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,  2008





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 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




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  February 2, 2009,  10,044,359 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 StatementsCondensed
      Consolidated Balance Sheets –
                                    December
      31, 2008 (unaudited) and September 30, 2008
                                  4Condensed
      Consolidated Statements of Operations -
                                    Three Months
      ended December 31, 2008 (unaudited) and
      2007  (unaudited)
                                  5Condensed
      Consolidated Statements of Other Comprehensive Income (Loss)
                                    Three Months
      ended December 31, 2008 (unaudited)  and
      2007  (unaudited)
                                  6Condensed
      Consolidated Statements of Cash Flows-three months ended
                                    December
      31, 2008 (unaudited) and 2007 (unaudited)
                                  7Notes
      to Condensed Consolidated Financial Statements
                                  8-16Item
      2. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                                  17-22Item
      3. Quantitative and Qualitative Disclosures about Market
    Risks
                                  23Item  4T.
      Controls and Procedures
                                  23




2





PART II.  OTHER
      INFORMATIONItem
      1. Legal Proceedings
                        25Item
      1A.  Risk Factors
                        25Item  2.  Unregistered
      Sales of Equity Securities and Use of Proceeds
                        25Item
      6. Exhibits
                        25-26Signatures




3




PART I. FINANCIAL
INFORMATION




Item
1. Financial Statements





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED BALANCE SHEETS





December 31,
                                  2008
                                  (unaudited)
                                
                                
                                September 30,
                                  2008Assets:Cash
      and cash  equivalents
                                
                                $
                                11,372,560
                                
                                
                                $
                                14,191,721Trade
      receivables, net of  various allowances
                                
                                
                                7,745,752
                                
                                
                                
                                6,932,400Other
      non trade receivables
                                
                                
                                4,005,106
                                
                                
                                
                                2,316,057Inventories
                                
                                
                                12,460,945
                                
                                
                                
                                12,236,166Deferred
      tax asset-current
                                
                                
                                1,133,073
                                
                                
                                
                                1,133,073Prepaid
      expenses and other current assets
                                
                                
                                984,288
                                
                                
                                
                                1,093,406Total  current
      assets
                                
                                
                                37,701,724
                                
                                
                                
                                37,902,823Intangible
      assets
                                
                                
                                4,094,014
                                
                                
                                
                                -Goodwill
                                
                                
                                1,023,504
                                
                                
                                
                                -Property,
      plant and equipment, net
                                
                                
                                938,485
                                
                                
                                
                                769,288Security
      deposits and other non current assets
                                
                                
                                108,400
                                
                                
                                
                                102,227Deferred
      tax asset-non current
                                
                                
                                887,611
                                
                                
                                
                                887,611Total
      assets
                                
                                $
                                44,753,738
                                
                                
                                $
                                39,661,949Liabilities
      and  Stockholders’  Equity:Current
      Liabilities:Accounts
      payable
                                
                                $
                                13,123,510
                                
                                
                                $
                                10,406,836Accrued
      expenses –license  fees
                                
                                
                                8,995,828
                                
                                
                                
                                7,952,244Accrued
      expenses – other
                                
                                
                                2,808,309
                                
                                
                                
                                2,256,099Note
      payable
                                
                                
                                2,500,000
                                
                                
                                
                                -Income
      taxes payable
                                
                                
                                84,504
                                
                                
                                
                                58,234Total
      current  liabilities
                                
                                
                                27,512,151
                                
                                
                                
                                20,673,413Stockholders'
      Equity:Common
      stock, $.01 par value; 25,000,000 shares authorized,10,795,239  and
      10,784,717  issued, respectively
                                
                                
                                107,952
                                
                                
                                
                                107,847Additional
      paid-in capital
                                
                                
                                16,852,689
                                
                                
                                
                                16,709,201Retained
      earnings
                                
                                
                                6,166,382
                                
                                
                                
                                7,938,695Accumulated
      other comprehensive loss
                                
                                
                                (3,481,099
                                )
                                
                                
                                (3,362,870
                                )Treasury
      Stock, at cost, 759,579 shares
                                
                                
                                (2,404,337
                                )
                                
                                
                                (2,404,337
                                )Total
      stockholders' equity
                                
                                
                                17,241,587
                                
                                
                                
                                18,988,536Total  liabilities
      and  stockholders' equity
                                
                                $
                                44,753,738
                                
                                
                                $
                                39,661,949





See
accompanying notes to condensed consolidated financial statements




4




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)





Three months ended December 31,2008
                                          
                                          
                                          2007Net
      sales
                                          
                                          $
                                          17,288,680
                                          
                                          
                                          $
                                          37,047,461Cost  of
      sales
                                          
                                          
                                          14,690,419
                                          
                                          
                                          
                                          28,906,400Gross
      profit
                                          
                                          
                                          2,598,261
                                          
                                          
                                          
                                          8,141,061Selling,
      general and  administrative expenses
                                          
                                          
                                          3,838,896
                                          
                                          
                                          
                                          4,552,569Research
      and development expenses
                                          
                                          
                                          845,642
                                          
                                          
                                          
                                          913,757Income
      (loss)  from operations
                                          
                                          
                                          (2,086,277
                                          )
                                          
                                          
                                          2,674,735Other  income
      (expense):Interest  income
                                          
                                          
                                          4,469
                                          
                                          
                                          
                                          6,194Foreign
      currency  gain (loss)
                                          
                                          
                                          347,002
                                          
                                          
                                          
                                          (27,609
                                          )Other
      income
                                          
                                          
                                          351,471
                                          
                                          
                                          
                                          (21,415
                                          )Income
      (loss) before taxes
                                          
                                          
                                          (1,734,806
                                          )
                                          
                                          
                                          2,653,320Tax  provision
                                          
                                          
                                          37,507
                                          
                                          
                                          
                                          190,332Net
      income (loss)
                                          
                                          $
                                          (1,772,313
                                          )
                                          
                                          $
                                          2,462,988Net
      income (loss)  per share:Basic
                                          
                                          $
                                          (0.18
                                          )
                                          
                                          $
                                          0.25Diluted
                                          
                                          $
                                          (0.18
                                          )
                                          
                                          $
                                          0.24





See
accompanying notes to condensed  consolidated financial
statements




5




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONDENSED  CONSOLIDATED
STATEMENTS OF OTHER  COMPREHENSIVE INCOME (LOSS)


(UNAUDITED)





Three months ended December 31,2008
                            
                            
                            2007Net
      income (loss)
                            
                            $
                            (1,772,313
                            )
                            
                            $
                            2,462,988Foreign
      currency translation loss
                            
                            
                            (172,963
                            )
                            
                            
                            (463,007
                            )Forward
      exchange contracts marked to market gain
                            
                            
                            54,734
                            
                            
                            
                            38,793Other  comprehensive
      income ( loss)
                            
                            $
                            (1,890,542
                            )
                            
                            $
                            2,038,774





See
accompanying notes to condensed consolidated financial statements




6




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


CONDENSED  CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)




Three months ended December 312008
                                                                
                                                                
                                                                2007Net
      income (loss)
                                                                
                                                                $
                                                                (1,772,313
                                                                )
                                                                
                                                                $
                                                                2,462,988Adjustments
      to reconcile net income (loss) to net cash
                                                                  used
      in  operating  activities:Depreciation
      and amortization
                                                                
                                                                
                                                                64,995
                                                                
                                                                
                                                                
                                                                65,093Inventory
      reserve
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                650,000Bad
      debt
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                100,000Stock
      based  compensation expense
                                                                
                                                                
                                                                132,593
                                                                
                                                                
                                                                
                                                                139,179Other
      non cash items
                                                                
                                                                
                                                                (6,173
                                                                )
                                                                
                                                                
                                                                8,172Changes
      in current assets and liabilities, net of effects of
      acquisition:Accounts
      receivable
                                                                
                                                                
                                                                (2,502,401
                                                                )
                                                                
                                                                
                                                                (6,246,813
                                                                )Inventories
                                                                
                                                                
                                                                (224,779
                                                                )
                                                                
                                                                
                                                                (1,348,754
                                                                )Prepaid
      expenses and other current assets
                                                                
                                                                
                                                                109,118
                                                                
                                                                
                                                                
                                                                (662,495
                                                                )Accounts
      payable
                                                                
                                                                
                                                                2,559,525
                                                                
                                                                
                                                                
                                                                3,400,979Accrued
      expenses  and other current liabilities
                                                                
                                                                
                                                                1,207,564
                                                                
                                                                
                                                                
                                                                547,804Total
      adjustments
                                                                
                                                                
                                                                1,340,442
                                                                
                                                                
                                                                
                                                                (3,346,835
                                                                )Net
      cash used in  operating activities
                                                                
                                                                
                                                                (431,871
                                                                )
                                                                
                                                                
                                                                (883,847
                                                                )Cash
      Flows From Investing Activities:PCTV
      acquisition
                                                                
                                                                
                                                                (2,273,000
                                                                )
                                                                
                                                                
                                                                -Purchases
      of property, plant and equipment
                                                                
                                                                
                                                                (7,061
                                                                )
                                                                
                                                                
                                                                (138,446
                                                                )Net
      cash used in investing activities
                                                                
                                                                
                                                                (2,280,061
                                                                )
                                                                
                                                                
                                                                (138,446
                                                                )Cash
      Flows From Financing Activities:Purchase
      of treasury stock
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                (40,832
                                                                )Proceeds
      from the exercise of stock options and employee  stock
      purchases
                                                                
                                                                
                                                                11,000
                                                                
                                                                
                                                                
                                                                18,988Net
      cash  provided by (used in)  financing
      activities
                                                                
                                                                
                                                                11,000
                                                                
                                                                
                                                                
                                                                (21,844
                                                                )Effect
      of exchange rates on cash
                                                                
                                                                
                                                                (118,229
                                                                )
                                                                
                                                                
                                                                (424,214
                                                                )Net  decrease  in
      cash and cash equivalents
                                                                
                                                                
                                                                (2,819,161
                                                                )
                                                                
                                                                
                                                                (1,468,351
                                                                )Cash
      and cash equivalents, beginning of period
                                                                
                                                                
                                                                14,191,721
                                                                
                                                                
                                                                
                                                                11,581,657Cash
      and cash equivalents, end of period
                                                                
                                                                $
                                                                11,372,560
                                                                
                                                                
                                                                $
                                                                10,113,306Supplemental
      disclosures:Income
      taxes paid
                                                                
                                                                $
                                                                11,002
                                                                
                                                                
                                                                $
                                                                159,036Note
      payable to Avid Technology, Inc.
                                                                
                                                                $
                                                                2,500,000
                                                                
                                                                
                                                                
                                                                -





See accompanying notes to condensed
consolidated financial statements




7




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




Note
1.  Basis of  Presentation





The
accompanying unaudited condensed 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, 2008 Form 10-K.





The
operating results for the three months ended  December 31, 2008 are
not necessarily indicative of the results to be expected for the September 30,
2009 year end.





During
the three months ended December 31, 2008, the Company completed an acquisition
which is reflected in the Company’s financial statements for this period (see
Note 11, "Acquisition of PCTV assets from Avid Technology, Inc.").





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




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, 2008 and September 30, 2008 consisted of
:




8




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





December 31,
                  
                  
                  September 30,2008
                  
                  
                  2008Trade
      receivables
                  
                  $
                  12,379,785
                  
                  
                  $
                  11,668,214Allowances
      and reserves
                  
                  
                  (4,634,033
                  )
                  
                  
                  (4,735,814
                  )Total
      trade receivables
                  
                  
                  7,745,752
                  
                  
                  
                  6,932,400Receivable
      from contract manufacturers
                  
                  
                  3,492,614
                  
                  
                  
                  1,795,225GST
      and VAT taxes receivables
                  
                  
                  469,702
                  
                  
                  
                  484,086Other
                  
                  
                  42,790
                  
                  
                  
                  36,746Total
      non trade receivables
                  
                  $
                  4,005,106
                  
                  
                  $
                  2,316,057




Note
3.   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 prevailing average spot
rate.   Translation adjustments arising from the translation to
U.S. dollars at differing exchange rates  are included in the
accumulated other comprehensive 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 $3,346,325 recorded on
the balance sheet  as of September 30, 2008. For the three months
ended December 31, 2008, the Company  recorded on the balance sheet a
deferred translation loss of $172,963, resulting in a translation loss of
$3,519,288 recorded as a component of accumulated other comprehensive loss as
of  December 31, 2008.




Note
4.  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 30,2008
                  
                  
                  2008Component
      parts
                  
                  $
                  4,410,053
                  
                  
                  $
                  4,561,140Finished
      goods
                  
                  
                  8,050,892
                  
                  
                  
                  7,675,026$
                  12,460,945
                  
                  
                  $
                  12,236,166




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:




9




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Three
      monthsEndedDecember 31,2008
                  
                  
                  2007Weighted
      average shares outstanding-basic
                  
                  
                  10,035,088
                  
                  
                  
                  9,843,799Number
      of shares issued on the assumed exercise of  stock
      options
                  
                  
                  -
                  
                  
                  
                  294,171Weighted
      average shares outstanding-diluted
                  
                  
                  10,035,088
                  
                  
                  
                  10,137,970





Options
to purchase 1,767,744  and 882,000 shares of common
stock  at  prices  ranging from  $1.05
to $8.75 and $3.38 to  $8.75 were outstanding for the three months
ended December 31, 2008 and 2007, respectively, but were not included in the
computation of diluted earnings per share because they were
anti-dilutive.




Note
6.  Accumulated  Other Comprehensive Loss





Accumulated
other comprehensive loss consists of two components: translation
gains  and losses  and FAS 133 mark to market gains and
losses  on the Company’s open foreign exchange contracts. As of
December 31, 2008,  appearing in the equity section under  “
Accumulated other  comprehensive loss” was a  loss
of  $3,481,099, which consisted of a deferred translation loss of
$3,519,288 and a deferred gain of $38,189 due to the mark to
market  differences between  the  value
of  the Company’s open forward exchange  contracts at the
contract rates versus the same contracts valued at the period ending forward
rate.





The table
below  details the gains and losses  that make up the
accumulated other  comprehensive  loss  on the
Company’s balance sheet as of  December 31, 2008:





Accumulated other comprehensive
      loss
                        
                        Balance as of
                        
                        
                        Oct 08 to Dec 08
                        
                        
                        Balance as ofFiscal 2009 activity
                        
                        Sept 30, 2008
                        
                        
                        gains (losses)
                        
                        
                        Dec 31, 2008Translation  losses
                        
                        $
                        (3,346,325
                        )
                        
                        $
                        (172,963
                        )
                        
                        $
                        (3,519,288
                        )FAS
      133 mark to market adjustment gain (loss)
                        
                        
                        (16,545
                        )
                        
                        
                        54,734
                        
                        
                        
                        38,189$
                        (3,362,870
                        )
                        
                        $
                        (118,229
                        )
                        
                        $
                        (3,481,099
                        )




Note
7. Revenue recognition





The
Company  sells its products through a sales channel which consist 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 primarily given 30 to 60 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.


10
  HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)


The
Company offers some of its customers a right of return. The Company’s accounting
complies with 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  to arrive at 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 EITF 01-09,
“Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor’s Products)”.




Note
8.  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.





The
Company’s products fall under three product categories:





·
            Analog
      TV tuners


·
            Digital  TV
      tuners, and combination analog and digital TV
  tuners


·
            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:




11





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Three months endedDecember 31,Product line sales
                      
                      2008
                      
                      
                      2007Analog
      TV tuner sales
                      
                      $
                      656,661
                      
                      
                      $
                      11,687,545Digital
      and combination analog and digital TV
    tuner  sales
                      
                      
                      15,822,858
                      
                      
                      
                      24,025,631Other
      non-TV tuner products
                      
                      
                      809,161
                      
                      
                      
                      1,334,285Total
      sales
                      
                      $
                      17,288,680
                      
                      
                      $
                      37,047,461




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 Dec 31,Geographic region
                  
                  2008
                  
                  
                  2007The
      Americas
                  
                  
                  42
                  %
                  
                  
                  50
                  %Europe
                  
                  
                  54
                  %
                  
                  
                  48
                  %Asia
                  
                  
                  4
                  %
                  
                  
                  2
                  %Total
                  
                  
                  100
                  %
                  
                  
                  100
                  %





Note
9. Tax provision





Our  tax
provision for the three  months ended  December 31, 2008 and
2007 is as follows:





Three months ended December 31,2008
                          
                          
                          2007Federal
      income tax expense
                          
                          $
                          -
                          
                          
                          $
                          100,000Tax  expense  on
      international  operations
                          
                          
                          27,507
                          
                          
                          
                          78,332State
      taxes
                          
                          
                          10,000
                          
                          
                          
                          12,000Tax
      provision
                          
                          $
                          37,507
                          
                          
                          $
                          190,332





Note
10. Recent Accounting  Pronouncements





The
Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS
No. 157”) on October 1, 2008. SFAS No. 157 defines fair value,
establishes a methodology for measuring fair value, and expands the required
disclosure for fair value measurements. On February 12, 2008, the Financial
Accounting Standards Board (“FASB”) issued FASB Staff Position No. SFAS 157-2,
“Effective Date of FASB Statement No. 157,” which amends SFAS No. 157
by delaying its effective date by one year for non-financial assets and
non-financial liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis.  The
adoption of SFAS No. 157 for the Company’s financial assets and financial
liabilities did not have a material impact on its consolidated financial
statements.  At December 31, 2008 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
6).  Effective October 1, 2009, SFAS No. 157 will also apply to
all other fair value measurements for the Company.  The Company is
evaluating the effect the implementation of SFAS No. 157 will have on its
non-financial assets and non-financial liabilities on its consolidated financial
statements.





12




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities- An Amendment of FASB Statement No. 133” (“SFAS No.
161”). SFAS 161 requires enhanced qualitative disclosures about objectives and
strategies for using derivatives, quantitative disclosures about fair value
amounts of and gains and losses on derivative instruments, and disclosures about
credit-risk-related contingent features in derivative agreements. SFAS 161 is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. The Company is currently evaluating the
impact of SFAS 161 on its consolidated financial statements.





Note
11. 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.





The
purchase price consisted of $2,238,000 payable in cash; $2,500,000 payable
pursuant to Promissory Note, dated December 24, 2008, made payable by the Buyer
to Avid (the “Note”) and the assumption of certain liabilities.  The
principal amount due pursuant to the Note is payable in 12 equal monthly
installments of $208,333. The first such payment was due and payable on January
24, 2009.   Interest on the outstanding principal amount of the
Note is payable at a rate equal to (i) from December 24, 2008 until the Maturity
Date (as defined in the Note), five percent (5%), (ii) from and after the
Maturity Date, or during the continuance of an Event of Default (as defined in
the Note), at seven percent (7%).  Pursuant to the terms of the Note,
the Buyer and its affiliates are prohibited from (i) declaring or paying any
cash dividend, or making a distribution on, repurchasing, or redeeming, any
class of stock or other equity or ownership interest in the Buyer or its
affiliates, (ii) selling, leasing, transferring or otherwise disposing of any
assets or property of the Buyer or any of its affiliates, or attempting to or
contracting to do so, other than (a) the sale of inventory in the ordinary
course of business
and consistent with past practice, (b) the granting of non-exclusive licenses of
intellectual property in the ordinary course of business and consistent with
past practice and (c) the sale, lease, transfer or disposition of any assets or
property (other than the Acquired Assets) with a value not toexceed
$500,000 in the aggregate, or (iii) dissolving or liquidating, or merging or
consolidating with any other entity, or acquiring all or substantially all of
the stock or assets of any other entity.




13




HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





The
following allocation of the purchase price and the estimated transaction costs
are preliminary and based on information available to the Company’s management
at the time the condensed consolidated financial statements were
prepared.  Accordingly, the allocation is subject to change and the
impact of such changes could be material:





Purchase Price PaidCash
      paid to seller at closing
                        
                        $
                        2,238,000Notes
      payable assumed
                        
                        
                        2,500,000Warranty
      liability assumed
                        
                        
                        262,000Direct
      acquisition costs
                        
                        
                        344,649Total
      purchase price
                        
                        $
                        5,344,649Allocation of Purchase
PriceIdentifiable
      intangible assets
                        
                        $
                        4,094,014Goodwill
                        
                        
                        1,023,504Fixed
      assets
                        
                        
                        227,131$
                        5,344,649





The
values allocated to goodwill and identifiable intangible assets in the
acquisition are expected to be deductible for income tax purposes.





Because  the
acquisition was completed on December 24, 2008, there are no results from
the  operations of the acquisition  included in the
Company’s December 31, 2008 operating results. The Company  is in the
process of  obtaining  a
purchase  price  allocation from an independent third party.
On the Company’s  December 31, 2008 balance sheet the acquisition was
recorded by allocating the purchase price to the assets acquired, including
intangible assets such as customer lists, technology and reference
designs,  based on an estimate  provided by the Company’s
management. The Company expects the independent allocation to be completed
during the Company’s second fiscal quarter.





The
following unaudtited pro forma results assume the acquisition occurred on
October 1, 2007.  The pro forma results do not purport to represent what
our results of operations actually would have been if the transactions set forth
above had occurred on the date indicated or what our 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.




14





HAUPPAUGE
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Three months
                  
                  
                  Three monthsended
                  
                  
                  endedDecember 31,
                  
                  
                  December 31,Pro forma statements:
                  
                  2008
                  
                  
                  2007Revenue
                  
                  $
                  28,311,680
                  
                  
                  $
                  49,505,461Net
      income (loss)
                  
                  $
                  (1,279,937
                  )
                  
                  $
                  3,076,564Net
      income (loss) per shareBasic
                  
                  $
                  (0.13
                  )
                  
                  $
                  0.31Diluted
                  
                  $
                  (0.13
                  )
                  
                  $
                  0.30





In
connection with the transactions contemplated by the Asset Purchase Agreement,
the Buyer, Hauppauge Digital Europe Sarl (“HDES”), and Hauppauge Computer Works,
Inc. (“HCW”), each a wholly-owned subsidiary of ours (collectively, the
“Subsidiaries”) and the Sellers entered into a Transition Services Agreement,
dated December 24, 2008 (the “TSA”), pursuant to which, among other things, the
parties agreed to provide each other with certain services relating to
infrastructure and systems, order processing and related matters and systems
transition and related matters (the “Services”), as set forth in detail in the
TSA.  The fees for such Services are set forth in the
TSA.  The term of the TSA shall be until the earlier to occur of (i)
18 months following the Closing or (ii) termination of the last of the Services
to be provided pursuant to the TSA.  The TSA may be terminated by the
Subsidiaries at any time upon thirty (30) days prior written notice to the
Sellers and may be terminated with respect to any particular Service to be
provided pursuant to the TSA upon ten (10) days prior written notice to
Seller.





Further,
Avid, Avid Technology International BV (collectively, the
“Consignor”), and HCW and HDES (collectively, the “Consignee”) entered into an
Inventory and Product Return Agreement, dated December 24, 2008 (the “Inventory
Agreement”).  Pursuant to the terms of the Inventory Agreement, the
Consignor is obligated to deliver the Consigned Inventory (as defined in the
Inventory Agreement) to the Consignee and the Consignee is obligated to, as
applicable, fill orders from products held as Consigned Inventory before filling
any such orders with products or inventory other than the Consigned
Inventory.  Upon the sale of Consigned Inventory by the Consignee, the
Consignee has agreed to pay the Consignor for such Consigned Inventory as
follows: (i) if Consignee sells Consigned Inventory for a price equal to or
greater than Consignor’s Cost (as defined in the Inventory Agreement) for such
Consigned Inventory, then Consignee has agreed to pay Consignor an amount equal
to one hundred percent (100%) of the Consignor Cost for such Consigned
Inventory; or (ii) if Consignee sells Consigned Inventory for a price less than
the Consignor Cost for such Consigned Inventory, then Consignee has agreed to
pay Consignor an amount equal to eighty percent (80%) of the sales price for
such Consigned Inventory.  The term of the Inventory Agreement expires
18 months from the date of execution.




15




In
connection with the transactions contemplated by the Asset Purchase Agreement,
Avid, Pinnacle and the Buyer also entered into an Intellectual Property License
Agreement, dated December 24, 2008 (the “IP Agreement”).  Pursuant to
the terms of the IP Agreement, Avid and Pinnacle have granted the Buyer certain
irrevocable, personal, non-exclusive, worldwide, fully paid, royalty-free and
non-transferable licenses to certain copyrights and other intellectual property
rights owned by Avid, Pinnacle and their respective subsidiaries, subject to
certain termination provisions as set forth in the IP Agreement.




16




ITEM
2.    MANAGEMENT'S DISCUSSION AND ANALYSIS
OF   FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS




THREE
MONTH PERIOD  ENDED DECEMBER  31, 2008 COMPARED TO THREE


MONTH
PERIOD ENDED DECEMBER 31, 2007





Results
of operations for the three months ended  December 31, 2008 compared
to December  31, 2007 are as follows:





Three
                                        
                                        
                                        ThreeMonths
                                        
                                        
                                        MonthsEnded
                                        
                                        
                                        Ended
                                        
                                        
                                        Variance
                                        
                                        
                                        Percentage of sales12/31/08
                                        
                                        
                                        12/31/07
                                        
                                        
                                        $
                                        
                                        
                                        2008
                                        
                                        
                                        2007
                                        
                                        
                                        VarianceNet
      sales
                                        
                                        $
                                        17,288,680
                                        
                                        
                                        $
                                        37,047,461
                                        
                                        
                                        $
                                        (19,758,781
                                        )
                                        
                                        
                                        100.00
                                        %
                                        
                                        
                                        100.00
                                        %
                                        
                                        
                                        -Cost
      of sales
                                        
                                        
                                        14,690,419
                                        
                                        
                                        
                                        28,906,400
                                        
                                        
                                        
                                        (14,215,981
                                        )
                                        
                                        
                                        84.97
                                        %
                                        
                                        
                                        78.03
                                        %
                                        
                                        
                                        6.94
                                        %Gross
      profit
                                        
                                        
                                        2,598,261
                                        
                                        
                                        
                                        8,141,061
                                        
                                        
                                        
                                        (5,542,800
                                        )
                                        
                                        
                                        15.03
                                        %
                                        
                                        
                                        21.97
                                        %
                                        
                                        
                                        -6.94
                                        %Gross
      profit %
                                        
                                        
                                        15.03
                                        %
                                        
                                        
                                        21.97
                                        %
                                        
                                        
                                        -6.94
                                        %Selling,
      general and administrative expenses:Sales
      and marketing
                                        
                                        
                                        2,759,291
                                        
                                        
                                        
                                        3,249,853
                                        
                                        
                                        
                                        (490,562
                                        )
                                        
                                        
                                        15.96
                                        %
                                        
                                        
                                        8.77
                                        %
                                        
                                        
                                        7.19
                                        %Technical
      support
                                        
                                        
                                        135,384
                                        
                                        
                                        
                                        150,007
                                        
                                        
                                        
                                        (14,623
                                        )
                                        
                                        
                                        0.78
                                        %
                                        
                                        
                                        0.40
                                        %
                                        
                                        
                                        0.38
                                        %General  and
      administrative
                                        
                                        
                                        858,793
                                        
                                        
                                        
                                        1,057,468
                                        
                                        
                                        
                                        (198,675
                                        )
                                        
                                        
                                        4.97
                                        %
                                        
                                        
                                        2.85
                                        %
                                        
                                        
                                        2.12
                                        %Stock
      compensation
                                        
                                        
                                        85,428
                                        
                                        
                                        
                                        95,241
                                        
                                        
                                        
                                        (9,813
                                        )
                                        
                                        
                                        0.49
                                        %
                                        
                                        
                                        0.26
                                        %
                                        
                                        
                                        0.23
                                        %Total
      selling, general and administrative expenses
                                        
                                        
                                        3,838,896
                                        
                                        
                                        
                                        4,552,569
                                        
                                        
                                        
                                        (713,673
                                        )
                                        
                                        
                                        22.20
                                        %
                                        
                                        
                                        12.28
                                        %
                                        
                                        
                                        9.92
                                        %Research
      and development expenses
                                        
                                        
                                        798,477
                                        
                                        
                                        
                                        869,819
                                        
                                        
                                        
                                        (71,342
                                        )
                                        
                                        
                                        4.62
                                        %
                                        
                                        
                                        2.35
                                        %
                                        
                                        
                                        2.27
                                        %Research
      & development stock compensation
                                        
                                        
                                        47,165
                                        
                                        
                                        
                                        43,938
                                        
                                        
                                        
                                        3,227
                                        
                                        
                                        
                                        0.27
                                        %
                                        
                                        
                                        0.12
                                        %
                                        
                                        
                                        0.15
                                        %Total
      expenses
                                        
                                        
                                        4,684,538
                                        
                                        
                                        
                                        5,466,326
                                        
                                        
                                        
                                        (781,788
                                        )
                                        
                                        
                                        27.09
                                        %
                                        
                                        
                                        14.75
                                        %
                                        
                                        
                                        12.34
                                        %Net
      operating income (loss)
                                        
                                        
                                        (2,086,277
                                        )
                                        
                                        
                                        2,674,735
                                        
                                        
                                        
                                        (4,761,012
                                        )
                                        
                                        
                                        -12.06
                                        %
                                        
                                        
                                        7.22
                                        %
                                        
                                        
                                        -19.28
                                        %Other
      income (expense) :Interest
      income
                                        
                                        
                                        4,469
                                        
                                        
                                        
                                        6,194
                                        
                                        
                                        
                                        (1,725
                                        )
                                        
                                        
                                        0.03
                                        %
                                        
                                        
                                        0.02
                                        %
                                        
                                        
                                        0.01
                                        %Foreign
      currency
                                        
                                        
                                        347,002
                                        
                                        
                                        
                                        (27,609
                                        )
                                        
                                        
                                        374,611
                                        
                                        
                                        
                                        2.01
                                        %
                                        
                                        
                                        -0.07
                                        %
                                        
                                        
                                        2.08
                                        %Total
      other income (expense)
                                        
                                        
                                        351,471
                                        
                                        
                                        
                                        (21,415
                                        )
                                        
                                        
                                        372,886
                                        
                                        
                                        
                                        2.04
                                        %
                                        
                                        
                                        -0.05
                                        %
                                        
                                        
                                        2.09
                                        %Income
      (loss)  before taxes
                                        
                                        
                                        (1,734,806
                                        )
                                        
                                        
                                        2,653,320
                                        
                                        
                                        
                                        (4,388,126
                                        )
                                        
                                        
                                        -10.02
                                        %
                                        
                                        
                                        7.17
                                        %
                                        
                                        
                                        -17.19
                                        %Taxes  on
      income (loss)
                                        
                                        
                                        37,507
                                        
                                        
                                        
                                        190,332
                                        
                                        
                                        
                                        (152,825
                                        )
                                        
                                        
                                        0.22
                                        %
                                        
                                        
                                        0.51
                                        %
                                        
                                        
                                        -0.29
                                        %Net
      income  (loss)
                                        
                                        $
                                        (1,772,313
                                        )
                                        
                                        $
                                        2,462,988
                                        
                                        
                                        $
                                        (4,235,301
                                        )
                                        
                                        
                                        -10.24
                                        %
                                        
                                        
                                        6.66
                                        %
                                        
                                        
                                        -16.90
                                        %





Net sales
for the three months ended December 31, 2008 decreased $19,758,781 compared to
the three months ended December 31, 2007 as shown in the table
below.




Increase
                
                
                Increase(decrease)
                
                
                (decrease)
                
                
                Percentage of sales byThree Months
                
                
                Three Months
                
                
                Dollar
                
                
                dollar
                
                
                Geographic regionended 12/31/08
                
                
                ended 12/31/07
                
                
                Variance
                
                
                variance %
                
                
                2008
                
                
                2007The
      Americas
                
                
                7,273,125
                
                
                
                18,701,785
                
                
                
                (11,428,660
                )
                
                
                -61
                %
                
                
                42
                %
                
                
                50
                %Europe
                
                
                9,405,299
                
                
                
                17,783,120
                
                
                
                (8,377,821
                )
                
                
                -47
                %
                
                
                54
                %
                
                
                48
                %Asia
                
                
                610,256
                
                
                
                562,556
                
                
                
                47,700
                
                
                
                8
                %
                
                
                4
                %
                
                
                2
                %Total
                
                $
                17,288,680
                
                
                $
                37,047,461
                
                
                $
                (19,758,781
                )
                
                
                -53
                %
                
                
                100
                %
                
                
                100
                %




17




Net sales
to customers in The  Americas were 42%  and 50% of net sales
for the three months ended December  31, 2008 and 2007,
respectively.  Net sales to customers in Europe were
54%  and 48%  of net sales for the three months ended
December 31, 2008 and 2007, respectively.   Net sales to
customers in Asia were 4% and 2% of net sales for the three months ended
December 31, 2008  and  2007, respectively.  We
experienced a decrease in unit sales of about 52% while the dynamics of new
production and changes in sales mix lowered the average sales price by about
4%.





Factors
driving the  decline in  sales for the first quarter of
fiscal 2009 were the effects of a weakened economy which curtailed consumer
spending,  the financial problems leadng up to the liquidation
of  Circuit City,  the weakening of the Euro
and  the shift in emphasis  by the  PC
manufacturers  to lower cost PCs which do not include TV
tuners.





Gross
profit





Gross
profit  decreased $5,542,800 for the three months ended December 31,
2008 compared to the  three months ended December 31,
2007.





The
decrease in  the gross profit are detailed below:


Increase (decrease)Lower
      sales
                  
                  $
                  (5,750,069
                  )Higher
      gross profit on  sales mix
                  
                  
                  272,656Decrease
      in the Euro exchange rate
                  
                  
                  (884,734
                  )Production
      and production related expenses
                  
                  
                  819,347Total  decrease
      in gross profit
                  
                  $
                  (5,542,800
                  )





Gross
profit percentage for the three months  ended December 31, 2008 was
15.03 % compared to 21.97% for the three  months
ended  December 31, 2007, resulting in a  gross profit
decrease of  6.94%.





The
decrease in the gross profit  percentage are detailed
below:


DecreaseLower  gross
      profit on sales mix
                      
                      
                      (0.04
                      )%Decrease
      in the Euro exchange rate
                      
                      
                      (3.50
                      )%Production
      and production related expenses
                      
                      
                      (3.40
                      )%Net
      increase in gross profit  percentage
                      
                      
                      (6.94
                      )%





Selling,
general and administrative expenses





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





Three months ended
      December 31,Dollar Costs
                
                
                Percentage of Sales2008
                
                
                2007
                
                
                Decrease
                
                
                2008
                
                
                2007
                
                
                IncreaseSales
      and marketing
                
                $
                2,759,291
                
                
                $
                3,249,853
                
                
                $
                (490,562
                )
                
                
                15.96
                %
                
                
                8.77
                %
                
                
                7.19
                %Technical  support
                
                
                135,384
                
                
                
                150,007
                
                
                
                (14,623
                )
                
                
                0.78
                %
                
                
                0.40
                %
                
                
                0.38
                %General
      and administrative
                
                
                858,793
                
                
                
                1,057,468
                
                
                
                (198,675
                )
                
                
                4.97
                %
                
                
                2.85
                %
                
                
                2.12
                %Stock
      compensation
                
                
                85,428
                
                
                
                95,241
                
                
                
                (9,813
                )
                
                
                0.49
                %
                
                
                0.26
                %
                
                
                0.23
                %Total
                
                $
                3,838,896
                
                
                $
                4,552,569
                
                
                $
                (713,673
                )
                
                
                22.20
                %
                
                
                12.28
                %
                
                
                9.92
                %




18


Selling,
general and administrative expenses decreased $ 713,673 from the
prior  year’s fiscal first quarter.  Sales and marketing
expense decreased $490,562.  The  decrease in the Euro
accounted for   $186,650  of
the  decrease.  The average Euro rate for the first fiscal
quarter of 2009 was  $1.3167 to 1 Euro compared to $1.4493 to 1 Euro
for the first  fiscal quarter of  2008. Excluding the
decrease due to the change in exchange rate sales and marketing expenses
decreased $303,912.   Lower sales resulted in expenses related to
sales, such as commissions and marketing development
and  advertising  expense to decrease by
$409,927.  Lower expenses of our European sales offices contributed an
expense reduction of $66,683.  Offsetting these increases was in
increase of $ 170,576 in sales and marketing personnel related
expenses.





The  decrease  in
general and administrative expense  of 198,675 was primarily due lower
professional fees primarily for  legal fees
of  $92,854  and a decrease in bad debt expense
of  $100,000 related to the February 2008 liquidation of
CompUSA.





Research
and  development expenses





Research
and development expenses decreased  $71,342.  Lower
compensation due to the reduction of personnel and lower project expenses were
responsible for the decrease.




Tax
provision





Our  tax
provision for the three months ended  December 31, 2008 and 2007 is as
follows:





Three months ended December 31,2008
                    
                    
                    2007Federal
      income tax expense
                    
                    $
                    -
                    
                    
                    $
                    100,000Tax  expense  on
      international  operations
                    
                    
                    27,507
                    
                    
                    
                    78,332State
      taxes
                    
                    
                    10,000
                    
                    
                    
                    12,000Tax
      provision
                    
                    $
                    37,507
                    
                    
                    $
                    190,332





We
recorded 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  compared to a net income of $2,462,988 for
the three months ended December 31, 2007, which resulted in  basic and
diluted net income per share of $0.25 and $0.24, respectively,  on
weighted average  basic and diluted shares of 9,843,799 and
10,137,970, respectively.





Options
to purchase 1,767,744  and 882,000 shares of common
stock  at  prices  ranging from  $1.05
to $8.75 and $3.38 to  $8.75 were outstanding for the three months
ended December 31, 2008 and 2007, respectively, but were not included in the
computation of diluted earnings per share because they were
anti-dilutive.





19




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%, 44% and
54% of sales for the years ended September 30, 2008, 2007 and 2006,
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,
2008 and September 30, 2008 is set forth below:





December 31, 2008
                        
                        
                        September 30, 2008Cash
                        
                        $
                        11,372,560
                        
                        
                        $
                        14,191,721Working
      Capital
                        
                        
                        10,189,573
                        
                        
                        
                        17,229,410Stockholders’
      Equity
                        
                        
                        17,241,587
                        
                        
                        
                        18,988,536





We had
cash and cash equivalents as of December 31,2008 of $11,372,560, a decrease
of  $2,819,161 from September 30, 2008.





The
decrease  in cash was due to :





Sources of cash:Increase  in  accounts
      payable and accrued expenses
                          
                          $
                          3,767,089Decrease
      in prepaid expenses and other current assets
                          
                          
                          109,118Proceeds
      from employee stock purchases
                          
                          
                          11,000Less cash used
      for:PCTV
      acquisition-net of note payable
                          
                          
                          (2,273,000
                          )Net
      loss adjusted for non cash items
                          
                          
                          (1,580,898
                          )Effect
      of exchange rates on cash
                          
                          
                          (118,229
                          )Increase
      in  accounts receivables
                          
                          
                          (2,502,401
                          )Increase
      in inventory
                          
                          
                          (224,779
                          )Capital
      equipment purchases
                          
                          
                          (7,061
                          )Net
      cash  decrease
                          
                          $
                          (2,819,161
                          )





Net cash
of $431,871 used in operating activities was due to the net loss for the quarter
adjusted for non cash items of $1,580,898 and increases in accounts receivable
and inventories of $2,502,401 and $224,779,
respectively,  offset  by a decrease in accounts payable and
accrued expenses of $3,767,089  and a decrease  in prepaid
expenses and other current assets of
$109,118.  The  increase in   accounts
receivable  was due to an increase in sales of approximately 10%
between the fourth fiscal quarter of fiscal 2008 and the  first fiscal
quarter of 2009.




20




Cash of
$2,280,061 was used to in investment activities.  Of this amount,
$2,273,000 was used for the acquisition of the PCTV assets and $7,061 was used
to purchase fixed assets. The $2,273,000  used for the PCTV
acquisition consisted of   $2,238,000 used  against the
$5,000,000 purchase price and $35,000   disbursed in payment of
direct expenses of the acquisition. We also incurred a Note Payable to Avid
Technology, Inc. of $2,500,000 payable with interest over a twelve month period
starting January 24, 2009 and ending December 24, 2009. The note bears interest
at a 5% annual  rate.


Cash of
$11,000 was provided from purchases of stock pursuant to our employee stock
purchase plan.





Line
of Credit





On
December 12, 2008, Hauppauge Computer Works, Inc. (“HCW”), a wholly-owned
subsidiary of ours, executed a Fourth Amended and Restated Promissory Note (the
“Fourth Amendment”) to the order of JPMorgan Chase Bank, N.A. (the “Bank”). The
Fourth Amendment modified the terms and conditions of that certain Promissory
Note dated December 1, 2005, executed by HCW and made payable to the order of
the Bank (the “Note”), as amended by an Amended and Restated Promissory Note
dated March 31, 2006, as further amended by a Second Amended and Restated
Promissory Note dated February 28, 2007 and as further amended by a Third
Amended and Restated Promissory Note dated March 31, 2008.  The Fourth
Amendment, among other things, reduces the amount HCW is authorized to borrow
from the Bank from a principal amount of up to Five Million Dollars ($5,000,000)
to a principal amount of up to Seven Hundred Thousand Dollars ($700,000), based
upon borrowings made under the Fourth Amendment which may be made from time to
time by HCW (each, a “Loan”).  The Fourth Amendment matures on March 31,
2009 (the “Maturity Date”) and principal payments are due on the Maturity Date,
and thereafter on demand.  Until the Maturity Date, Loans made under
the Amendment bear interest annually at HCW’s option of (i) the Eurodollar Rate
(as defined in the Fourth Amendment) (each, a “Eurodollar Loan”) or (ii) the
Prime Rate (as defined in the Fourth Amendment) minus one percent (1.0%) (each,
a “Prime Loan”).  Interest is payable with respect to each Eurodollar
Loan at the end of one month after the date of such Loan (the “Interest
Period”), provided that, upon the expiration of the first Interest Period and
each Interest Period thereafter, each Eurodollar Loan will be automatically
continued with an Interest Period of the same duration, unless HCW notifies the
Bank that it intends to convert a Eurodollar Loan to a Prime Loan or if the Bank
is prohibited from making Eurodollar Loans, and with respect to each Prime Loan
the last day of each calendar month during the term of the Fourth Amendment and
on the date on which a Prime Loan is converted to a Eurodollar Loan, until such
Loan(s) shall be due and payable. Interest due after the Maturity Date shall be
payable at a rate of three percent (3%) per annum over the Prime
Rate.





In
connection with the Fourth Amendment, we agreed that all of the terms and
conditions of (i) our Guaranty as entered into with the Bank, dated as of
December 1, 2005, and (ii) the Pledge Agreement by and among us, the Bank and
HCW, dated as of December 1, 2005 (pursuant to which, among other things, we
granted to the Bank a first priority right of pledge on approximately two-thirds
of the outstanding capital shares of Hauppauge Digital Europe Sarl), each as
amended, restated, supplemented or modified, from time to time and as entered
into in connection with the Note, shall remain in full force and effect and
apply to the terms and conditions of the Amendment.





Further,
on December 12, 2008, in connection with the Fourth Amendment, HCW entered into
a Pledge Security Agreement with the Bank (the “Pledge Security Agreement”),
whereby HCW grants the Bank a security interest in its certificate of deposit
account held with the Bank.  The aggregate value of the Collateral (as
defined in the Pledge Security Agreement) held pursuant to the Pledge Security
Agreement shall not be less than Seven Hundred Thousand Dollars ($700,000) at
any given time.




21








Our cash
requirements for the next twelve months will include the cash required to pay
off the  note  to Avid Technology, Inc related to
the  purchase the  PCTV product line and the cash needed to
fund the acquisition’s working capital needs.  With the proper
execution of our business and operational integration plan, we believe that our
cash and cash equivalents as of  December 31, 2008 and our internally
generated cash flow  will provide us with sufficient liquidity to meet
our capital needs for the next twelve months.   Failure to meet
the operating and integration 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.




Future
contractual  obligations





The
following table shows our contractual obligations related to lease obligations
as of  December 31, 2008:





Payments
      due by periodTotal
                  
                  
                  Less than 1 year
                  
                  
                  1-3 years
                  
                  
                  3 to 5 yearsNote
      payable to Avid Technology Inc.
                  
                  $
                  2,500,000
                  
                  
                  $
                  2,500,000Operating
      lease obligations
                  
                  $
                  1,576,207
                  
                  
                  $
                  580,953
                  
                  
                  $
                  910,228
                  
                  
                  $
                  85,026Total
                  
                  $
                  4,076,207
                  
                  
                  $
                  3,080,953
                  
                  
                  $
                  910,228
                  
                  
                  $
                  85,026





Effective
December 24, 2008, pursuant to an Asset Purchase Agreement dated as of October
25, 2008,  we acquired certain assets and properties of Avid
Technology, Inc., Pinnacle Systems, Inc., Avid Technology GmbH, Avid Development
GmbH, and Avid Technology International BV.  The purchase price
consisted of $2,238,000 payable in cash and $2,500,000 payable pursuant to
Promissory Note  made payable by  us to Avid. The principal
amount due pursuant to the Note is payable in 12 equal monthly installments of
$208,333.  The first payment is due and payable on January 24,
2009.   Interest on the outstanding principal amount of the Note
is payable at a rate equal to (i) from December 24, 2008 until the Maturity Date
, five percent (5%), (ii) from and after the Maturity Date, or during the
continuance of an Event of Default , at seven percent (7%).  Pursuant
to the terms of the Note, we and our affiliates are prohibited from (i)
declaring or paying any cash dividend, or making a distribution on,
repurchasing, or redeeming, any class of stock or other equity or ownership
interest in the Buyer or its affiliates, (ii) selling, leasing, transferring or
otherwise disposing of any assets or property of the Buyer or any of its
affiliates, or attempting to or contracting to do so, other than (a) the sale of
inventory in the ordinary course of business and consistent with past practice,
(b) the granting of non-exclusive licenses of intellectual property in the
ordinary course of business and consistent with past practice and (c) the sale,
lease, transfer or disposition of any assets or property (other than the
Acquired Assets) with a value not to exceed $500,000 in the aggregate, or (iii)
dissolving or liquidating, or merging or consolidating with any other entity, or
acquiring all or substantially all of the stock or assets of any other
entity.




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.




22




Item  3.  Quantitative and
qualitative disclosures about market risks





For each
of the three fiscal years ended September 30, 2008, at least 40% of
our  sales were generated by our European subsidiary and were
invoiced  and collected  in local currency, which was
primarily the Euro. On the supply side, since we predominantly deal with North
American and Asian suppliers and contract manufacturers, approximately 90% of
our inventory required to support  our 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,
our financial results are subject to market risks resulting from the
fluctuations in the Euro to U.S. Dollar exchange rates.





We
attempt 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 our European
sales.




Item 4T. Controls and procedures





Evaluation
of 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,
2008.





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.




23




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 business plans or
strategies, projected or anticipated benefits or other consequences of our plans
or strategies, projected or anticipated benefits from acquisitions to be made by
us, or projections involving anticipated revenues, earnings or other aspects of
our operating results.  The words “may,” “will,” “expect,” “believe,”
“anticipated,” “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 (including, but not limited to, those set forth in
our Annual Report on Form 10-K for the year ended September 30, 2008), many of
which are beyond our control, that may influence the accuracy of the statements
and the projections upon which the statements are based.  Any one or
more of these uncertainties, risks and other influences could materially affect
our results of operations and whether forward looking statements made by us
ultimately prove to be accurate.  Our actual results, performance and
achievements could differ materially from those expressed or implied in these
forward-looking statements.  We undertake no obligation to publicly
update or revise any forward-looking statements, whether from new information,
future events or otherwise.  All cautionary statements made in this
Quarterly Report should be read as being applicable to all related
forward-looking statements wherever they appear.




24




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,
2008.





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,
2008.




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





None
sold  during the first fiscal quarter ended December 31.
2008.




Item
6.  Exhibits





2.1
                                            Asset
      Purchase Agreement, dated October 25, 2008, by and among Avid Technology,
      Inc., Pinnacle Systems, Inc., Avid Technology GMBH, Avid Development GMBH,
      Avid Technology International BV, and PCTV Corp. (1)2.1.1
                                            Buyer
      Parent Guaranty, dated October  25, 2008, by Hauppauge Digital,
      Inc. to and for the benefit of Avid Technology, Inc., Pinnacle Systems,
      Inc., Avid Technology GMBH, Avid Development GMBH, and Avid Technology
      International BV (1)2.1.2
                                            Amendment
      No. 1 to Asset Purchase Agreement, dated December 24, 2008, by and among
      Avid Technology, Inc., Pinnacle Systems, Inc., Avid Technology GMBH, Avid
      Development GMBH, Avid Technology International BV, and PCTV Corp.
      (2)2.1.3
                                            Secured
      Promissory Note, dated December 24, 2008, made by PCTV Systems S.a.r.l. in
      favor of Avid Technology, Inc. (2)2.1.4
                                            Transition
      Services Agreement, dated December 24, 2008, by and among Hauppauge
      Digital Europe S.a.r.l., PCTV Systems S.a.r.l., Hauppauge Computer Works,
      Inc., Avid Technology, Inc., Pinnacle Systems, Inc., Avid Technology GMBH,
      Avid Development GMBH, and Avid Technology International BV.
      (2)2.1.5
                                            Inventory
      and Product Return Agreement, dated December 24, 2008, by and among Avid
      Technology, Inc., Avid Technology International BV, Hauppauge Computer
      Works, Inc. and Hauppauge Digital Europe S.a.r.l. (2)2.1.6
                                            Intellectual
      Property License Agreement, dated December 24, 2008, by and among Avid
      Technology, Inc., Pinnacle Systems, Inc. and PCTV Systems S.a.r.l.
      (2)
  25
  3.1
                                          Certificate
      of Incorporation (3)3.1.1
                                          Certificate
      of Amendment of the Certificate of Incorporation, dated July 14, 2000
      (4)3.2
                                          By-laws,
      as amended to date (5)4.1
                                          Form
      of Common Stock Certificate (3)10.1
                                          Fourth
      Amended and Restated Promissory Note, dated as of December 2, 2008, made
      payable by Hauppauge Computer Works, Inc. to the order of JP Morgan Chase
      Bank, N.A. in the original principal amount of Seven Hundred Thousand
      ($700,000) Dollars. (6)10.2
                                          Pledge
      Security Agreement, dated as of December 2, 2008, by Hauppauge Computer
      Works, Inc. and JP Morgan Chase Bank, N.A. (6)31.1
                                          Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) as
      adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200231.2
                                          Certification
      of the Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a)
      as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200232
                                          Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002




(1)           Denotes
document filed as an Exhibit to our Form 8-K dated October 25, 2008 and
incorporated herein by reference.


(2)           Denotes
document filed as an Exhibit to our Form 8-K dated December 24, 2008, and
incorporated herein by reference.


(3)           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.


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


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


(6)           Denotes
document filed as an Exhibit to our Form 8-K dated December 12, 2008 and
incorporated herein by reference.




26




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 13, 2009
                                
                                By
                                /s/Kenneth PlotkinKENNETH  PLOTKINChief
      Executive Officer, Chairman of theBoard,
      President (Principal Executive Officer)Date:
                                February 13, 2009
                                
                                By
                                /s/Gerald TucciaroneGERALD
      TUCCIARONETreasurer,
      Chief Financial Officer,(Principal
      Financial Officer and PrincipalAccounting
      Officer) and
Secretary




27