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  December
31,  2009





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 definition 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   January 28, 2010, 10,065,717 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 –
                        December
      31, 2009 (unaudited) and September 30, 2009
                      3Consolidated
      Statements of Operations –
                        Three
      Months ended December 31, 2009 (unaudited) and 2008
      (unaudited)
                      4Consolidated
      Statements of Other Comprehensive Loss
                        Three
      Months ended December 31, 2009 (unaudited) and 2008
      (unaudited)
                      5Consolidated
      Statements of Cash Flows-Three Months ended December 31, 2009 (unaudited)
      and 2008 (unaudited)
                      6Notes
      to Consolidated Financial Statements
                      7-14Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                      15-20Item
      3. Quantitative and Qualitative Disclosures about Market
    Risks
                      20Item  4T.
      Controls and Procedures
                      20PART
      II.  OTHER INFORMATIONItem
      1. Legal Proceedings
                      21Item
      1A.  Risk Factors
                      21Item  2.  Unregistered
      Sales of Equity Securities and Use of Proceeds
                      22Item
      4.  Submission of Matters to a Vote of Security
      Holders
                      22Item
      6. Exhibits
                      22Signatures
                      23




2


PART I. FINANCIAL
INFORMATION




Item
1. Financial Statements


HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





December 31,
                                  2009
                                  (unaudited)
                                
                                
                                September 30 ,
                                  2009Assets:Cash
      and cash  equivalents
                                
                                $
                                10,183,591
                                
                                
                                $
                                8,368,342Trade  receivables,
      net of  various allowances
                                
                                
                                9,499,984
                                
                                
                                
                                9,770,584Other
      non trade receivables
                                
                                
                                3,802,869
                                
                                
                                
                                4,116,392Inventories
                                
                                
                                8,705,417
                                
                                
                                
                                8,616,800Deferred
      tax asset-current
                                
                                
                                1,297,574
                                
                                
                                
                                1,297,574Prepaid
      expenses and other current assets
                                
                                
                                825,432
                                
                                
                                
                                928,680Total  current
      assets
                                
                                
                                34,314,867
                                
                                
                                
                                33,098,372Intangible
      assets, net
                                
                                
                                4,507,393
                                
                                
                                
                                4,696,102Property,
      plant and equipment, net
                                
                                
                                690,740
                                
                                
                                
                                757,488Security
      deposits and other non current assets
                                
                                
                                108,070
                                
                                
                                
                                108,088Deferred
      tax asset-non current
                                
                                
                                887,611
                                
                                
                                
                                887,611Total
      assets
                                
                                $
                                40,508,681
                                
                                
                                $
                                39,547,661Liabilities
      and  Stockholders’  Equity:Current
      Liabilities:Accounts
      payable
                                
                                $
                                12,326,707
                                
                                
                                $
                                12,478,625Accrued
      expenses  fees
                                
                                
                                6,533,173
                                
                                
                                
                                5,753,546Accrued
      expenses
                                
                                
                                9,449,327
                                
                                
                                
                                8,131,263Note
      payable
                                
                                
                                0
                                
                                
                                
                                625,045Income
      taxes payable
                                
                                
                                212,335
                                
                                
                                
                                224,316Total
      current  liabilities
                                
                                
                                28,521,542
                                
                                
                                
                                27,212,795Stockholders'
      Equity:Common
      stock, $.01 par value; 25,000,000 shares authorized,10,819,694  and
      10,814,042  issued, respectively
                                
                                
                                108,197
                                
                                
                                
                                108,140Additional
      paid-in capital
                                
                                
                                17,388,082
                                
                                
                                
                                17,276,651Retained
      earnings
                                
                                
                                461,123
                                
                                
                                
                                795,674Accumulated
      other comprehensive loss
                                
                                
                                (3,565,926
                                )
                                
                                
                                (3,441,262
                                )Treasury
      Stock, at cost, 759,579 shares
                                
                                
                                (2,404,337
                                )
                                
                                
                                (2,404,337
                                )Total
      stockholders' equity
                                
                                
                                11,987,139
                                
                                
                                
                                12,334,866Total  liabilities
      and  stockholders' equity
                                
                                $
                                40,508,681
                                
                                
                                $
                                39,547,661





See accompanying notes to
consolidated financial statements


3





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(UNAUDITED)





Three months ended December 31,2009
                      
                      
                      2008Net
      sales
                      
                      $
                      17,878,358
                      
                      
                      $
                      17,288,680Cost  of
      sales
                      
                      
                      12,655,961
                      
                      
                      
                      14,690,419Gross
      profit
                      
                      
                      5,222,397
                      
                      
                      
                      2,598,261Selling,
      general and  administrative expenses
                      
                      
                      4,332,523
                      
                      
                      
                      3,838,896Research
      and development expenses
                      
                      
                      1,170,071
                      
                      
                      
                      845,642Loss  from
      operations
                      
                      
                      (280,197
                      )
                      
                      
                      (2,086,277
                      )Other  income
      (expense):Interest  income
                      
                      
                      1,452
                      
                      
                      
                      4,469Interest
      expense
                      
                      
                      (4,340
                      )
                      
                      
                      -Foreign
      currency  gain
                      
                      
                      (240
                      )
                      
                      
                      347,002Total  other
      income  (expense)
                      
                      
                      (3,128
                      )
                      
                      
                      351,471Loss
      before tax provision
                      
                      
                      (283,325
                      )
                      
                      
                      (1,734,806
                      )Tax  provision
                      
                      
                      51,226
                      
                      
                      
                      37,507Net
      loss
                      
                      $
                      (334,551
                      )
                      
                      $
                      (1,772,313
                      )Net  loss  per
      share:Basic
      and diluted
                      
                      $
                      (0.03
                      )
                      
                      $
                      (0.18
                      )





See
accompanying notes to consolidated financial statements


4





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OTHER  COMPREHENSIVE LOSS


(UNAUDITED)





Three months ended December 31,2009
                    
                    
                    2008Net
      loss
                    
                    $
                    (334,551
                    )
                    
                    $
                    (1,772,313
                    )Foreign
      currency translation   loss
                    
                    
                    (122,240
                    )
                    
                    
                    (172,963
                    )Forward
      exchange contracts marked to market (loss) gain
                    
                    
                    (2,424
                    )
                    
                    
                    54,734Other  comprehensive
      loss
                    
                    $
                    (459,215
                    )
                    
                    $
                    (1,890,542
                    )





See
accompanying notes to consolidated financial statements


5





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)


Three months ended December 31,2009
                                              
                                              
                                              2008Net
      loss
                                              
                                              $
                                              (334,551
                                              )
                                              
                                              $
                                              (1,772,313
                                              )Adjustments
      to reconcile net loss to net cash provided by (used
      in)  operating  activities:Depreciation
      and amortization
                                              
                                              
                                              69,521
                                              
                                              
                                              
                                              64,995Amortization
      of intangible assets
                                              
                                              
                                              188,709
                                              
                                              
                                              
                                              -Stock  compensation
      expense
                                              
                                              
                                              106,251
                                              
                                              
                                              
                                              132,593Sales
      reserve, net
                                              
                                              
                                              78,300
                                              
                                              
                                              
                                              -Bad
      debt reserve
                                              
                                              
                                              20,000
                                              
                                              
                                              
                                              -Other
      non cash items
                                              
                                              
                                              18
                                              
                                              
                                              
                                              (6,173
                                              )Changes
      in current assets and liabilities, net of effects of
      acquisition:Accounts
      receivable
                                              
                                              
                                              251,123
                                              
                                              
                                              
                                              (2,502,401
                                              )Inventories
                                              
                                              
                                              146,083
                                              
                                              
                                              
                                              (224,779
                                              )Prepaid
      expenses and other current assets
                                              
                                              
                                              103,248
                                              
                                              
                                              
                                              109,118Accounts
      payable
                                              
                                              
                                              (151,918
                                              )
                                              
                                              
                                              2,559,525Accrued
      expenses  and other current liabilities
                                              
                                              
                                              1,971,997
                                              
                                              
                                              
                                              1,207,564Total
      adjustments
                                              
                                              
                                              2,783,332
                                              
                                              
                                              
                                              1,340,442Net
      cash provided by (used in) operating activities
                                              
                                              
                                              2,448,781
                                              
                                              
                                              
                                              (431,871
                                              )Cash
      Flows From Investing Activities:PCTV
      acquisition
                                              
                                              
                                              (511,332
                                              )
                                              
                                              
                                              (2,273,000
                                              )Purchases
      of property, plant and equipment
                                              
                                              
                                              (2,773
                                              )
                                              
                                              
                                              (7,061
                                              )Net
      cash used in investing activities
                                              
                                              
                                              (514,105
                                              )
                                              
                                              
                                              (2,280,061
                                              )Cash
      Flows From Financing Activities:Proceeds
      from the exercise of stock options and employee  stock
      purchases
                                              
                                              
                                              5,237
                                              
                                              
                                              
                                              11,000Net 
      cash   provided by  financing
    activities
                                              
                                              
                                              5,237
                                              
                                              
                                              
                                              11,000Effect
      of exchange rates on cash
                                              
                                              
                                              (124,664
                                              )
                                              
                                              
                                              (118,229
                                              )Net  increase
      (decrease)  in cash and cash equivalents
                                              
                                              
                                              1,815,249
                                              
                                              
                                              
                                              (2,819,161
                                              )Cash
      and cash equivalents, beginning of period
                                              
                                              
                                              8,368,342
                                              
                                              
                                              
                                              14,191,721Cash
      and cash equivalents, end of period
                                              
                                              $
                                              10,183,591
                                              
                                              
                                              $
                                              11,372,560Supplemental
      disclosures:Interest
      paid
                                              
                                              $
                                              4,340
                                              
                                              
                                              $
                                              -Income
      taxes paid
                                              
                                              $
                                              61,171
                                              
                                              
                                              $
                                              11,102Note
      payable to Avid Technology, Inc.
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              2,500,000





See
accompanying notes to consolidated financial statements


6


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 months ended December 31, 2009 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 February 12, 2010 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




Trade
receivables and other non-trade receivables as of December 31, 2009 and
September 30, 2009 consisted of:


7





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





December 31,
                  
                  
                  September 30,2009
                  
                  
                  2009Trade
      receivables
                  
                  $
                  13,956,204
                  
                  
                  $
                  13,893,804Allowances
      and reserves
                  
                  
                  (4,456,220
                  )
                  
                  
                  (4,123,220
                  )Total
      trade receivables
                  
                  
                  9,499,984
                  
                  
                  
                  9,770,584Receivable
      from contract manufacturers
                  
                  
                  2,541,172
                  
                  
                  
                  2,933,918GST
      and VAT taxes receivables
                  
                  
                  1,194,389
                  
                  
                  
                  1,134,331Other
                  
                  
                  67,308
                  
                  
                  
                  48,143Total
      non trade receivables
                  
                  $
                  3,802,869
                  
                  
                  $
                  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:





December 31,
                    
                    
                    September 30,2009
                    
                    
                    2009Component
      parts
                    
                    $
                    2,955,483
                    
                    
                    $
                    2,799,723Finished
      goods
                    
                    
                    5,749,934
                    
                    
                    
                    5,817,077$
                    8,705,417
                    
                    
                    $
                    8,616,800





Note
4.  Intangible Assets





The
following is a summary of intangible assets as of December 31, 2009


Net
                  
                  
                  WeightedPurchase
                  
                  
                  Accumulated
                  
                  
                  Book
                  
                  
                  average remainingAsset description
                  
                  cost
                  
                  
                  Amortization
                  
                  
                  Value
                  
                  
                  life (in years)Customer
      relationships
                  
                  $
                  1,644,353
                  
                  
                  $
                  (137,029
                  )
                  
                  $
                  1,507,324
                  
                  
                  
                  11.00Value
      of technology
                  
                  
                  1,849,897
                  
                  
                  
                  (264,271
                  )
                  
                  
                  1,585,626
                  
                  
                  
                  6.00Covenant  not
      to compete
                  
                  
                  1,767,979
                  
                  
                  
                  (353,536
                  )
                  
                  
                  1,414,443
                  
                  
                  
                  4.00Total
      intangible  assets
                  
                  $
                  5,262,229
                  
                  
                  $
                  (754,836
                  )
                  
                  $
                  4,507,393
                  
                  
                  
                  8.24





Amortization
expense totaled approximately $188,000 for the three months ended December 31,
2009.  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.


8





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
                          December 31,2009
                        
                        
                        2008Weighted
      average shares outstanding-basic
                        
                        
                        10,059,808
                        
                        
                        
                        10,035,088Number
      of shares issued on the assumedexercise
      of  stock options
                        
                        
                        -
                        
                        
                        
                        -Weighted
      average shares outstanding-diluted
                        
                        
                        10,059,808
                        
                        
                        
                        10,035,088





Options
to purchase 1,522,394 and 1,767,744  shares of common
stock,  at  prices for both periods ranging
from  $1.05 to $8.75,  were outstanding for the three months
ended December 31, 2009 and 2008, 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 three months ended December
31, 2009 the Company recorded on the balance sheet translation losses
of  $122,240, resulting in an accumulated translation loss of
$3,563,502  recorded as a component of accumulated other comprehensive
income as of December 31, 2009.


9





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, 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  December 31, 2009, the Company had foreign currency contracts
outstanding of approximately $1,072,150 against the delivery of the Euro. These
contracts expired each month through June 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,” which amounted to losses of
$2,424  as of  December 31, 2009.


10





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 price of the product and payment terms are fixed per the
terms of the purchase order.  Upon shipment of the order to the
customer, the title to the goods is passed to the customer. The customer is
legally obligated to pay for the order within the payment terms stated on the
customer’s purchase order.  The obligation to insure the boards and
the cost of any pilferage while in the customer’s possession is the
responsibility of the customer.  The 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 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.


11





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





The
Company’s products fall under three product categories:





·
            Analog
      TV tuner boards


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


·
            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 shows on a
PC for playback on  portable video players.





Sales by
functional category are as follows:




Three months ended December 31Product line sales
                  
                  2009
                  
                  
                  2008Analog
      TV tuner products
                  
                  $
                  277,870
                  
                  
                  $
                  656,661Digital
      and combination analog and  digital TV  tuner
      products
                  
                  
                  15,805,316
                  
                  
                  
                  15,822,858Other
      non-TV tuner products
                  
                  
                  1,795,172
                  
                  
                  
                  809,161Total
      sales
                  
                  $
                  17,878,358
                  
                  
                  $
                  17,288,680




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





Three months ended December 31Geographic region
                  
                  2009
                  
                  
                  2008The
      Americas
                  
                  
                  43
                  %
                  
                  
                  42
                  %Europe
                  
                  
                  55
                  %
                  
                  
                  54
                  %Asia
                  
                  
                  2
                  %
                  
                  
                  4
                  %Total
                  
                  
                  100
                  %
                  
                  
                  100
                  %


12





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  December 31, 2009 and 2008 is as follows:





Three months ended December 31,2009
                  
                  
                  2008Tax  expense
      on international  operations
                  
                  $
                  41,226
                  
                  
                  
                  27,507State
      taxes
                  
                  
                  10,000
                  
                  
                  
                  10,000Tax
      provision
                  
                  $
                  51,226
                  
                  
                  $
                  37,507





Note
11. Fair Value Measurements





Effective
October 1, 2008 the Company adopted ASC 820-10, Fair Value Measurements, for
financial assets and liabilities.  This ASC defines fair value,
establishes a framework for measuring fair value, and expands the related
disclosure requirements. The ASC indicates, among other things, that a fair
value measurement assumes a transaction to sell an asset or transfer a liability
occurs in the principal market for the asset or liability or, in the absence of
a principal market, the most advantageous market for the asset or liability. The
Company also adopted the provisions of ASC 820-10 with respect to its
non-financial assets and liabilities during the first quarter of fiscal
2010.  In order to increase consistency and comparability in fair
value measurements, ASC 820-10 establishes a hierarchy for observable and
unobservable inputs used to measure fair value into three broad Levels, which
are described below:





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


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


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





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





At
December 31, 2009,  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 SFAS 157 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


13





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




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
12. 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.





Three monthsendedDecember 31,Pro forma statements:
                    
                    2008Revenue
                    
                    $
                    28,311,680Net  loss
                    
                    $
                    (1,279,937
                    )Net  loss
      per shareBasic
      net loss per share
                    
                    $
                    (0.13
                    )Diluted
      net loss per share
                    
                    $
                    (0.13
                    )




14


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


AND
RESULTS OF OPERATIONS




THREE
MONTH PERIOD  ENDED DECEMBER 31, 2009 COMPARED TO THREE MONTH


PERIOD
ENDED DECEMBER 31, 2008





Results
of operations for the three months ended December 31, 2009 compared to December
31, 2008 is as follows:





Three
                  
                  
                  ThreeMonths
                  
                  
                  MonthsEnded
                  
                  
                  Ended
                  
                  
                  Variance
                  
                  
                  Percentage
      of sales12/31/09
                  
                  
                  12/31/08
                  
                  
                  $
                  
                  
                  2009
                  
                  
                  2008
                  
                  
                  VarianceNet
      Sales
                  
                  $
                  17,878,358
                  
                  
                  $
                  17,288,680
                  
                  
                  $
                  589,678
                  
                  
                  
                  100.00
                  %
                  
                  
                  100.00
                  %
                  
                  
                  -Cost
      of sales
                  
                  
                  12,655,961
                  
                  
                  
                  14,690,419
                  
                  
                  
                  (2,034,458
                  )
                  
                  
                  70.79
                  %
                  
                  
                  84.97
                  %
                  
                  
                  -14.18
                  %Gross
      Profit
                  
                  
                  5,222,397
                  
                  
                  
                  2,598,261
                  
                  
                  
                  2,624,136
                  
                  
                  
                  29.21
                  %
                  
                  
                  15.03
                  %
                  
                  
                  14.18
                  %Gross
      Profit %
                  
                  
                  29.21
                  %
                  
                  
                  15.03
                  %
                  
                  
                  14.18
                  %Expenses:Sales
      & marketing
                  
                  
                  2,900,815
                  
                  
                  
                  2,759,291
                  
                  
                  
                  141,524
                  
                  
                  
                  16.23
                  %
                  
                  
                  15.96
                  %
                  
                  
                  0.27
                  %Sales
      & marketing-PCTV
                  
                  
                  124,713
                  
                  
                  
                  0
                  
                  
                  
                  124,713
                  
                  
                  
                  0.70
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.70
                  %Technical
      support
                  
                  
                  121,173
                  
                  
                  
                  135,384
                  
                  
                  
                  (14,211
                  )
                  
                  
                  0.68
                  %
                  
                  
                  0.78
                  %
                  
                  
                  -0.10
                  %General   &
      administrative
                  
                  
                  835,677
                  
                  
                  
                  858,793
                  
                  
                  
                  (23,116
                  )
                  
                  
                  4.67
                  %
                  
                  
                  4.97
                  %
                  
                  
                  -0.30
                  %General   &
      administrative-PCTV
                  
                  
                  92,980
                  
                  
                  
                  0
                  
                  
                  
                  92,980
                  
                  
                  
                  0.52
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.52
                  %Amortization
      of intangible assets
                  
                  
                  188,709
                  
                  
                  
                  0
                  
                  
                  
                  188,709
                  
                  
                  
                  1.06
                  %
                  
                  
                  0.00
                  %
                  
                  
                  1.06
                  %Selling,
      general and administrative stock compensation expense
                  
                  
                  68,456
                  
                  
                  
                  85,428
                  
                  
                  
                  (16,972
                  )
                  
                  
                  0.38
                  %
                  
                  
                  0.49
                  %
                  
                  
                  -0.11
                  %Total  selling,
      general and administrative expense
                  
                  
                  4,332,523
                  
                  
                  
                  3,838,896
                  
                  
                  
                  493,627
                  
                  
                  
                  24.24
                  %
                  
                  
                  22.20
                  %
                  
                  
                  2.04
                  %Research  and
      development
                  
                  
                  627,757
                  
                  
                  
                  798,477
                  
                  
                  
                  (170,720
                  )
                  
                  
                  3.51
                  %
                  
                  
                  4.62
                  %
                  
                  
                  -1.11
                  %Research  and
      development-PCTV
                  
                  
                  504,519
                  
                  
                  
                  0
                  
                  
                  
                  504,519
                  
                  
                  
                  2.82
                  %
                  
                  
                  0.00
                  %
                  
                  
                  2.82
                  %Research
      and development stock compensation expense
                  
                  
                  37,795
                  
                  
                  
                  47,165
                  
                  
                  
                  (9,370
                  )
                  
                  
                  0.21
                  %
                  
                  
                  0.27
                  %
                  
                  
                  -0.06
                  %Total
      expenses
                  
                  
                  5,502,594
                  
                  
                  
                  4,684,538
                  
                  
                  
                  818,056
                  
                  
                  
                  30.78
                  %
                  
                  
                  27.09
                  %
                  
                  
                  3.69
                  %Net
      operating  loss
                  
                  
                  (280,197
                  )
                  
                  
                  (2,086,277
                  )
                  
                  
                  1,806,080
                  
                  
                  
                  -1.57
                  %
                  
                  
                  -12.06
                  %
                  
                  
                  10.49
                  %Other
      income :Interest
      income
                  
                  
                  1,452
                  
                  
                  
                  4,469
                  
                  
                  
                  (3,017
                  )
                  
                  
                  0.01
                  %
                  
                  
                  0.03
                  %
                  
                  
                  -0.02
                  %Interest  (expense)
                  
                  
                  (4,340
                  )
                  
                  
                  0
                  
                  
                  
                  (4,340
                  )
                  
                  
                  -0.02
                  %
                  
                  
                  0.00
                  %
                  
                  
                  -0.02
                  %Foreign
      currency
                  
                  
                  (240
                  )
                  
                  
                  347,002
                  
                  
                  
                  (347,242
                  )
                  
                  
                  0.00
                  %
                  
                  
                  2.01
                  %
                  
                  
                  -2.01
                  %Total
      other income
                  
                  
                  (3,128
                  )
                  
                  
                  351,471
                  
                  
                  
                  (354,599
                  )
                  
                  
                  -0.01
                  %
                  
                  
                  2.04
                  %
                  
                  
                  -2.05
                  %Loss  before
      tax provision
                  
                  
                  (283,325
                  )
                  
                  
                  (1,734,806
                  )
                  
                  
                  1,451,481
                  
                  
                  
                  -1.58
                  %
                  
                  
                  -10.02
                  %
                  
                  
                  8.44
                  %Income
      tax provision
                  
                  
                  51,226
                  
                  
                  
                  37,507
                  
                  
                  
                  13,719
                  
                  
                  
                  0.29
                  %
                  
                  
                  0.22
                  %
                  
                  
                  0.07
                  %Net
      loss
                  
                  $
                  (334,551
                  )
                  
                  $
                  (1,772,313
                  )
                  
                  $
                  1,437,762
                  
                  
                  
                  -1.87
                  %
                  
                  
                  -10.24
                  %
                  
                  
                  8.37
                  %




15





Net sales
for the three months ended December 31, 2009 increased $589,678 compared to the
three months ended December 31, 2008 as shown in the table below.





Increase
                  
                  
                  Increase(decrease)
                  
                  
                  (decrease)
                  
                  
                  Percentage
      of sales byThree
      Months
                  
                  
                  Three
      Months
                  
                  
                  Dollar
                  
                  
                  dollar
                  
                  
                  Geographic
      regionended 12/31/09
                  
                  
                  ended 12/31/08
                  
                  
                  Variance
                  
                  
                  variance %
                  
                  
                  2009
                  
                  
                  2008The
      Americas
                  
                  $
                  7,663,098
                  
                  
                  $
                  7,273,124
                  
                  
                  $
                  389,974
                  
                  
                  
                  5
                  %
                  
                  
                  43
                  %
                  
                  
                  42
                  %Europe
                  
                  
                  9,812,426
                  
                  
                  
                  9,405,299
                  
                  
                  
                  407,127
                  
                  
                  
                  4
                  %
                  
                  
                  55
                  %
                  
                  
                  54
                  %Asia
                  
                  
                  402,834
                  
                  
                  
                  610,257
                  
                  
                  
                  (207,423
                  )
                  
                  
                  -34
                  %
                  
                  
                  2
                  %
                  
                  
                  4
                  %Total
                  
                  $
                  17,878,358
                  
                  
                  $
                  17,288,680
                  
                  
                  $
                  589,678
                  
                  
                  
                  3
                  %
                  
                  
                  100
                  %
                  
                  
                  100
                  %





The
sales increase was attributable to increased domestic sales due to the addition
of customers acquired in the PCTV acquisition, increased sales to computer
manufacturers and a strengthening of the Euro exchange rate against the U.S.
dollar. A favorable mix of higher sales priced product contributed to an 8.28%
increase in average sales price while units sales declined by about
4.50%.





Gross
profit





Gross
profit increased $2,624,136 for the three months ended December 31, 2009
compared to the same period in the prior year.  The increase in gross
profit was due to:




The
increase in the gross profit is detailed below:




Increase (decrease)Increased  sales
                  
                  $
                  150,724Increase
      due strengthening of the  Euro exchange rate
                  
                  
                  786,427Higher
      gross profit due to favorable sales mix
                  
                  
                  1,781,278Higher
      production and production related expenses
                  
                  
                  (94,293
                  )Total  decrease
      in gross profit
                  
                  $
                  2,624,136





Gross
profit percentage for the three months ended December 31, 2009 was 29.21 %
compared to 15.03% for the three months ended December 31, 2008, resulting in a
gross profit increase of 14.18%.




The
increase in gross profit percentage is detailed below:





Increase (decrease)Higher
      gross profit due favorable sales mix, including PCTV
    products
                  
                  
                  11.25
                  %Increase
      due to strengthening of the  Euro exchange rate
                  
                  
                  3.11
                  %Production
      and production related expenses
                  
                  
                  (0.18
                  )%Net
      increase in gross profit  percentage
                  
                  
                  14.18
                  %





Selling,
general and administrative expenses





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


16




Three months ended December
      31,Dollar Costs
                    
                    
                    Percentage of Sales2009
                    
                    
                    2008
                    
                    
                    Decrease
                    
                    
                    2009
                    
                    
                    2008
                    
                    
                    IncreaseSales
      and marketing-HCW
                    
                    $
                    2,900,815
                    
                    
                    $
                    2,759,291
                    
                    
                    $
                    141,524
                    
                    
                    
                    16.23
                    %
                    
                    
                    15.96
                    %
                    
                    
                    0.27
                    %Sales
      and marketing-PCTV
                    
                    
                    124,713
                    
                    
                    
                    0
                    
                    
                    
                    124,713
                    
                    
                    
                    0.70
                    %
                    
                    
                    0.00
                    %
                    
                    
                    0.70
                    %Technical  support
                    
                    
                    121,173
                    
                    
                    
                    135,384
                    
                    
                    
                    (14,211
                    )
                    
                    
                    0.68
                    %
                    
                    
                    0.78
                    %
                    
                    
                    -0.10
                    %General
      and administrative-HCW
                    
                    
                    835,677
                    
                    
                    
                    858,793
                    
                    
                    
                    (23,116
                    )
                    
                    
                    4.67
                    %
                    
                    
                    4.97
                    %
                    
                    
                    -0.30
                    %General
      and administrative-PCTV
                    
                    
                    92,980
                    
                    
                    
                    0
                    
                    
                    
                    92,980
                    
                    
                    
                    0.52
                    %
                    
                    
                    0.00
                    %
                    
                    
                    0.52
                    %Amortization
      of intangible assets
                    
                    
                    188,709
                    
                    
                    
                    0
                    
                    
                    
                    188,709
                    
                    
                    
                    1.06
                    %
                    
                    
                    0.00
                    %
                    
                    
                    1.06
                    %Stock
      compensation
                    
                    
                    68,456
                    
                    
                    
                    85,428
                    
                    
                    
                    (16,972
                    )
                    
                    
                    0.38
                    %
                    
                    
                    0.49
                    %
                    
                    
                    -0.11
                    %Total
                    
                    $
                    4,332,523
                    
                    
                    $
                    3,838,896
                    
                    
                    $
                    493,627
                    
                    
                    
                    24.24
                    %
                    
                    
                    22.20
                    %
                    
                    
                    2.04
                    %





Selling,
general and administrative expense increased $493,627 from last year’s first
quarter as follows.





Excluding
the PCTV expenses and amortization of intangible assets acquired in the PCTV
acquisition, selling, general and administrative expense increased $87,225 from
the prior year’s first quarter. Sales and marketing expense for HCW increased
$141,524, driven by the increase in the Euro exchange rate compared to the U.S.
dollar, which resulted in an expense increase of $208,261 and higher commissions
of $105,082 due to higher sales  offset by lower compensation expenses
of $28,625 due to personnel reductions, lower travel expenses of $12,217,
reduction in  trade show expenses of $23,153 and lower sales office
expenses of $112,461.





The  decrease  in
general and administrative expense for HCW of $23,116 was primarily due
to  lower professional fees, primarily for  legal and
consulting  fees of  $8,075 and  decrease in
compensation expense of $25,943 due to staff reductions and a 10% salary
reduction offset by higher depreciation expense of $4,426.





Offsetting
the selling, general and administrative expense decreases were increases of
$124,713 in sales and marketing expense and $92,980 in general and
administrative expense related to personnel and overhead expense of the PCTV
business acquired at the end of December 2008.  Amortization of
intangible assets of $188,709 was related to intangible assets acquired in the
purchase of the PCTV business.





Research
and  development expenses





Research
and development expense for the three months ended December 31, 1009 increased
$324,429 from the  three months ended December 31, 2008  as
follows:


HCW
                  
                  
                  PCTV
                  
                  
                  TotalResearch
      and development expense-HCW
                  
                  $
                  (170,720
                  )
                  
                  $
                  0
                  
                  
                  $
                  (170,720
                  )Research
      and development expense-PCTV
                  
                  
                  0
                  
                  
                  
                  504,519
                  
                  
                  
                  504,519Stock
      compensation expense
                  
                  
                  (9,370
                  )
                  
                  
                  0
                  
                  
                  
                  (9,370
                  )Total
      research and development expense
                  
                  $
                  (180,090
                  )
                  
                  $
                  504,519
                  
                  
                  $
                  324,429





Excluding
the expense of the PCTV division, research and development expense decreased
$180,090 from the prior year’s first fiscal quarter. The decrease was primarily
due to personnel and personnel related reductions and the number of development
programs in process.





Offsetting
the expense decreases were $504,519 in expense related to personnel and
development programs of the PCTV business acquired at the end of December
2008.


17




Tax
provision





Our  tax
provision for the three months ended December 31, 2009 and 2008 is as
follows:





Three months ended December
      31,2009
                    
                    
                    2008Tax  expense on
      international operations
                    
                    $
                    41,226
                    
                    
                    
                    27,507State
      taxes
                    
                    
                    10,000
                    
                    
                    
                    10,000Tax
      provision
                    
                    $
                    51,226
                    
                    
                    $
                    37,507




Summary





We
recorded a net loss of  $334,551, for the three  months
ended December 31, 2009, which resulted in basic and diluted net loss per share
of $0.03 on weighted average basic and diluted shares of  10,059,808
compared to a net loss of $1,772,313 for the three months ended December 31,
2008, which resulted in  basic and diluted net loss per share of
$0.18  on weighted average  basic and diluted shares
of  10,035,088.





Options
to purchase 1,522,394 and 1,767,744  shares of common
stock,  at  prices for both periods ranging
from  $1.05 to $8.75,  were outstanding for the three months
ended December 31, 2009 and 2008, 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.  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.





To offset
the above cycles, we target a wide range of customer types in order to moderate
the seasonal nature  of our  retail sales.




Liquidity
and capital resources





Our cash,
working capital and stockholders’ equity position as of  December 31 ,
2009 and September 30, 2009 is set forth below:





December 31, 2009
                  
                  
                  September 30, 009Cash
                  
                  $
                  10,183,591
                  
                  
                  $
                  8,368,342Working
      Capital
                  
                  
                  5,793,325
                  
                  
                  
                  5,885,577Stockholders’
      Equity
                  
                  
                  11,987,139
                  
                  
                  
                  12,334,866




18




The
Company had cash and cash equivalents as of December 31, 2009 of $10,183,591, an
increase of $1,815, 249 from September 30, 2009.





The
increase in cash was due to:





Operating
                  
                  
                  Investing
                  
                  
                  FinancingSources of cash:
                  
                  Activities
                  
                  
                  activities
                  
                  
                  Activities
                  
                  
                  TotalIncrease  in  accounts
      payable and accrued expenses
                  
                  $
                  1,820,079
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  1,820,079Decrease  in  accounts
      receivables
                  
                  
                  251,123
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  251,123Decrease
      in inventory
                  
                  
                  146,083
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  146,083Net
      loss adjusted for non cash items
                  
                  
                  128,248
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  128,248Decrease  in
      prepaid expenses and other current assets
                  
                  
                  103,248
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  103,248Proceeds
      from employee stock purchases
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  5,237
                  
                  
                  
                  5,237Total
      sources of cash
                  
                  
                  2,448,781
                  
                  
                  
                  -
                  
                  
                  
                  5,237
                  
                  
                  
                  2,454,018Less cash used for:PCTV
      acquisition
                  
                  
                  -
                  
                  
                  
                  (511,332
                  )
                  
                  
                  -
                  
                  
                  
                  (511,332
                  )Effect
      of exchange rates on cash
                  
                  
                  (124,664
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (124,664
                  )Capital
      equipment purchases
                  
                  
                  -
                  
                  
                  
                  (2,773
                  )
                  
                  
                  -
                  
                  
                  
                  (2,773
                  )Total
      usage of cash
                  
                  
                  (124,664
                  )
                  
                  
                  (514,105
                  )
                  
                  
                  -
                  
                  
                  
                  (638,769
                  )Net
      cash increase
                  
                  $
                  2,324,117
                  
                  
                  $
                  (514,105
                  )
                  
                  $
                  5,237
                  
                  
                  $
                  1,815,249





Net
cash  provided by operating activities was due to an increase in
account payables and accrued expenses of $1,820,079 and a decrease in accounts
receivable, inventory and prepaid expenses and other current
assets  of $251,123, $146,083, and $103,248,
respectively.  The net loss adjusted for non cash expenses provided
$128,248 in operating cash. The decrease in accounts receivable was primarily
due to timing of shipments. Approximately 76% of sales were shipped in the first
two months of the quarter.  The decrease in inventory was due to the
timing of inventory purchases.  Offsetting these cash increases was
$124,664 related to the effect of exchange rate on cash.





Cash of
$514,105 was used in investing activities.  Of this amount, the
Company paid $511,332 on the outstanding note payable as of September 30, 2009
of $625,045 less $113,713 which was owed to us from Avid Technologies, Inc. for
collections made on behalf of the Company and $2,773 was used to purchase fixed
assets.  As of December 31, 2009, the note to Avid Technologies, Inc
was fully paid.  Cash of $5,237 from financing activities came from
purchases of stock under our employee stock purchase plan.





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  December 31, 2009 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 working capital needs.


19




Future
contractual obligations





The
following table shows our contractual obligations related to lease obligations
as of December 31, 2009:





Payments
      due by periodTotal
                    
                    
                    Less than 1 year
                    
                    
                    1-3 years
                    
                    
                    3 to 5 yearsOperating
      lease obligations
                    
                    $
                    1,627,002
                    
                    
                    $
                    735,734
                    
                    
                    $
                    861,799
                    
                    
                    $
                    29,469




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 risks





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




Item 4T. 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  December 31,
2009.


20


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, 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 and our Form 10-Q for the three months
ended December 31, 2009.   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
1.  Legal  proceedings





There
have been no material changes with respect to legal proceedings disclosed in our
Annual Report on Form 10-K for the fiscal year ended September 30,
2009.





Item
1A.  Risk factors





There
have been no material changes with respect to the risk factors disclosed in our
Annual Report on Form 10-K for the fiscal year ended September 30,
2009.


21




Item
2.  Unregistered sales of equity securities and use of
proceeds





None sold
during the first fiscal quarter ended December 31, 2009.




Item
4.  Submission of matters to a vote of security holders





The
following proposal was submitted to the stockholders for approval at the Annual
Meeting of Stockholders held on December 9, 2009:





Proposal
No. 1:   Election of directors





The
following directors were elected by the votes indicated:


For
                      
                      
                      WithheldKenneth
      Plotkin
                      
                      
                      8,844,347
                      
                      
                      
                      515,601Bernard
      Herman
                      
                      
                      8,868,239
                      
                      
                      
                      491,709Christopher
      G. Payan
                      
                      
                      8,858,278
                      
                      
                      
                      501,670Seymour
      G. Siegel
                      
                      
                      8,863,128
                      
                      
                      
                      496,820




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
      200232.0
                                
                                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.


22





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.RegistrantDate: 
      February 12,
      2010
                        By
                        /s/Kenneth PlotkinKENNETH  PLOTKINChief
      Executive Officer, Chairman of theBoard,
      President (Principal Executive Officer)Date: 
      February 12,
      2010
                        By
                        /s/Gerald TucciaroneGERALD
      TUCCIARONETreasurer,
      Chief Financial Officer,(Principal
      Financial Officer and PrincipalAccounting
      Officer) and
Secretary




23