
                6,244,422
                
                
                
                33.16
                %
                
                
                20.39
                %
                
                
                12.77
                %Gross
      Profit %
                
                
                33.16
                %
                
                
                20.39
                %
                
                
                12.77
                %Expenses:Sales
      & marketing
                
                
                7,613,677
                
                
                
                7,753,381
                
                
                
                (139,704
                )
                
                
                16.80
                %
                
                
                17.99
                %
                
                
                -1.19
                %Sales
      & marketing-PCTV
                
                
                335,840
                
                
                
                203,380
                
                
                
                132,460
                
                
                
                0.74
                %
                
                
                0.47
                %
                
                
                0.27
                %Technical
      support
                
                
                353,928
                
                
                
                398,906
                
                
                
                (44,978
                )
                
                
                0.78
                %
                
                
                0.93
                %
                
                
                -0.14
                %General
      & administrative
                
                
                2,506,680
                
                
                
                2,493,210
                
                
                
                13,470
                
                
                
                5.53
                %
                
                
                5.79
                %
                
                
                -0.26
                %General
      & administrative-PCTV
                
                
                229,572
                
                
                
                169,845
                
                
                
                59,727
                
                
                
                0.51
                %
                
                
                0.39
                %
                
                
                0.11
                %Amortization
      of intangible assets
                
                
                566,127
                
                
                
                377,418
                
                
                
                188,709
                
                
                
                1.25
                %
                
                
                0.88
                %
                
                
                0.37
                %Selling,
      general and administrative stock compensation expense
                
                
                210,263
                
                
                
                258,963
                
                
                
                (48,700
                )
                
                
                0.46
                %
                
                
                0.60
                %
                
                
                -0.14
                %Total
      selling, general and administrative expense
                
                
                11,816,087
                
                
                
                11,655,103
                
                
                
                160,984
                
                
                
                26.07
                %
                
                
                27.05
                %
                
                
                -0.98
                %Research
      and development
                
                
                1,805,991
                
                
                
                2,197,065
                
                
                
                (391,074
                )
                
                
                3.99
                %
                
                
                5.09
                %
                
                
                -1.10
                %Research
      and development-PCTV
                
                
                1,336,583
                
                
                
                896,363
                
                
                
                440,220
                
                
                
                2.95
                %
                
                
                2.08
                %
                
                
                0.87
                %Research
      and development stock compensation expense
                
                
                116,087
                
                
                
                142,973
                
                
                
                (26,886
                )
                
                
                0.26
                %
                
                
                0.32
                %
                
                
                -0.06
                %Total
      expenses
                
                
                15,074,748
                
                
                
                14,891,504
                
                
                
                183,244
                
                
                
                33.27
                %
                
                
                34.54
                %
                
                
                -1.27
                %Loss
      from operations
                
                
                (46,100
                )
                
                
                (6,107,278
                )
                
                
                6,061,178
                
                
                
                -0.11
                %
                
                
                -14.15
                %
                
                
                14.04
                %Other
      income :Interest
      income
                
                
                4,336
                
                
                
                11,332
                
                
                
                (6,996
                )
                
                
                0.01
                %
                
                
                0.03
                %
                
                
                -0.02
                %Interest
      (expense)
                
                
                (4,340
                )
                
                
                (49,478
                )
                
                
                45,138
                
                
                
                -0.01
                %
                
                
                -0.11
                %
                
                
                0.10
                %Foreign
      currency
                
                
                213,770
                
                
                
                669,209
                
                
                
                (455,439
                )
                
                
                0.47
                %
                
                
                1.55
                %
                
                
                -1.08
                %Total
      other income
                
                
                213,766
                
                
                
                631,063
                
                
                
                (417,297
                )
                
                
                0.47
                %
                
                
                1.47
                %
                
                
                -1.00
                %Income
      (loss) before tax provision
                
                
                167,666
                
                
                
                (5,476,215
                )
                
                
                5,643,881
                
                
                
                0.36
                %
                
                
                -12.68
                %
                
                
                13.04
                %Income
      tax provision
                
                
                489,874
                
                
                
                115,550
                
                
                
                374,324
                
                
                
                1.08
                %
                
                
                0.27
                %
                
                
                0.81
                %Net
      loss
                
                $
                (322,208
                )
                
                $
                (5,591,765
                )
                
                $
                5,269,557
                
                
                
                -0.72
                %
                
                
                -12.95
                %
                
                
                12.23
                %




22




Net sales
for the nine months ended June 30, 2010 increased $2,229,722 compared to the
nine months ended June 30, 2009 as shown in the table below.





Increase
                  
                  
                  Increase(decrease)
                  
                  
                  (decrease)
                  
                  
                  Percentage
      of sales byNine
      Months
                  
                  
                  Nine
      Months
                  
                  
                  dollar
                  
                  
                  dollar
                  
                  
                  Geographic
      regionended 6/30/10
                  
                  
                  ended 6/30/09
                  
                  
                  variance
                  
                  
                  variance %
                  
                  
                  2010
                  
                  
                  2009The
      Americas
                  
                  $
                  20,257,893
                  
                  
                  $
                  21,341,299
                  
                  
                  $
                  (1,083,406
                  )
                  
                  
                  -5
                  %
                  
                  
                  45
                  %
                  
                  
                  51
                  %Europe
                  
                  
                  24,029,538
                  
                  
                  
                  20,363,226
                  
                  
                  
                  3,666,312
                  
                  
                  
                  18
                  %
                  
                  
                  53
                  %
                  
                  
                  46
                  %Asia
                  
                  
                  1,031,524
                  
                  
                  
                  1,384,708
                  
                  
                  
                  (353,184
                  )
                  
                  
                  -26
                  %
                  
                  
                  2
                  %
                  
                  
                  3
                  %Total
                  
                  $
                  45,318,955
                  
                  
                  $
                  43,089,233
                  
                  
                  $
                  2,229,722
                  
                  
                  
                  5
                  %
                  
                  
                  100
                  %
                  
                  
                  100
                  %





The sales
increase was attributable to increased European sales due to the addition of
customers acquired in the PCTV acquisition. The stronger Euro exchange rate
against the U.S. dollar for the nine months ended June 30, 2010 resulted in
higher Euro sales when converted to U.S. dollars. A favorable sales mix of
higher priced product contributed to a 1.66% increase in the average sales price
while unit sales increased by about 3.45%.





Gross
profit





Gross
profit increased $6,244,422 for the nine months ended June 30, 2010 compared to
the same period in the prior year.





The
increase in the gross profit is detailed below:





Increase (decrease)Increased
      sales
                  
                  $
                  691,768Increase
      due to strengthening of the Euro exchange rate
                  
                  
                  718,827Higher
      gross profit due to favorable sales mix, including PCTV
      products
                  
                  
                  2,846,103Change
      in accrued expense fees due to settlements and changes in estimates ( See
      Note 11)
                  
                  
                  2,199,167Higher
      production and production related expenses
                  
                  
                  (211,443
                  )Total
      increase in gross profit
                  
                  $
                  6,244,422





Gross
profit percentage for the nine months ended June 30, 2010 was 33.16 % compared
to 20.39% for the nine months ended June 30, 2009, resulting in a gross profit
percentage increase of 12.77%.





The
increase in gross profit percentage is detailed below:





Increase (decrease)Higher
      gross profit due to favorable sales mix, including PCTV
      products
                  
                  
                  6.76
                  %Increase
      due to strengthening of the Euro exchange rate
                  
                  
                  1.10
                  %Change
      in accrued expense fees due to settlements and changes in estimates ( See
      Note 11)
                  
                  
                  4.85
                  %Production
      and production related expenses
                  
                  
                  0.06
                  %Net
      increase in gross profit percentage
                  
                  
                  12.77
                  %




23




Selling,
general and administrative expenses





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





Nine months ended June
    30,Dollar Costs
                  
                  
                  Percentage of SalesIncrease
                  
                  
                  
                  
                  
                  
                  
                  
                  Increase2010
                  
                  
                  2009
                  
                  
                  (Decrease)
                  
                  
                  2010
                  
                  
                  2009
                  
                  
                  (Decrease)Sales
      and marketing-HCW
                  
                  $
                  7,613,677
                  
                  
                  $
                  7,753,381
                  
                  
                  $
                  (139,704
                  )
                  
                  
                  16.80
                  %
                  
                  
                  17.99
                  %
                  
                  
                  -1.19
                  %Sales
      and marketing-PCTV
                  
                  
                  335,840
                  
                  
                  
                  203,380
                  
                  
                  
                  132,460
                  
                  
                  
                  0.74
                  %
                  
                  
                  0.47
                  %
                  
                  
                  0.27
                  %Technical
      support
                  
                  
                  353,928
                  
                  
                  
                  398,906
                  
                  
                  
                  (44,978
                  )
                  
                  
                  0.78
                  %
                  
                  
                  0.93
                  %
                  
                  
                  -0.14
                  %General
      and administrative-HCW
                  
                  
                  2,506,680
                  
                  
                  
                  2,493,210
                  
                  
                  
                  13,470
                  
                  
                  
                  5.53
                  %
                  
                  
                  5.79
                  %
                  
                  
                  -0.26
                  %General
      and administrative-PCTV
                  
                  
                  229,572
                  
                  
                  
                  169,845
                  
                  
                  
                  59,727
                  
                  
                  
                  0.51
                  %
                  
                  
                  0.39
                  %
                  
                  
                  0.11
                  %Amortization
      of intangible assets
                  
                  
                  566,127
                  
                  
                  
                  377,418
                  
                  
                  
                  188,709
                  
                  
                  
                  1.25
                  %
                  
                  
                  0.88
                  %
                  
                  
                  0.37
                  %Stock
      compensation
                  
                  
                  210,263
                  
                  
                  
                  258,963
                  
                  
                  
                  (48,700
                  )
                  
                  
                  0.46
                  %
                  
                  
                  0.60
                  %
                  
                  
                  -0.14
                  %Total
                  
                  $
                  11,816,087
                  
                  
                  $
                  11,655,103
                  
                  
                  $
                  160,984
                  
                  
                  
                  26.07
                  %
                  
                  
                  27.05
                  %
                  
                  
                  -0.98
                  %





Selling,
general and administrative expense for the nine months ended June 30, 2010
increased $160,984 compared to the same period in the prior year.





Excluding
the PCTV expenses and amortization of intangible assets acquired in the PCTV
acquisition, selling, general and administrative expenses decreased $219,612
over the prior year. Sales and marketing expenses for HCW decreased 139,704,
driven by reductions in trade show expenses of $62,859, lower sales office
expenses of $246,344, mainly due to personnel and overhead reductions, lower
travel expenses of $13,625 and lower sales compensation expense of $33,845 due
to personnel reductions, offset by an increase in expenses of $190,471 resulting
from the increase in the Euro exchange rate compared to the U.S. dollar and an
increase in sales volume related expenses, mainly commissions and co-op
advertising expense of $26,310.





Sales and
marketing expenses related to the PCTV product line increased $132,460. The PCTV
acquisition was finalized at the end of December 2008, so the results for nine
months ended June 30, 2009 only included six months of PCTV expenses while the
results for the nine months ended June 30, 2010 included PCTV expenses for nine
months.





The
increase in general and administrative expense for HCW of $13,470 was driven by
higher rent expense of $11,620, higher bad debt expense of $40,000 and higher
credit costs of $92,440 due primarily to premiums paid to purchase Euro
denominated option put contracts, offset by lower professional fees, mainly for
legal, consulting fees and directors fees of $83,400 and a decrease in
compensation expense of $41,149 due to staff reductions and a 10% salary
reduction.





General
and administrative expenses related to the PCTV product line increased $59,727.
The PCTV acquisition was finalized at the end of December 2008, so the results
for the nine months ended June 30, 2009 only included six months of PCTV
expenses, while the results for the nine months ended June 30, 2010 included
PCTV expenses for nine months.





The increase in amortization of
intangible assets of $188,709 was related to intangible assets acquired in the
purchase of the PCTV business.The PCTV acquisition was finalized at the
end of December 2008, so the results for the nine months ended June 30, 2009
only included six months of intangible asset amortization while the results for
the nine months ended June 30, 2010 included nine months of intangible asset
amortization.


24





Research
and development expenses





Research
and development expense for the nine months ended June 30, 2010 increased
$22,260 from the nine months ended June 30, 2009 as follows:




HCW
                  
                  
                  PCTV
                  
                  
                  TotalResearch
      and development expense-HCW
                  
                  $
                  (391,074
                  )
                  
                  $
                  0
                  
                  
                  $
                  (391,074
                  )Research
      and development expense-PCTV
                  
                  
                  -
                  
                  
                  
                  440,220
                  
                  
                  
                  440,220Stock
      compensation expense
                  
                  
                  (26,886
                  )
                  
                  
                  -
                  
                  
                  
                  (26,886
                  )Total
      research and development expense
                  
                  $
                  (417,960
                  )
                  
                  $
                  440,220
                  
                  
                  $
                  22,260





Excluding
the expense of the PCTV division, research and development expense decreased
$417,960 from the same period in the prior year. The decrease was primarily due
to personnel and personnel related reductions and the number of development
programs in process.





Offsetting
the expense decreases were $440,220 in expenses related to personnel and
development programs of the PCTV business acquired at the end of December 2008.
The PCTV acquisition was
finalized at the end of December 2008, so the results for the nine months ended
June 30, 2009 only included six months of research and development expense,
while the results for the nine months ended June 30, 2010 included nine months
of research and development expense.




Tax
provision





Our tax
provision for the nine months ended June 30, 2010 and 2009 is as
follows:





Nine months ended June 30,2010
                  
                  
                  2009Tax
      expense on international operations
                  
                  $
                  129,274
                  
                  
                  $
                  85,550State
      taxes
                  
                  
                  30,000
                  
                  
                  
                  30,000Deferred
      tax expense
                  
                  
                  330,600
                  
                  
                  
                  -Tax
      provision
                  
                  $
                  489,874
                  
                  
                  $
                  115,550




Summary





We
recorded a net loss of $322,208 for the nine months ended June 30, 2010, which
resulted in basic and diluted net loss per share of $0.03 on weighted average
basic and diluted shares of 10,064,618, compared to a net loss of $5,591,765 for
the nine months ended June 30, 2009, which resulted in basic and diluted net
loss per share of $0.56 on weighted average basic and diluted shares of
10,042,546.





Options
to purchase 1,529,442 and 1,522,394 shares of common stock, at prices from $0.95
to $7.45 and from $1.05 to $8.75, were outstanding for the nine months ended
June 30, 2010 and 2009, respectively, but were not included in the computation
of diluted earnings per share because they were anti-dilutive.




Seasonality





As our
sales are primarily to the consumer market, we have experienced certain seasonal
revenue trends. Our peak sales quarter due to holiday season sales of computer
equipment is our first fiscal quarter (October to December), followed by our
second fiscal quarter (January to March). In addition, our international sales,
mostly in the European market, were 52% of sales for the two years ended
September 30, 2009 and 2008 respectively,and 55% for the nine months ended June
30, 2010. Part of our third and fourth quarters (April through June and
July to September) can be potentially impacted by the reduction of activity
experienced in Europe during the summer holiday period.


25





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





Liquidity
and capital resources





Our cash,
working capital and stockholders’ equity position as of June 30, 2010 and
September 30, 2009 is set forth below:





June 30, 2010
                      
                      
                      September 30, 2009Cash
                      
                      $
                      8,166,507
                      
                      
                      $
                      8,368,342Working
      Capital
                      
                      
                      5,265,054
                      
                      
                      
                      5,885,577Stockholders’
      Equity
                      
                      
                      10,996,572
                      
                      
                      
                      12,334,866




The
Company had cash and cash equivalents as of June 30, 2010 of $8,166,507, a
decrease of $201,835 from September
30, 2009.





The
decrease in cash was due to was:





Operating
                                
                                
                                Investing
                                
                                
                                FinancingSources of cash:
                                
                                Activities
                                
                                
                                Activities
                                
                                
                                Activities
                                
                                
                                TotalDecrease
      in accounts receivable
                                
                                $
                                5,350,574
                                
                                
                                $
                                0
                                
                                
                                $
                                0
                                
                                
                                $
                                5,350,574Net
      loss adjusted for non cash items
                                
                                
                                1,452,526
                                
                                
                                
                                -
                                
                                
                                
                                
                                
                                
                                
                                1,452,526Proceeds
      from employee stock purchases
                                
                                
                                0
                                
                                
                                
                                -
                                
                                
                                
                                12,750
                                
                                
                                
                                12,750Total
      sources of cash
                                
                                
                                6,803,100
                                
                                
                                
                                -
                                
                                
                                
                                12,750
                                
                                
                                
                                6,815,850Less cash used for:Increase
      in inventory
                                
                                $
                                (2,855,649
                                )
                                
                                $
                                0
                                
                                
                                $
                                0
                                
                                
                                $
                                (2,855,649
                                )Decrease
      in accounts payable and accrued expenses
                                
                                
                                (2,029,506
                                )
                                
                                
                                0
                                
                                
                                
                                0
                                
                                
                                
                                (2,029,506
                                )Effect
      of exchange rates on cash
                                
                                
                                (1,353,975
                                )
                                
                                
                                0
                                
                                
                                
                                0
                                
                                
                                
                                (1,353,975
                                )PCTV
      acquisition-net of note payable
                                
                                
                                0
                                
                                
                                
                                (511,332
                                )
                                
                                
                                0
                                
                                
                                
                                (511,332
                                )Increase
      in prepaid expenses and other current assets
                                
                                
                                (225,239
                                )
                                
                                
                                0
                                
                                
                                
                                0
                                
                                
                                
                                (225,239
                                )Capital
      equipment purchases
                                
                                
                                0
                                
                                
                                
                                (40,773
                                )
                                
                                
                                0
                                
                                
                                
                                (40,773
                                )Purchase
      of treasury shares
                                
                                
                                0
                                
                                
                                
                                (1,211
                                )
                                
                                
                                0
                                
                                
                                
                                (1,211
                                )Total
      cash usage
                                
                                
                                (6,464,369
                                )
                                
                                
                                (553,316
                                )
                                
                                
                                0
                                
                                
                                
                                (7,017,685
                                )Net
      cash decrease
                                
                                $
                                338,731
                                
                                
                                $
                                (553,316
                                )
                                
                                $
                                12,750
                                
                                
                                $
                                (201,835
                                )





Net cash
provided by operating activities was  due to a decrease in accounts
receivable of $5,350,574 plus the net loss adjusted for non cash items, which
added $1,452,526 to cash. The decrease in accounts receivable was primarily due
to lower fiscal third quarter sales compared to fiscal first quarter sales.
Offsetting these cash increases were increases in inventory of $2,855,649,
increases in prepaid expenses of $225,239 and a decrease in accounts payable and
accrued expenses of $2,029,506. The increase in inventory was due to inventory
purchased to cover expected sales volume for world cup promotions.





Cash of
$533,316 was used in investing activities. Of this amount, the Company paid
$511,332 on the note payable to Avid Technologies, Inc. and $40,773 was used to
purchase fixed assets. As of December 31, 2009, the note to Avid Technologies,
Inc. was fully paid. Cash of $12,750 from financing activities came from
purchases of stock under our employee stock purchase plan.


26





Our cash
requirements for the next twelve months will include, among other things, the
cash needed to fund our operating and working capital needs. With the proper
execution of our business and operating plan, we believe that our cash and cash
equivalents as of June 30, 2010 and our internally generated cash will provide
us with sufficient liquidity to meet our capital needs for the next twelve
months. Failure to meet the business and operating plan could require the need
for additional sources of capital.  In light of the current economic and
credit conditions there can be no assurances that we will be able to find
external sources of financing to fund our additional capital needs. In addition,
if we are able to obtain financing, there can be no assurances that it will be
on financially reasonable terms.




Future
contractual obligations





The
following table shows our contractual obligations related to lease obligations
as of June 30, 2010:


Payments
      due by periodTotal
                  
                  
                  Less than 1 year
                  
                  
                  1-3 years
                  
                  
                  3 to 5 yearsOperating
      lease obligations
                  
                  $
                  1,265,146
                  
                  
                  $
                  717,396
                  
                  
                  $
                  459,343
                  
                  
                  $
                  88,407




Inflation





While
inflation has not had a material effect on our operations in the past, there can
be no assurance that we will be able to continue to offset the effects of
inflation on the costs of our products or services through price increases to
our customers without experiencing a reduction in the demand for our products;
or that inflation will not have an overall effect on the computer equipment
market that would have a material affect on us.




Item  3.  Quantitative
and Qualitative Disclosures About Market Risk





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




Item
4. Controls and Procedures





Disclosure
Controls and Procedures





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





As
required by Exchange Act Rule 13a-15(b), as of the end of the period covered by
this Quarterly Report, with the participation of our principal executive officer
and principal financial officer, we evaluated the effectiveness of our
disclosure controls and procedures. Based on this evaluation, our principal
executive officer and principal financial officer concluded that our disclosure
controls and procedures were effective as of June 30, 2010.


27





Changes
in Internal Control over Financial Reporting





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




Special
note regarding forward-looking statements





This
Quarterly Report contains forward-looking statements as that term is defined in
the federal securities laws. The events described in forward-looking statements
contained in this Quarterly Report may not occur. Generally, these statements
relate to our business plans or strategies, projected or anticipated benefits or
other consequences of our plans or strategies, financing plans, projected or
anticipated benefits from acquisitions that we may make, or projections
involving anticipated revenues, earnings or other aspects of our operating
results or financial position, and the outcome of any contingencies. Any such
forward-looking statements are based on current expectations, estimates and
projections of management.  We intend for these forward-looking statements
to be covered by the safe-harbor provisions for forward-looking statements.
Words such as “may,” “will,” “expect,” “believe,” “anticipate,” “project,”
“plan,” “intend,” “estimate,” and “continue,” and their opposites and similar
expressions are intended to identify forward-looking statements. We caution you
that these statements are not guarantees of future performance or events and are
subject to a number of uncertainties, risks and other influences, many of which
are beyond our control, that may influence the accuracy of the statements and
the projections upon which the statements are based.  Factors that
could cause actual results to differ materially from those set forth or implied
by any forward-looking statement include, but are not limited to, the mix of
products sold and the profit margins thereon, order cancellation or a reduction
in orders from customers, competitive product offerings and pricing actions, the
availability and pricing of key raw materials, the availability of
financing,  dependence on key members of
management,  successful integration of
acquisitions,  economic  conditions in the United States and
abroad,  as well as other risks and uncertainties discussed in our
reports filed with the Securities and Exchange Commission, including, but not
limited to,  our Annual Report on  Form 10-K for the fiscal
year ended September 30, 2009, our Form 10-Q for the three months ended December
31, 2009 and March 31, 2010 and this Quarterly Report.   Copies of
these filings are available at www.sec.gov.




Any one
or more of these uncertainties, risks and other influences could materially
affect our results of operations and whether forward-looking statements made by
us ultimately prove to be accurate.  Our actual results, performance
and achievements could differ materially from those expressed or implied in
these forward-looking statements.  We undertake no obligation to
publicly update or revise any forward-looking statements, whether from new
information, future events or otherwise.





PART
II.  OTHER INFORMATION




Item
2. Unregistered Sales of Equity Securities and Use of Proceeds




On
November 8, 1996, we approved and announced a stock repurchase
program.  The program authorized us to repurchase up to 850,000 shares
of our own stock. The stock repurchase program was extended by a resolution of
our Board of Directors on December 17, 1997.  At our August 3, 2007
Board meeting, our Board of Directors approved an increase in the number of
shares which can be repurchased under the plan to 1,200,000, which we announced
on August 6, 2007.


28





The table
below summarized repurchases of our Common Stock under our stock repurchase
program:





Total
      Number
                  
                  
                  MaximumAverage
                  
                  
                  of
      Shares
                  
                  
                  NumberTotal
                  
                  
                  Price
                  
                  
                  Purchased
      as
                  
                  
                  Of
      SharesNumber
                  
                  
                  Paid
                  
                  
                  Part
      of
                  
                  
                  That
      May Yetof
                  
                  
                  per
                  
                  
                  Publicly
                  
                  
                  Be
      PurchasedShares
                  
                  
                  Paid
                  
                  
                  Announced
                  
                  
                  Under
      thePurchased
                  
                  
                  Share
                  
                  
                  Plan
                  
                  
                  PlanBeginning
      shares that may be repurchased under the plan as of April 1,
      2010
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  440,421April
      1 to April 30, 2010
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -May
      1 to May 31, 2010
                  
                  
                  900
                  
                  
                  
                  1.35
                  
                  
                  
                  900
                  
                  
                  
                  439,521June
      1 to June 30, 2010
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  
                  900
                  
                  
                  
                  1.35
                  
                  
                  
                  900Ending
      shares that may be repurchased under the plan as of June 30,
      2010
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  439,521




Item
6.  Exhibits




3.1
            Certificate
      of Incorporation (1)3.1.1
            Certificate
      of Amendment of the Certificate of Incorporation, dated July 14, 2000
      (2)3.2
            By-laws,
      as amended to date (3)4.1
            Form
      of Common Stock Certificate (1)31.1
            Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) as
      adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200231.2
            Certification
      of the Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a)
      as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200232
            Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C.  Section  1350, as adopted pursuant to
      Section  906 of the Sarbanes-Oxley  Act
      of  2002


(1)
              Denotes
      document filed as an Exhibit to our Registration Statement on Form SB-2
      (No. 33- 85426), as amended, effective January 10, 1995 and incorporated
      herein by reference.


(2)
            Denotes
      document filed as an Exhibit to our Form 10-K for the period ended
      September 30, 2006, and incorporated herein by
  reference.


(3)
            Denotes
      document filed as an Exhibit to our Form 8-K dated December 26, 2007 and
      incorporated herein by
reference.


29





SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





HAUPPAUGE
      DIGITAL INC.Date:  August 16,
      2010
                                    
                                    By
                                    /s/Kenneth PlotkinKENNETH  PLOTKINChief
      Executive Officer, Chairman of theBoard,
      President (Principal Executive Officer)Date:August 16,
      2010
                                    
                                    By
                                    /s/Gerald TucciaroneGERALD
      TUCCIARONETreasurer,
      Chief Financial Officer,(Principal
      Financial Officer and PrincipalAccounting
      Officer) and
Secretary




30