UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, 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 March 31, 2006

OR

oTRANSITION 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. Employer   
|incorporation 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.

xYESoNO

Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer or a non-accelerated filer (See definition of accelerated filer and
large accelerated filer in Rule 12b-2 of the Exchange Act).

|                         |                    |                       
|------------------------ | ------------------ | ----------------------
|oLARGE ACCELERATED FILER | oACCELERATED FILER | xNON-ACCELERATED FILER

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

oYESxNO

As of May 3,
2006, 9,623,772 shares of .01 par value Common Stock of the registrant were
outstanding.

2

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HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES

INDEX

|                                                                                                                                               |          | 
|---------------------------------------------------------------------------------------------------------------------------------------------- | -------- | 
|                                                                                                                                               | Page No.
|                                                                                                                                               |         
|PART I. FINANCIAL INFORMATION                                                                                                                  |          | 
|                                                                                                                                               |          | 
|Item 1. Financial Statements                                                                                                                   |          | 
|                                                                                                                                               |          | 
|Condensed Consolidated Balance Sheets 
  March 31, 2006 (unaudited) and September 30, 2005 (audited)                                          | 5        | 
|                                                                                                                                               |          | 
|Condensed Consolidated Statements of Income -
  Three Months ended March 31, 2006 (unaudited) and 2005 (unaudited)                             | 6        | 
|                                                                                                                                               |          | 
|Condensed Consolidated Statements of Income -
  Six Months ended March 31, 2006 (unaudited) and 2005(unaudited)                                | 7        | 
|                                                                                                                                               |          | 
|Condensed Consolidated Statements of Other Comprehensive Income -
  Three and six months ended March 31, 2006 (unaudited) and 2005 (unaudited) | 8        | 
|                                                                                                                                               |          | 
|Condensed Consolidated Statements of Cash Flows -
  Six Months ended March 31, 2006 (unaudited) and 2005 (unaudited)                           | 9        | 
|                                                                                                                                               |          | 
|Notes to Condensed Consolidated Financial Statements                                                                                           | 10 - 18  | 
|                                                                                                                                               |          | 
|Item 2. Managements Discussion and Analysis of Financial Condition
  and Results of
  Operations                                              | 19 - 31  | 
|                                                                                                                                               |          | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk                                                                             | 31       | 
|                                                                                                                                               |          | 
|Item 4. Controls and Procedures                                                                                                                | 32       | 

3

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|                                                                      |    | 
|--------------------------------------------------------------------- | -- | 
|PART II. OTHER INFORMATION                                            |    | 
|                                                                      |    | 
|Item 2. Unregistered Sales of Equity
  Securities and Use of Proceeds | 33 | 
|                                                                      |    | 
|Item 6. Exhibits                                                      | 33 | 
|                                                                      |    | 
|Signatures                                                            | 34 | 

4

---



PART I.
FINANCIAL INFORMATION

Item 1. Financial
Statements

HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS

|                                                                                                            |  |                            |            |                             |   |            |  
|----------------------------------------------------------------------------------------------------------- |  | -------------------------- | ---------- | --------------------------- | - | ---------- | -
|                                                                                                            |  | March 31, 2006 (unaudited) |            | September 30, 2005(audited) |  
|                                                                                                            |  |                            |            |                             |  
|Assets:                                                                                                     |  |                            |            |                             |   |            |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Cash and cash equivalents                                                                                   |  | $                          | 4,455,518  |                             | $ | 7,567,393  |  
|Receivables, net of various allowances                                                                      |  |                            | 27,861,474 |                             |   | 13,048,076 |  
|Inventories                                                                                                 |  |                            | 12,752,933 |                             |   | 9,806,785  |  
|Prepaid expenses and other current assets                                                                   |  |                            | 1,138,202  |                             |   | 1,087,453  |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Total
  current assets                                                                                      |  |                            | 46,208,127 |                             |   | 31,509,707 |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Property, plant and equipment, net                                                                          |  |                            | 542,169    |                             |   | 525,108    |  
|Security deposits and other non current
  assets                                                            |  |                            | 83,240     |                             |   | 81,529     |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Total assets                                                                                                |  | $                          | 46,833,536 |                             | $ | 32,116,344 |  
|                                                                                                            |  |                            |            |                             |   |            |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Liabilities and Stockholders Equity:                                                                       |  |                            |            |                             |   |            |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Current
  Liabilities:                                                                                      |  |                            |            |                             |   |            |  
|Accounts payable                                                                                            |  | $                          | 23,568,278 |                             | $ | 10,750,560 |  
|Accrued expenses-licensing fees                                                                             |  |                            | 4,437,659  |                             |   | 4,126,506  |  
|Accrued expenses                                                                                            |  |                            | 1,378,634  |                             |   | 1,121,842  |  
|Income taxes payable                                                                                        |  |                            | 198,577    |                             |   | 175,944    |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Total current liabilities                                                                                   |  |                            | 29,583,148 |                             |   | 16,174,852 |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Stockholders Equity:                                                                                       |  |                            |            |                             |   |            |  
|                                                                                                           
|Common stock $.01 par value; 25,000,000 shares
authorized, 10,226,804
  and 10,107,936 issued, respectively |  |                            | 102,269    |                             |   | 101,080    |  
|Additional paid-in capital                                                                                  |  |                            | 13,995,648 |                             |   | 13,603,705 |  
|Retained earnings                                                                                           |  |                            | 5,290,240  |                             |   | 3,311,888  |  
|Accumulated other comprehensive (loss)
income                                                               |  |                            | (379,818   | )                           |   | 682,770    |  
|Treasury Stock, at cost, 607,547 shares                                                                     |  |                            | (1,757,951 | )                           |   | (1,757,951 | )
|                                                                                                            |  |                            |            |                             |   |            |  
|Total stockholders equity                                                                                  |  |                            | 17,250,388 |                             |   | 15,941,492 |  
|                                                                                                            |  |                            |            |                             |   |            |  
|Total liabilities and stockholders equity                                                                  |  | $                          | 46,833,536 |                             | $ | 32,116,344 |  
|                                                                                                            |  |                            |            |                             |   |            |  

See accompanying notes to condensed
consolidated financial statements

5

---



HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

|                                               |  |                                |            |      |   |            | 
|---------------------------------------------- |  | ------------------------------ | ---------- | ---- | - | ---------- | 
|                                               |  | Three
  months ended March 31, |           
|                                               |  |                                |           
|                                               |  | 2006                           |            | 2005 |  
|                                               |  |                                |           
|                                              
|Net sales                                      |  | $                              | 26,685,393 |      | $ | 20,362,293 | 
|Cost
  of sales                                |  |                                | 21,503,859 |      |   | 15,542,399 | 
|                                               |  |                                |            |      |   |            | 
|Gross profit                                   |  |                                | 5,181,534  |      |   | 4,819,894  | 
|                                               |  |                                |            |      |   |            | 
|Selling,
  general and administrative expenses |  |                                | 3,429,858  |      |   | 3,326,814  | 
|Research
  & development expenses              |  |                                | 768,832    |      |   | 631,437    | 
|                                               |  |                                |            |      |   |            | 
|Income from operations                         |  |                                | 982,844    |      |   | 861,643    | 
|                                               |  |                                |            |      |   |            | 
|Other income:                                  |  |                                |            |      |   |            | 
|Interest income                                |  |                                | 6,275      |      |   | 3,150      | 
|Foreign currency                               |  |                                | 13,487     |      |   | 7,672      | 
|                                               |  |                                |            |      |   |            | 
|Other
  income                                 |  |                                | 19,762     |      |   | 10,822     | 
|                                               |  |                                |            |      |   |            | 
|Income before taxes on income                  |  |                                | 1,002,606  |      |   | 872,465    | 
|Tax
  provision                                |  |                                | 44,728     |      |   | 45,000     | 
|                                               |  |                                |            |      |   |            | 
|Net income                                     |  | $                              | 957,878    |      | $ | 827,465    | 
|                                               |  |                                |            |      |   |            | 
|                                               |  |                                |            |      |   |            | 
|Net income per share:                          |  |                                |            |      |   |            | 
|Basic                                          |  | $                              | 0.10       |      | $ | 0.09       | 
|Diluted                                        |  | $                              | 0.10       |      | $ | 0.08       | 
|                                               |  |                                |            |      |   |            | 

See accompanying notes to condensed
consolidated financial statements

6

---



HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

|                                               |  |                              |            |      |   |            |  
|---------------------------------------------- |  | ---------------------------- | ---------- | ---- | - | ---------- | -
|                                               |  | Six months
  ended March 31, |           
|                                               |  |                              |           
|                                               |  | 2006                         |            | 2005 |  
|                                               |  |                              |            |      |  
|                                               |  |                              |            |      |   |            |  
|Net sales                                      |  | $                            | 51,730,383 |      | $ | 43,722,736 |  
|Cost
  of sales                                |  |                              | 41,317,065 |      |   | 33,591,477 |  
|                                               |  |                              |            |      |   |            |  
|Gross profit                                   |  |                              | 10,413,318 |      |   | 10,131,259 |  
|                                               |  |                              |            |      |   |            |  
|Selling,
  general and administrative expenses |  |                              | 6,810,926  |      |   | 6,753,870  |  
|Research
  & development expenses              |  |                              | 1,562,833  |      |   | 1,188,967  |  
|                                               |  |                              |            |      |   |            |  
|Income from operations                         |  |                              | 2,039,559  |      |   | 2,188,422  |  
|                                               |  |                              |            |      |   |            |  
|Other income (expense):                        |  |                              |            |      |   |            |  
|Interest income                                |  |                              | 11,481     |      |   | 4,661      |  
|Foreign currency                               |  |                              | 14,451     |      |   | (928       | )
|                                               |  |                              |            |      |   |            |  
|Other
  income                                 |  |                              | 25,932     |      |   | 3,733      |  
|                                               |  |                              |            |      |   |            |  
|Income before taxes on income                  |  |                              | 2,065,491  |      |   | 2,192,155  |  
|Tax
  provision                                |  |                              | 87,139     |      |   | 101,000    |  
|                                               |  |                              |            |      |   |            |  
|Net income                                     |  | $                            | 1,978,352  |      | $ | 2,091,155  |  
|                                               |  |                              |            |      |   |            |  
|                                               |  |                              |            |      |   |            |  
|Net income per share:                          |  |                              |            |      |   |            |  
|Basic                                          |  | $                            | 0.21       |      | $ | 0.22       |  
|Diluted                                        |  | $                            | 0.20       |      | $ | 0.21       |  
|                                               |  |                              |            |      |   |            |  

See
accompanying notes to condensed consolidated financial statements

7

---



HAUPPAUGE DIGITAL, INC. AND
SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE
INCOME
(UNAUDITED)

|                                              |  |                                |          |      |   |          |  
|--------------------------------------------- |  | ------------------------------ | -------- | ---- | - | -------- | -
|                                              |  | Three
  months ended March 31, |         
|                                              |  |                                |         
|                                              |  | 2006                           |          | 2005 |  
|                                              |  |                                |          |      |  
|Net income                                    |  | $                              | 957,878  |      | $ | 827,465  |  
|Foreign currency translation (loss)
  gain    |  |                                | (175,651 | )    |   | 406,300  |  
|Forward exchange contracts
  marked to market |  |                                | (39,528  | )    |   | (237,461 | )
|                                              |  |                                |          |      |   |          |  
|Other comprehensive income                    |  | $                              | 742,699  |      | $ | 996,304  |  
|                                              |  |                                |          |      |   |          |  

|                                            |  |                            |           |      |   |           | 
|------------------------------------------- |  | -------------------------- | --------- | ---- | - | --------- | 
|                                            |  | Six months ended March 31, |          
|                                            |  |                            |          
|                                            |  | 2006                       |           | 2005 |  
|                                            |  |                            |           |      |  
|Net income                                  |  | $                          | 1,978,352 |      | $ | 2,091,155 | 
|Foreign currency translation (loss)
gain    |  |                            | (918,922  | )    |   | 126,509   | 
|Forward exchange contracts marked to
market |  |                            | (143,666  | )    |   | 346,800   | 
|                                            |  |                            |           |      |   |           | 
|Other comprehensive income                  |  | $                          | 915,764   |      | $ | 2,564,464 | 
|                                            |  |                            |           |      |   |           | 

See accompanying
notes to condensed consolidated financial statements

8

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HAUPPAUGE DIGITAL, INC. AND
SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                                                                |  |                              |             |      |   |            |  
|------------------------------------------------------------------------------- |  | ---------------------------- | ----------- | ---- | - | ---------- | -
|                                                                                |  | Six months
  ended March 31, |            
|                                                                                |  |                              |            
|                                                                                |  | 2006                         |             | 2005 |  
|                                                                                |  |                              |             |      |  
|Net income                                                                      |  | $                            | 1,978,352   |      | $ | 2,091,155  |  
|                                                                                |  |                              |             |      |   |            |  
|Adjustments
  to reconcile net income to net cash used in operating activities: |  |                              |             |      |   |            |  
|Depreciation
  and amortization                                                 |  |                              | 90,609      |      |   | 109,084    |  
|Non
  cash stock compensation expense                                           |  |                              | 187,824     |      |   |           |  
|Other
  non cash items                                                          |  |                              | (1,711      | )    |   |           |  
|Changes in current assets and
liabilities:                                      |  |                              |             |      |   |            |  
|Accounts
  receivable                                                           |  |                              | (14,813,398 | )    |   | (3,239,030 | )
|Inventories                                                                     |  |                              | (2,946,148  | )    |   | 117,778    |  
|Prepaid
  expenses and other current assets                                     |  |                              | (50,749     | )    |   | (346,477   | )
|Accounts
  payable                                                              |  |                              | 12,817,718  |      |   | 303,466    |  
|Accrued
  expenses and other current liabilities                                |  |                              | 590,578     |      |   | 444,796    |  
|                                                                                |  |                              |             |      |   |            |  
|Total
  adjustments                                                             |  |                              | (4,125,277  | )    |   | (2,610,383 | )
|                                                                                |  |                              |             |      |   |            |  
|Net cash used in operating
activities                                           |  |                              | (2,146,925  | )    |   | (519,228   | )
|                                                                                |  |                              |             |      |   |            |  
|                                                                                |  |                              |             |      |   |            |  
|Cash Flows From Investing
Activities:                                           |  |                              |             |      |   |            |  
|Purchases
  of property, plant and equipment                                    |  |                              | (107,670    | )    |   | (145,514   | )
|                                                                                |  |                              |             |      |   |            |  
|Net cash used in investing
activities                                           |  |                              | (107,670    | )    |   | (145,514   | )
|                                                                                |  |                              |             |      |   |            |  
|                                                                                |  |                              |             |      |   |            |  
|Cash Flows From Financing
Activities:                                           |  |                              |             |      |   |            |  
|Proceeds
  from exercise of stock options and employee stock purchases          |  |                              | 205,308     |      |   | 656,309    |  
|Purchase
  of treasury stock                                                    |  |                              |            |      |   | (149,757   | )
|                                                                                |  |                              |             |      |   |            |  
|Net cash provided by financing
activities                                       |  |                              | 205,308     |      |   | 506,552    |  
|                                                                                |  |                              |             |      |   |            |  
|Effect
  of exchange rates on cash                                              |  |                              | (1,062,588  | )    |   | 473,309    |  
|Net (decrease) increase in
cash and cash
  equivalents                          |  |                              | (3,111,875  | )    |   | 315,119    |  
|Cash and cash equivalents, beginning of
  period                                |  |                              | 7,567,393   |      |   | 8,661,589  |  
|                                                                                |  |                              |             |      |   |            |  
|Cash and cash equivalents, end of
period                                        |  | $                            | 4,455,518   |      | $ | 8,976,708  |  
|                                                                                |  |                              |             |      |   |            |  
|Supplemental disclosures:                                                       |  |                              |             |      |   |            |  
|Income
taxes paid                                                               |  | $                            | 16,776      |      | $ | 38,863     |  
|                                                                                |  |                              |             |      |   |            |  

See accompanying notes to condensed
consolidated financial statements

9

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HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)

Note 1.
Basis of Presentation

The accompanying unaudited condensed consolidated
financial statements 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, 2005 Form 10-K.

The operating results for the three months and six
months ended March 31, 2006 are not necessarily indicative of the results to be
expected for the September 30, 2006 year end.

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

Note 2.
Receivables

Accounts and other receivables as of March 31, 2006
and September 30, 2005 consisted of:

|                                         |  |                  |            |                      |   |            |  
|---------------------------------------- |  | ---------------- | ---------- | -------------------- | - | ---------- | -
|                                         |  | March 31,
  2006 |            | September 30,
  2005 |  
|                                         |  |                  |            |                      |  
|Trade
  receivables                      |  | $                | 17,799,326 |                      | $ | 10,186,232 |  
|Receivable
  from contract manufacturers |  |                  | 12,182,972 |                      |   | 5,491,524  |  
|GST
  and VAT taxes receivables          |  |                  | 1,073,753  |                      |   | 567,820    |  
|Allowances
  and reserves                |  |                  | (3,257,000 | )                    |   | (3,257,000 | )
|Other                                    |  |                  | 62,423     |                      |   | 59,500     |  
|                                         |  |                  |            |                      |   |            |  
|                                         |  | $                | 27,861,474 |                      | $ | 13,048,076 |  
|                                         |  |                  |            |                      |   |            |  

10

---



NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 3.
Derivative Financial Instruments

As of March 31, 2006, the Company had foreign currency
contracts outstanding of approximately $2,911,400 against the delivery of the
Euro. The contracts expire from April 2006 through June 2006. The Companys
accounting policies for these instruments designate such instruments as cash
flow hedging transactions. The Company does not enter into such contracts for
speculative purposes. The Company records all derivative gains and losses on
the balance sheet as a component of stockholders equity under the caption
Accumulated other comprehensive income (loss). The Company recorded a loss of
$143,666 for the six months ended March 31, 2006 on its statement of other comprehensive
income. As of March 31, 2006, a deferred loss of $7,248, reflecting the
cumulative mark to market losses of the Companys derivatives, was recorded on
the Companys balance sheet as a component of accumulated other comprehensive
income (loss) in our equity section.

The Company uses the average monthly forward contract
exchange rate to translate our Euro denominated sales into the Companys U.S.
dollar reporting currency. For the three and six months ended March 31, 2006,
the use of the monthly average spot rate instead of the average monthly forward
contract exchange rate to value Euro denominated sales would have resulted
in a decrease in sales of $219,496 and $848,735, respectively. These sales
increases are related to contracts that closed during these periods and
the changes in the fair value of our derivative contracts. For the three and
six months ended March 31, 2005, the use of the monthly average spot rate
instead of the average monthly forward contract exchange rate to value Euro
denominated sales would have resulted in an increase of sales of $337,699 and
$978,484, respectively.

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:

|                |  |                  |            |                        |   |           | 
|--------------- |  | ---------------- | ---------- | ---------------------- | - | --------- | 
|                |  | March 31,
  2006 |            | September
  30,
  2005 |  
|                |  |                  |            |                        |  
|                |  |                  |            |                        |  
|Component Parts |  | $                | 5,237,539  |                        | $ | 4,131,732 | 
|Finished Goods  |  |                  | 7,515,394  |                        |   | 5,675,053 | 
|                |  |                  |            |                        |   |           | 
|                |  | $                | 12,752,933 |                        | $ | 9,806,785 | 
|                |  |                  |            |                        |   |           | 
|                |  |                  |            |                       

Note 5.
Net Income Per Share

Basic net income per share includes no dilution and is
computed by dividing net income 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:

11

---



NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 5.
Net Income Per Share-continued

|                                                                 |  |                      |            |                    |  |            |  |      |           |  |  |           | 
|---------------------------------------------------------------- |  | -------------------- | ---------- | ------------------ |  | ---------- |  | ---- | --------- |  |  | --------- | 
|                                                                 |  | Three
  Months Ended |            | Six months
  Ended | 
|                                                                 |  | March 31,            |            | March 31,          | 
|                                                                 |  | 2006                 |            | 2005               |  | 2006       |  | 2005 |          
|                                                                 |  |                      |            |                    |  |            |  |      |          
|Weighted average shares outstanding-basic                        |  |                      | 9,576,522  |                    |  | 9,460,702  |  |      | 9,541,935 |  |  | 9,368,428 | 
|Number of shares issued on the assumed exercise of stock
options |  |                      | 481,063    |                    |  | 640,468    |  |      | 447,764   |  |  | 630,977   | 
|                                                                 |  |                      |            |                    |  |            |  |      |           |  |  |           | 
|Weighted average shares outstanding-diluted                      |  |                      | 10,057,585 |                    |  | 10,101,170 |  |      | 9,989,699 |  |  | 9,999,405 | 
|                                                                 |  |                      |            |                    |  |            |  |      |           |  |  |           | 

Options to purchase 173,111 and 88,109 shares of
common stock, at prices ranging $3.19 to $ 8.75 and $5.25 to $10.06, were
outstanding for the three months ended March 31, 2006 and 2005, respectively,
but were not included in the computation of diluted earnings per share because
they were anti-dilutive.

Options to purchase 218,173 and 91,878 shares of
common stock, at prices ranging $3.19 to $ 8.75 and $5.25 to $10.06, were
outstanding for the six months ended March 31, 2006 and 2005, respectively, but
were not included in the computation of diluted earnings per share because they
were anti-dilutive.

Note 6. Accumulated other comprehensive income

As of March 31, 2006, appearing in the equity section
under Accumulated other comprehensive income (loss) was a loss of $379,818,
which consisted of a deferred translation loss of $372,570 and a deferred loss
of $7,248 due to the mark to market losses on the difference 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.

Accumulated other comprehensive income (loss) consists
of two components: translation gains and losses and FAS 133 mark to market
gains and losses on our open foreign exchange contracts. The table below
details the gains and losses that make up the accumulated other comprehensive
loss of $379,818 recorded on our balance sheet as of March 31, 2006:

|                                                |  |               |         |                  |   |               |   |   |          |  
|----------------------------------------------- |  | ------------- | ------- | ---------------- | - | ------------- | - | - | -------- | -
|Accumulated Other Comprehensive
  Income (Loss) |  | Balance as of |         | Oct 05 to Mar 06 |   | Balance as of |  
|Fiscal 2006 activity                            |  | Sept 30 2005  |         | (losses)         |   | March 31 2006 |  
|                                                |  |               |         |                  |   |               |  
|Translation gains and losses                    |  | $             | 546,352 |                  | $ | (918,922      | ) | $ | (372,570 | )
|FAS 133 mark to market adjustment               |  |               | 136,418 |                  |   | (143,666      | ) |   | (7,248   | )
|                                                |  |               |         |                  |   |               |   |   |          |  
|                                                |  | $             | 682,770 |                  | $ | (1,062,588    | ) | $ | (379,818 | )
|                                                |  |               |         |                  |   |               |   |   |          |  

12

---



NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 7.
Revenue Recognition

The Company sells through a sales channel which
consist of retailers, distributors and original equipment manufacturers
(OEMs). The Companys prices are fixed consistently over the entire sales
channel. The majority of the Companys customers are granted lines of credit.
The product is shipped on open account with the majority of the Companys
customers given 30 to 45 day payment terms. Those customers deemed as large
credit risks either pay in advance or issue us 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 products 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 and 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 end-caps and advertisements in the stores circular,
the Company has no further obligation to assist in the resale of the product.

The Company offers its customers a right of return,
but does not offer stock balancing. The Companys accounting method complies
with SFAS 48 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.

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 receiver products for the personal computer market. The
products are similar in function and share commonality of component parts and
manufacturing processes. The Company offers three primary types of analog
products and four types of digital TV receivers. The Companys products are
either sold, or can be sold, by the same retailers and distributors in our
marketing channel. The Company also sells product directly to OEM customers.
The Company evaluates its product lines under the functional categories of
analog and digital products. Sales by functional category are as follows:

13

---



NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited)

|                   |  |                              |            |                            |   |            |  |      |            |  |   |            | 
|------------------ |  | ---------------------------- | ---------- | -------------------------- | - | ---------- |  | ---- | ---------- |  | - | ---------- | 
|                   |  | Three months ended March 31, |            | Six months ended March 31, |  
|                   |  | 2006                         |            | 2005                       |   | 2006       |  | 2005 |           
|                   |  |                              |            |                            |   |            |  |      |           
|Product line sales |  |                              |            |                            |   |            |  |      |            |  |   |            | 
|Analog sales       |  | $                            | 19,491,041 |                            | $ | 16,362,392 |  | $    | 34,948,073 |  | $ | 34,753,380 | 
|Digital sales      |  |                              | 7,194,352  |                            |   | 3,999,901  |  |      | 16,782,310 |  |   | 8,969,356  | 
|                   |  |                              |            |                            |   |            |  |      |            |  |   |            | 
|                   |  | $                            | 26,685,393 |                            | $ | 20,362,293 |  | $    | 51,730,383 |  | $ | 43,722,736 | 
|                   |  |                              |            |                            |   |            |  |      |            |  |   |            | 

The Company
sells its products through an international network of distributors and
retailers. Sales percent by geographic region are as follows:

|                                   |  |                              |     |                            |  |      |   |      |     |   |  |     |  
|---------------------------------- |  | ---------------------------- | --- | -------------------------- |  | ---- | - | ---- | --- | - |  | --- | -
|                                   |  | Three months ended March 31, |     | Six months ended March 31, | 
|                                   |  | 2006                         |     | 2005                       |  | 2006 |   | 2005 |    
|                                   |  |                              |     |                            |  |      |   |      |    
|Sales percent by geographic region |  |                              |     |                            |  |      |   |      |     |   |  |     |  
|United States                      |  |                              | 51  | %                          |  | 49   | % |      | 46  | % |  | 43  | %
|Europe                             |  |                              | 47  | %                          |  | 49   | % |      | 52  | % |  | 55  | %
|Asia                               |  |                              | 2   | %                          |  | 2    | % |      | 2   | % |  | 2   | %
|                                   |  |                              |     |                            |  |      |   |      |     |   |  |     |  
|Total                              |  |                              | 100 | %                          |  | 100  | % |      | 100 | % |  | 100 | %
|                                   |  |                              |     |                            |  |      |   |      |     |   |  |     |  

Note 9. Stock-Based Compensation

Prior to
October 1, 2005, the Company accounted for employee stock option plans based on
the intrinsic value method in accordance with Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock
Issued to Employees, and related Interpretations and had adopted
the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation
(SFAS No.123). Accordingly,
compensation cost for stock options was measured as the excess, if any, of the
quoted market price of the Companys stock at the grant date over the amount an
employee must pay to acquire the stock. The Company granted stock options with
exercise prices equal to the market price of the underlying stock on the date
of grant, therefore, the Company did not record stock-based compensation
expense under APB Opinion No. 25.

Effective
October 1, 2005, the Company adopted SFAS No. 123R, Share-Based Payments
using the modified prospective method, which requires measurement of
compensation cost for all stock-based awards at fair value on date of grant and
recognition of compensation over the service period for awards expected to
vest. Therefore, prior period financial statements have not been restated. The
fair value of stock options were determined using the Black-Scholes valuation
model, which is consistent with our valuation techniques previously utilized
for stock options in footnote disclosures required under SFAS No. 123. Such
fair value is recognized as expense over the service period, net of estimated
forfeitures. The adoption of SFAS No.123R resulted in an immaterial cumulative
change in accounting as of the date of adoption.

14

---



NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited)

Note 9. Stock-Based Compensation-continued

The Company
had as of March 31, 2006 options issued from four incentive option plans and
one non qualified option plan. These options
typically vest over a period of four to five years. Options granted subsequent
to the Companys October 1, 2005 adoption of SFAS 123R, have a contract term of
10 years and the fair value for these options was estimated at the date of
grant using a Black-Scholes option pricing model with the following weighted
average assumptions based on historical data of the Companys stock:

| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| |  | Risk free
  interest rate-4.25%                                                                                                     
|
| |  | Expected
  volatility-50%                                                                                                           
|
| |  | Expected
  dividend yield-0%                                                                                                        
|
| |  | Weighted
  average expected life-5 to7 years, determined via the simplified method
  detailed in Staff Accounting Bulletin No. 107

Stock option
activity for the six months ended March 31, 2006 is as follows:

|                                         |  |         |           |                                     |   |                                                         |  |                               |      |  |   |           |  
|---------------------------------------- |  | ------- | --------- | ----------------------------------- | - | ------------------------------------------------------- |  | ----------------------------- | ---- |  | - | --------- | -
|                                         |  | Options |           | Weighted
  average
  exercise price |   | Weighted
  average
  remaining contract 
  term (years) |  | Aggregate
  intrinsic
  Value |     
|                                         |  |         |           |                                     |   |                                                         |  |                               |     
|Outstanding as of October 1, 2005        |  |         | 1,432,094 |                                     | $ | 3.12                                                    |  |                               | 4.95 |  | $ | 4,470,396 |  
|Options granted                          |  |         | 146,000   |                                     |   | 3.32                                                    |  |                               | 9.50 |  |   | 485,120   |  
|Options exercised                        |  |         | (88,647   | )                                   |   | 1.66                                                    |  |                               |     |  |   | (147,375  | )
|Options forfeited                        |  |         | (13,253   | )                                   |   | 1.46                                                    |  |                               |     |  |   | (19,381   | )
|                                         |  |         |           |                                     |   |                                                         |  |                               |      |  |   |           |  
|Options outstanding as of March 31, 2006 |  |         | 1,476,194 |                                     | $ | 3.24                                                    |  |                               | 4.73 |  | $ | 4,788,760 |  
|                                         |  |         |           |                                     |   |                                                         |  |                               |      |  |   |           |  
|Options exercisable as of March 31, 2006 |  |         | 1,014,944 |                                     | $ | 2.77                                                    |  |                               | 4.18 |  | $ | 2,810,784 |  
|                                         |  |         |           |                                     |   |                                                         |  |                               |      |  |   |           |  

For the non vested options outstanding that
were granted prior to the Companys October 1, 2005 adoption of SFAS 123R, the
fair value for these options was estimated using a Black-Scholes option pricing
model on the date of grant. Options granted prior to October 1, 2005 were
accounted for based on the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, 
Accounting for Stock Issued to Employees, and related
Interpretations. Additionally, the Company had adopted the disclosure
requirements of SFAS No. 123, Accounting
for Stock-Based Compensation (SFAS No.123).

Presented in the table below
are the options granted, weighted average fair value using a Black Sholes
pricing model and total compensation charges, net of estimated forfeitures.

15

---



NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited)

Note 9. Stock-Based Compensation-continued

|                                                            |  |                    |         |                                              |   |                          |  |   |           | 
|----------------------------------------------------------- |  | ------------------ | ------- | -------------------------------------------- | - | ------------------------ |  | - | --------- | 
|                                                            |  | Options 
  Granted |         | Weighted 
  Average 
  Black Scholes
  Value |   | Compensation
  
  Charge | 
|                                                            |  |                    |         |                                              |   |                          | 
|Options
  granted subsequent to adoption of SFAS 123R       |  |                    | 146,000 |                                              | $ | 2.1505                   |  | $ | 313,975   | 
|Non
  vested options granted prior to adoption of SFAS 123R |  |                    | 393,690 |                                              |   | 1.8412                   |  |   | 724,874   | 
|                                                            |  |                    |         |                                              |   |                          |  |   |           | 
|Total                                                       |  |                    | 539,690 |                                              | $ | 1.9249                   |  | $ | 1,038,849 | 
|                                                            |  |                    |         |                                              |   |                          |  |   |           | 

Unrecognized stock
compensation charges, weighted average stock compensation amortization and
stock compensation expenses charged to operations for the quarter and six months
ended March 31, 2006 are as follows:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $1,038,849
  of total unrecognized compensation cost, net of estimated forfeitures,
  related to non-vested share-based compensation arrangements and options
  granted subsequent to the October 1, 2005 adoption of SFAS 123R, was
  outstanding prior to the recognition of $187,824 of compensation charges in
  the six months ended March 31, 2006.                                                                                                          
|
| |  | Compensation
  cost is expected to be recognized over a weighted-average period of 3.75
  years                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Compensation
  costs charged to operations for the second quarter ended March 31, 2006 was
  $86,946, consisting of $20,945 for options granted during fiscal 2006 and
  $66,001 for non
  vested options granted prior to October 1, 2005 and has been recorded in
  SG&A and R&D expense. Expensing stock compensation costs against
  operations resulted in a $0.01 reduction in basic and diluted net income per
  share for the quarter                      
|
| |  | Compensation
  costs charged to operations for the six months ended March 31, 2006 was
  $187,824, consisting of $41,890 for options granted during fiscal 2006 and
  $145,934 for non
  vested options granted prior to October 1, 2005 and has been recorded in
  SG&A and R&D expense. Expensing stock compensation costs against
  operations resulted in a $0.02 reduction in basic and diluted net income per
  share for the six months ended March 31, 2006

In recognition
that stock compensation is a non cash expense, the effect of expensing options
had no affect on the Companys cash flow. However, it was reflected in the
Companys cash flow statement as a non-cash add back in the determination of
cash flows from operating activities.

A summary of
our non-vested shares as of March 31, 2006 and changes during the six months
ended March 31, 2006 is presented below:

16

---



NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited)

Note 9. Stock-Based Compensation-continued

|                                 |  |        |         |                                              |  |        | 
|-------------------------------- |  | ------ | ------- | -------------------------------------------- |  | ------ | 
|                                 |  | Shares |         | Weighted
  average
  Grant date
  fair value | 
|                                 |  |        |         |                                              | 
|Non-vested as of October 1, 2005 |  |        | 393,690 |                                              |  | 1.8412 | 
|Granted                          |  |        | 146,000 |                                              |  | 3.32   | 
|Vested                           |  |        | (77,252 | )                                            |  | 0.765  | 
|Forfeited                        |  |        | (1,188  | )                                            |  | 0.43   | 
|                                 |  |        |         |                                              |  |        | 
|Non-vested as of March 31, 2006  |  |        | 461,250 |                                              |  | 2.494  | 
|                                 |  |        |         |                                              |  |        | 

The following
table illustrates the effect on net income and net income per share for the
three and six months ended March 31, 2005 as if the Company has consistently
measured the compensation cost for the Companys stock option programs under
the fair value method adopted on October 1, 2005:

|                                                                                                                     |  |                                       |         |                                     |   |           |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------- | ----------------------------------- | - | --------- | -
|                                                                                                                     |  | Three
  months ended
  March 31, 2005 |         | Six months
  ended
  March 31, 2005 |  
|                                                                                                                     |  |                                       |         |                                     |  
|Net income as reported                                                                                               |  | $                                     | 827,465 |                                     | $ | 2,091,155 |  
|Deduct: Total stock-based
  employee compensation expense determined under fair value method, net of
  related taxes |  |                                       | (8,924  | )                                   |   | (17,848   | )
|                                                                                                                     |  |                                       |         |                                     |   |           |  
|Pro forma net income                                                                                                 |  | $                                     | 818,541 |                                     | $ | 2,073,307 |  
|                                                                                                                     |  |                                       |         |                                     |   |           |  
|Net income per share - as
  reported:                                                                                |  |                                       |         |                                     |   |           |  
|Basic                                                                                                                |  | $                                     | 0.09    |                                     | $ | 0.22      |  
|                                                                                                                     |  |                                       |         |                                     |   |           |  
|Diluted                                                                                                              |  | $                                     | 0.08    |                                     | $ | 0.21      |  
|                                                                                                                     |  |                                       |         |                                     |   |           |  
|Net income per share - pro
  forma:                                                                                  |  |                                       |         |                                     |   |           |  
|Basic                                                                                                                |  | $                                     | 0.09    |                                     | $ | 0.22      |  
|                                                                                                                     |  |                                       |         |                                     |   |           |  
|Diluted                                                                                                              |  | $                                     | 0.08    |                                     | $ | 0.21      |  
|                                                                                                                     |  |                                       |         |                                     |   |           |  

Note 10. Arrangements with Off-Balance Sheet
Risk - Guarantees

The Company
occupies a facility located in Hauppauge New York which is used for its
executive offices and for the testing, storage and shipping of the Companys
products. The Company leases this facility from a real estate partnership which
is principally owned by Kenneth Plotkin, the Companys Chairman of the Board,
Chief Executive Officer, President, Chief Operating Officer and Vice President
of Marketing and the holder of approximately 8.8% of the Companys Common Stock
as of March 31, 2006, Dorothy Plotkin, the wife of Kenneth Plotkin, holder of
approximately 5.9% of the Companys Common Stock as of March 31, 2006, and
Laura Aupperle, believed by the Company to be the holder of approximately 10.5%
of the Companys Common Stock, including Common Stock attributed to the Estate
of Kenneth R. Aupperle.

17

---



NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Unaudited)

Note 10.
Arrangements with Off-Balance Sheet Risk  Guarantees-continued

On February 17, 2004, HCW
and Ladokk terminated the 1990 Lease and HCW entered into a new lease agreement
with Ladokk Realty Co., LLC (the 2004 Lease). The 2004 Lease is for five
years and terminates on February 16, 2009. Annual rent under the 2004 Lease is
$360,000, payable monthly. Concurrently with the new lease, Ladokk completed a
refinancing of its mortgages, and the new lender did not require HCW to sign a
guarantee. Accordingly, the Company no longer guarantees the landlords
mortgages. The 2004 Lease
replaced a 1990 Lease which was due to expire on January 31, 2006. The
execution of the 2004 Lease provided an annual reduction in rent of nearly
$100,000 and released the Company from its guarantee of the mortgages of the
landlord.

The Audit Committee, under
applicable laws, rules and regulations, is required to review and approve the
2004 Lease because the landlord is affiliated with (although not under the
exclusive control of) the Companys Chief Executive Officer. Shortly following
the execution and delivery of the 2004 Lease, the Audit Committee engaged the
services of an independent law firm and an independent real estate appraiser to
ascertain if the 2004 Lease was within the current market range in our
geographic area for the building the Company occupies.

The real estate appraiser
determined that the rent provided in the 2004 Lease was somewhat above market value
without giving effect to, among other things, the costs and potential
disruption of the Companys operations that would be associated with any move
to a new facility. The Company and the landlord are negotiating the terms of a
new lease to replace the 2004 lease. Although there can be no assurances, the
Companys expectation is that the 2004 Lease will be replaced with such new
lease before the end of our fiscal third quarter.

18

---



Item 2. Managements Discussion and Analysis of
Financial Condition and Results of OperationsThree
Month Period ended March 31, 2006 Compared to March 31, 2005

Results of operations for the three months ended March
31, 2006 compared to March 31, 2005 are as follows:

|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|----------------------------------------------------- |  | -------------------------------- | ---------- | -------------------------------- | - | --------------------- | - | ---- | --------- | ---------- |  | ------ | - |  | ------ | - |  | ----- | -
|                                                      |  | Three
  Months
  Ended
  3/31/06 |            | Three
  Months
  Ended
  3/31/05 |   |                       |   |      |           |            |  |        |   | 
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |       
|                                                      |  |                                  |            |                                  |   | Percentage
  of sales |  
|                                                      |  |                                  |            | Variance $                       |   | 2006                  |   | 2005 |           | Variance % | 
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |  
|                                                     
|Net sales                                             |  | $                                | 26,685,393 |                                  | $ | 20,362,293            |   | $    | 6,323,100 |            |  | 100.00 | % |  | 100.00 | % |  |      |  
|Cost of sales                                         |  |                                  | 21,503,859 |                                  |   | 15,542,399            |   |      | 5,961,460 |            |  | 80.58  | % |  | 76.33  | % |  | 4.25  | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Gross profit                                          |  |                                  | 5,181,534  |                                  |   | 4,819,894             |   |      | 361,640   |            |  | 19.42  | % |  | 23.67  | % |  | -4.25 | %
|Gross profit%                                         |  |                                  | 19.42      | %                                |   | 23.67                 | % |      | -4.25     | %          |  |        |   |  |        |   |  |       |  
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Expenses:                                             |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Sales &
  marketing                                   |  |                                  | 2,315,414  |                                  |   | 2,350,422             |   |      | (35,008   | )          |  | 8.68   | % |  | 11.54  | % |  | -2.86 | %
|Technical
  support                                   |  |                                  | 154,771    |                                  |   | 124,417               |   |      | 30,354    |            |  | 0.57   | % |  | 0.61   | % |  | -0.04 | %
|General &
  administrative                            |  |                                  | 901,419    |                                  |   | 851,975               |   |      | 49,444    |            |  | 3.38   | % |  | 4.18   | % |  | -0.80 | %
|SG&A stock
  compensation expense                     |  |                                  | 58,254     |                                  |   |                      |   |      | 58,254    |            |  | 0.23   | % |  | 0.00   | % |  | 0.23  | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Total selling,
  general and administrative expenses  |  |                                  | 3,429,858  |                                  |   | 3,326,814             |   |      | 103,044   |            |  | 12.86  | % |  | 16.33  | % |  | -3.47 | %
|Research &
  development                              |  |                                  | 740,140    |                                  |   | 631,437               |   |      | 108,703   |            |  | 2.77   | % |  | 3.10   | % |  | -0.33 | %
|Research and
  development stock compensation expense |  |                                  | 28,692     |                                  |   |                      |   |      | 28,692    |            |  | 0.11   | % |  | 0.00   | % |  | 0.11  | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Total operating
  expenses                            |  |                                  | 4,198,690  |                                  |   | 3,958,251             |   |      | 240,439   |            |  | 15.74  | % |  | 19.43  | % |  | -3.69 | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Net operating income                                  |  |                                  | 982,844    |                                  |   | 861,643               |   |      | 121,201   |            |  | 3.68   | % |  | 4.24   | % |  | -0.56 | %
|Other income                                          |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Interest income                                       |  |                                  | 6,275      |                                  |   | 3,150                 |   |      | 3,125     |            |  | 0.02   | % |  | 0.02   | % |  | 0.00  | %
|Foreign currency                                      |  |                                  | 13,487     |                                  |   | 7,672                 |   |      | 5,815     |            |  | 0.05   | % |  | 0.04   | % |  | 0.01  | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Total other
  income (loss)                           |  |                                  | 19,762     |                                  |   | 10,822                |   |      | 8,940     |            |  | 0.07   | % |  | 0.06   | % |  | 0.01  | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Income before
  taxes                                 |  |                                  | 1,002,606  |                                  |   | 872,465               |   |      | 130,141   |            |  | 3.75   | % |  | 4.30   | % |  | -0.55 | %
|Taxes on income                                       |  |                                  | 44,728     |                                  |   | 45,000                |   |      | (272      | )          |  | 0.17   | % |  | 0.22   | % |  | -0.05 | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  
|Net income                                            |  | $                                | 957,878    |                                  | $ | 827,465               |   | $    | 130,413   |            |  | 3.58   | % |  | 4.08   | % |  | -0.50 | %
|                                                      |  |                                  |            |                                  |   |                       |   |      |           |            |  |        |   |  |        |   |  |       |  

19

---



Net sales for the three months ended March 31, 2006
increased $6,323,100 over the three months ended March 31, 2005 as shown in the
table below.

|         |  |                                  |            |                                  |   |                                         |  |                                    |           |                           |  |    |   |  |     |   |  |  |     |  
|-------- |  | -------------------------------- | ---------- | -------------------------------- | - | --------------------------------------- |  | ---------------------------------- | --------- | ------------------------- |  | -- | - |  | --- | - |  |  | --- | -
|         |  | Three
  Months
  Ended
  3/31/06 |            | Three
  Months
  Ended
  3/31/05 |   | Increase
  (Decrease)
  Dollar Variance |  | Increase
  (Decrease)
  Variance % |           | Sales by Geographicregion | 
|         |  |                                  |            |                                  |   |                                        
|Location |  |                                  |            |                                  |   | 2006                                    |  |                                    | 2005      |                          
|         |  |                                  |            |                                  |   |                                         |  |                                    |           |                           |  |    |   | 
|Domestic |  | $                                | 13,477,731 |                                  | $ | 10,031,697                              |  | $                                  | 3,446,034 |                           |  | 34 | % |  | 51  | % |  |  | 49  | %
|Europe   |  |                                  | 12,682,887 |                                  |   | 9,908,999                               |  |                                    | 2,773,888 |                           |  | 28 | % |  | 47  | % |  |  | 49  | %
|Asia     |  |                                  | 524,775    |                                  |   | 421,597                                 |  |                                    | 103,178   |                           |  | 24 | % |  | 2   | % |  |  | 2   | %
|         |  |                                  |            |                                  |   |                                         |  |                                    |           |                           |  |    |   |  |     |   |  |  |     |  
|Total    |  | $                                | 26,685,393 |                                  | $ | 20,362,293                              |  | $                                  | 6,323,100 |                           |  | 31 | % |  | 100 | % |  |  | 100 | %
|         |  |                                  |            |                                  |   |                                         |  |                                    |           |                           |  |    |   |  |     |   |  |  |     |  

The primary factors contributing to the sales increase
were:

|  |                                                             
|- | ------------------------------------------------------------
| | Sales of WinTV OEM products                                 
|  |                                                             
| | Sales of the new WinTV-HVR hybrid video recorders           
|  |                                                             
| | Sales of the new WinTV-HVR-3000 hybrid satellite
  receivers

Offsetting some of the sales increases were:

|  |                                                          
|- | ---------------------------------------------------------
| | Decrease in WinTV-NOVA series of digital TV
  receivers  
| 
| | Decrease in Digital entertainment center (DEC)
  products

Net sales to domestic customers were 51% of net sales
for the three months ended March 31, 2006 compared to 49% for the three months
ended March 31, 2005. Net sales to European customers were 47% of net sales
compared to 49% for the same period of last year. Net sales to Asian customers
were 2% for the three months ended March 31, 2006 and March 31, 2005.

Gross profit increased $361,640 for the three months
ended March 31, 2006 compared to the prior years second quarter.

The increases and (decreases) in the gross profit are
detailed below:


|                                                     |  |                       |           |  
|---------------------------------------------------- |  | --------------------- | --------- | -
|                                                     |  | Increase
  (decrease) |          
|                                                     |  |                       |          
|Increased sales                                      |  | $                     | 2,019,386 |  
|Lower gross profit on retail sales mix               |  |                       | (467,124  | )
|Effect on gross profit due to sales mix of OEM sales |  |                       | (633,568  | )
|Due to increases in production costs                 |  |                       | (557,054  | )
|                                                     |  |                       |           |  
|Total decrease
  in gross profit                     |  | $                     | 361,640   |  
|                                                     |  |                       |           |  

Gross profit percentage for the three months ended
March 31, 2006 was 19.42% compared to 23.67% for the three months ended March
31, 2005, a decrease of 4.25%.

The increase (decreases) in the gross profit percent
are detailed below:

20

---



|                                                       |  |                       |       |   
|------------------------------------------------------ |  | --------------------- | ----- | --
|                                                       |  | Increase
  (decrease) |      
|                                                       |  |                       |      
|Lower gross profit on
  retail sales mix               |  |                       | (1.61 | )%
|Effect on gross profit due
  to sales mix of OEM sales |  |                       | (2.51 | )%
|Production costs                                       |  |                       | (0.13 | )%
|                                                       |  |                       |       |   
|Net decrease in gross
  profit %                       |  |                       | (4.25 | )%
|                                                       |  |                       |       |   

The decrease in the gross profit percent of 4.25 % for
the three months ended March 31, 2006 compared to the three months ended March
31, 2005 was primarily due to:

|  |                                                                                                                                                                                                                                            
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Lower gross profit OEM sales contributed to a 2.51%
  decrease in gross profit. OEM sales require less sales, advertising and
  product support than retail sales, but the gross profit for OEM sales is
  lower than our retail products  
|  |                                                                                                                                                                                                                                            
| | A higher percentage of lower gross profit margin
  retail products contributed to a 1.61% decrease in gross profit                                                                                                                         
|  |                                                                                                                                                                                                                                            
| | Production and shipping increases contributed to a
  0.13% decrease in gross profit percent compared to three months ended March
  31, 2005. The increase in net sales was about 31% while the increase in
  production costs was about 33%

The chart below illustrates the components of selling,
general and administrative expenses:

|                                |  |                                |           |                       |   |                       |  |      |         |      |  |                       |   |  |       |   |  |       |  
|------------------------------- |  | ------------------------------ | --------- | --------------------- | - | --------------------- |  | ---- | ------- | ---- |  | --------------------- | - |  | ----- | - |  | ----- | -
|                                |  | Three
  months ended March 31, |           |                       |  
|                                |  |                                |           |                       |  
|                                |  | Dollar Costs                   |           | Percentage
  of Sales |   |                       |  |     
|                                |  |                                |           |                       |   |                       |  |     
|                                |  | 2006                           |           | 2005                  |   | Increase
  (Decrease) |  | 2005 |         | 2004 |  | Increase
  (Decrease) |  
|                                |  |                                |           |                       |   |                       |  |      |         |      |  |                       |  
|Sales and marketing             |  | $                              | 2,315,414 |                       | $ | 2,350,422             |  | $    | (35,008 | )    |  | 8.68                  | % |  | 11.54 | % |  | -2.86 | %
|Technical support               |  |                                | 154,771   |                       |   | 124,417               |  |      | 30,354  |      |  | 0.57                  | % |  | 0.61  | % |  | -0.04 | %
|General and administrative      |  |                                | 901,419   |                       |   | 851,975               |  |      | 49,444  |      |  | 3.38                  | % |  | 4.18  | % |  | -0.80 | %
|SG&A stock compensation expense |  |                                | 58,254    |                       |   |                      |  |      | 58,254  |      |  | 0.23                  | % |  | 0.00  | % |  | 0.23  | %
|                                |  |                                |           |                       |   |                       |  |      |         |      |  |                       |   |  |       |   |  |       |  
|Total                           |  | $                              | 3,429,858 |                       | $ | 3,326,814             |  | $    | 103,044 |      |  | 12.86                 | % |  | 16.33 | % |  | -3.47 | %
|                                |  |                                |           |                       |   |                       |  |      |         |      |  |                       |   |  |       |   |  |       |  

Selling, general and administrative expenses increased
$103,044 from the prior years second quarter. As a percentage of sales,
selling, general and administrative expenses decreased by 3.47% when compared
to the three months ended March 31, 2005.

The decrease in sales and marketing expense of
$35,008, was mainly due to:

|  |                                                         
|- | --------------------------------------------------------
| | Lower advertising and promotional expenses of
  $175,203

21

---



| |   |                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------
| |  | Increased compensation expenses of 118,725 due to
  higher sales commissions and mid year incentives

The increase in technical support expenses of $30,354
was primarily due to:

| |   |                                                                                    
| | - | -----------------------------------------------------------------------------------
| |  | Increased personnel required to handle increased
  phone volume due expanding sales

The increase in general and administrative expenses of
$49, 444 was primarily due to:

| |   |                                                                      
| | - | ---------------------------------------------------------------------
| |  | Compensation increases of $60,769 for additional
  managerial staff  
| |   |                                                                      
| |  | Lower legal fees of $33,481 as a result of lower non
  recurring fees

Reflected selling, general and administrative expenses
for the three months ended March 31, 2006 was $58,254 in stock compensation
expenses related to the issuance of stock options.

Research and development expenses increased $108,703.
The increase was mainly due to:

| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| |  | Higher compensation costs of $76,627 due to the
  hiring of additional engineering management and staff personnel    
| |   |                                                                                                                      
| |  | Increased program development costs of $20,733 due
  to higher volume of new product and product enhancement programs

Reflected in research and development expenses for the
three months ended March 31, 2006 was $28,692 in stock compensation expenses
related to the issuance of stock options.

Other
income (expense)

Net other income for the three months ended March 31,
2006 was $19,762 compared to net other income of $10,822 for the three months
ended March 31, 2005 as detailed below:

|                                              |  |                              |        |      |   |        | 
|--------------------------------------------- |  | ---------------------------- | ------ | ---- | - | ------ | 
|                                              |  | Three months ended March 31, |       
|                                              |  |                              |       
|                                              |  | 2006                         |        | 2005 |  
|                                              |  |                              |        |      |  
|Interest income                               |  |                              | 6,275  |      |   | 3,150  | 
|Foreign currency
  transaction gains (losses) |  |                              | 13,487 |      |   | 7,672  | 
|                                              |  |                              |        |      |   |        | 
|Total other
  income (expense)                |  | $                            | 19,762 |      | $ | 10,822 | 
|                                              |  |                              |        |      |   |        | 

22

---



Tax
provision

Our net tax provision for the three months ended March
31, 2006 and 2005 is as follows:

|                                         |  |                              |        |      |   |        | 
|---------------------------------------- |  | ---------------------------- | ------ | ---- | - | ------ | 
|                                         |  | Three months ended March 31, |       
|                                         |  |                              |       
|                                         |  | 2006                         |        | 2005 |  
|                                         |  |                              |        |      |  
|AMT Tax
  attributable to U.S operations |  | $                            | 20,000 |      | $ | 10,000 | 
|Tax expense
  European operations        |  |                              | 19,728 |      |   | 30,000 | 
|State taxes                              |  |                              | 5,000  |      |   | 5,000  | 
|                                         |  |                              |        |      |   |        | 
|Net tax
  provision                      |  | $                            | 44,728 |      | $ | 45,000 | 
|                                         |  |                              |        |      |   |        | 

For four out of the last five fiscal years, our
domestic operation has incurred losses. With the close of our fiscal first
quarter of 2006, we analyzed the future realization of our deferred tax assets
as of March 31, 2006, and although our domestic operation reported a profit for
the three months ended March 31, 2006, due to the seasonal nature of the
business it is uncertain at this time whether our domestic operation will have
a profit for the full year. In light of this, we did not make any adjustments
to our valuation allowance for the quarter ended March 31, 2006.

As a result of all of the above items mentioned in
this Managements Discussion and Analysis of Financial Condition and Results of
Operations, we recorded net income of $957,878, for the three months ended
March 31, 2006, which resulted in basic and diluted net income per share of
$0.10 on weighted average basic and diluted shares of 9,576,522 and 10,057,585,
respectively, compared to a net income of $827,465 for the three months ended
March 31, 2005, which resulted in basic net income per share of $0.09 and
diluted net income per share of $0.08 on weighted average basic and diluted
shares of 9,460,702 and 10,101,170, respectively.

23

---



Item
2. Managements Discussion and Analysis of Financial Condition and Results of
Operations Six Month Period ended March 31, 2006 Compared to March 31, 2005

Results of operations for the six months ended March
31, 2006 compared to March 31, 2005 are as follows:

|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|----------------------------------------------------- |  | ------- | ---------- | ------- | - | ---------- | - | --------------------- | --------- | ---- |  | -------- | - |  | ------ | - |  | ----- | -
|                                                      |  | Six     |            | Six     |   |            |   |                       |           |      |  |          |   |  |        |   | 
|                                                      |  | Months  |            | Months  |   |            |   |                       |           |      |  |          |   |  |        |   | 
|                                                      |  | Ended   |            | Ended   |   | Variance   |   | Percentage
  of sales |          
|                                                      |  | 3/31/06 |            | 3/31/05 |   | $          |   | 2006                  |           | 2005 |  | Variance |  
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |  
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Net sales                                             |  | $       | 51,730,383 |         | $ | 43,722,736 |   | $                     | 8,007,647 |      |  | 100.00   | % |  | 100.00 | % |  |      |  
|Cost of sales                                         |  |         | 41,317,065 |         |   | 33,591,477 |   |                       | 7,725,588 |      |  | 79.87    | % |  | 76.83  | % |  | 3.04  | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Gross profit                                          |  |         | 10,413,318 |         |   | 10,131,259 |   |                       | 282,059   |      |  | 20.13    | % |  | 23.17  | % |  | -3.04 | %
|Gross profit %                                        |  |         | 20.13      | %       |   | 23.17      | % |                       | -3.04     | %    |  |          |   |  |        |   |  |       |  
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Expenses:                                             |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Sales &
  marketing                                   |  |         | 4,671,985  |         |   | 4,782,013  |   |                       | (110,028  | )    |  | 9.03     | % |  | 10.94  | % |  | -1.91 | %
|Technical
  support                                   |  |         | 286,850    |         |   | 244,742    |   |                       | 42,108    |      |  | 0.55     | % |  | 0.56   | % |  | -0.01 | %
|General &
  administrative                            |  |         | 1,726,236  |         |   | 1,727,115  |   |                       | (879      | )    |  | 3.34     | % |  | 3.95   | % |  | -0.61 | %
|SG&A stock
  compensation expense                     |  |         | 125,855    |         |   |           |   |                       | 125,855   |      |  | 0.24     | % |  | 0.00   | % |  | 0.24  | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Total selling,
  general and administrative expenses  |  |         | 6,810,926  |         |   | 6,753,870  |   |                       | 57,056    |      |  | 13.16    | % |  | 15.45  | % |  | -2.29 | %
|Research &
  development                              |  |         | 1,500,864  |         |   | 1,188,967  |   |                       | 311,897   |      |  | 2.90     | % |  | 2.72   | % |  | 0.18  | %
|Research and
  development stock compensation expense |  |         | 61,969     |         |   |           |   |                       | 61,969    |      |  | 0.12     | % |  | 0.00   | % |  | 0.12  | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Total operating
  expenses                            |  |         | 8,373,759  |         |   | 7,942,837  |   |                       | 430,922   |      |  | 16.18    | % |  | 18.17  | % |  | -1.99 | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Net operating income                                  |  |         | 2,039,559  |         |   | 2,188,422  |   |                       | (148,863  | )    |  | 3.95     | % |  | 5.00   | % |  | -1.05 | %
|Other income                                          |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Interest income                                       |  |         | 11,481     |         |   | 4,661      |   |                       | 6,820     |      |  | 0.02     | % |  | 0.01   | % |  | 0.01  | %
|Foreign currency                                      |  |         | 14,451     |         |   | (928       | ) |                       | 15,379    |      |  | 0.03     | % |  | 0.00   | % |  | 0.03  | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Total other
  income (loss)                           |  |         | 25,932     |         |   | 3,733      |   |                       | 22,199    |      |  | 0.05     | % |  | 0.01   | % |  | 0.04  | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Income before
  taxes                                 |  |         | 2,065,491  |         |   | 2,192,155  |   |                       | (126,664  | )    |  | 4.00     | % |  | 5.01   | % |  | -1.01 | %
|Taxes on income                                       |  |         | 87,139     |         |   | 101,000    |   |                       | (13,861   | )    |  | 0.17     | % |  | 0.23   | % |  | -0.06 | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  
|Net income                                            |  | $       | 1,978,352  |         | $ | 2,091,155  |   | $                     | (112,803  | )    |  | 3.83     | % |  | 4.78   | % |  | -0.95 | %
|                                                      |  |         |            |         |   |            |   |                       |           |      |  |          |   |  |        |   |  |       |  

24

---



Net sales for the six months ended March 31, 2006
increased $8,007,647 over the six months ended March 31, 2005 as shown in the
table below.

|         |  |               |            |               |   |                     |  |            |           |        |          |      |                       |  |     |   |  |     |  
|-------- |  | ------------- | ---------- | ------------- | - | ------------------- |  | ---------- | --------- | ------ | -------- | ---- | --------------------- |  | --- | - |  | --- | -
|         |  |               |            |               |   |                     |  |            |           |        | Increase |      | Sales by
  Geographic | 
|         |  | Six Months    |            | Six Months    |   | Increase (Decrease) |  | (Decrease) |           | region |         
|Location |  | Ended 3/31/06 |            | Ended 3/31/05 |   | DollarVariance      |  | Variance % |           | 2006   |          | 2005 |                      
|         |  |               |            |               |   |                     |  |            |           |        |          |      |                      
|Domestic |  |               | 23,682,666 |               |   | 18,885,272          |  |            | 4,797,394 |        |          | 25   | %                     |  | 46  | % |  | 43  | %
|Europe   |  |               | 26,859,813 |               |   | 24,058,482          |  |            | 2,801,331 |        |          | 12   | %                     |  | 52  | % |  | 55  | %
|Asia     |  |               | 1,187,904  |               |   | 778,982             |  |            | 408,922   |        |          | 52   | %                     |  | 2   | % |  | 2   | %
|         |  |               |            |               |   |                     |  |            |           |        |          |      |                       |  |     |   |  |     |  
|Total    |  | $             | 51,730,383 |               | $ | 43,722,736          |  | $          | 8,007,647 |        |          | 18   | %                     |  | 100 | % |  | 100 | %
|         |  |               |            |               |   |                     |  |            |           |        |          |      |                       |  |     |   |  |     |  

The primary factors contributing to the sales increase
were:

|  |                                                             
|- | ------------------------------------------------------------
| | Sales of the new WinTV-HVR hybrid video recorders           
|  |                                                             
| | Sales of WinTV OEM products                                 
|  |                                                             
| | Sales of the new WinTV-HVR-3000 hybrid satellite
  receivers

Offsetting some of the sales increases were:

|  |                                                          
|- | ---------------------------------------------------------
| | Decrease in WinTV-NOVA series of digital TV
  receivers  
|  |                                                          
| | Decrease in Digital entertainment center (DEC)
  products
|  |                                                          
| | Decrease in WinTV series of analog TV receivers          
|  |                                                          
| | Decrease in WinTV personal video recorder products       

Net sales to domestic customers were 46% of net sales
for the six months ended March 31, 2006 compared to 43% for the six months
ended March 31, 2005. Net sales to European customers were 52% of net sales
compared to 55% for the same period of last year. Net sales to Asian customers
were 2% for the six months ended March 31, 2006 and March 31, 2005.

Gross profit decreased $282,059 for the six months
ended March 31, 2006 compared to the prior year.

The increases and (decreases) in the gross profit are
detailed below:

|                                                       |  |            |            |  
|------------------------------------------------------ |  | ---------- | ---------- | -
|                                                       |  | Increase   |           
|                                                       |  | (decrease) |           
|                                                       |  |            |           
|Increased sales                                        |  | $          | 2,458,922  |  
|Lower gross
  profit on retail sales mix               |  |            | (264,835   | )
|Effect on gross
  profit due to sales mix of OEM sales |  |            | (1,092,771 | )
|Due to increases
  in production costs                 |  |            | (819,257   | )
|                                                       |  |            |            |  
|Total decrease
  in gross profit                       |  | $          | 282,059    |  
|                                                       |  |            |            |  

Gross profit percentage for the six months ended March
31, 2006 was 20.13% compared to 23.17% for the prior year, a decrease of 3.04%.

25

---



The increases and (decreases) in the gross profit
percent are detailed below:

|                                                       |  |            |       |   
|------------------------------------------------------ |  | ---------- | ----- | --
|                                                       |  | Increase   |      
|                                                       |  | (decrease) |      
|                                                       |  |            |      
|Lower gross
  profit on retail sales mix               |  |            | (0.46 | )%
|Effect on gross
  profit due to sales mix of OEM sales |  |            | (2.17 | )%
|Due to increases
  in production costs                 |  |            | (0.41 | )%
|                                                       |  |            |       |   
|Net decrease in
  gross profit %                       |  |            | (3.04 | )%
|                                                       |  |            |       |   

The decrease in the gross profit percent of 3.04 % for
the six months ended March 31, 2006 compared to the six months ended March 31,
2005 was primarily due to:

| |   |                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Lower gross profit OEM sales contributed to a 2.17%
  decrease in gross profit. OEM sales require less sales, advertising and
  product support than retail sales, but the gross profit for OEM sales is
  lower than our retail products
| |   |                                                                                                                                                                                                                                          
| |  | A higher percentage of lower gross profit margin
  retail products contributed to a 0.46% decrease in gross profit                                                                                                                       
| |   |                                                                                                                                                                                                                                          
| |  | Production and shipping increases contributed to a
  0.41% decrease in gross profit percent compared to six months ended March 31,
  2005. The increase in net sales was about 18% while the increase in
  production costs was about 25%

The chart below illustrates the components of selling,
general and administrative expenses:

|                                  |  |                            |           |      |   |            |                     |          |          |      |  |            |   |  |       |          |  |       |  
|--------------------------------- |  | -------------------------- | --------- | ---- | - | ---------- | ------------------- | -------- | -------- | ---- |  | ---------- | - |  | ----- | -------- |  | ----- | -
|                                  |  | Six months ended March 31, |           |      |   |            |                     |          |          |      |  |            |   | 
|                                  |  |                            |           |      |   |            |                     |          |          |      |  |            |   | 
|                                  |  | Dollar Costs               |           |      |   |            | Percentage of Sales |          |          |      | 
|                                  |  |                            |           |      |   |            |                     |         
|                                  |  |                            |           |      |   |            |                     | Increase |          |      |  |            |   |  |       | Increase | 
|                                  |  | 2006                       |           | 2005 |   | (Decrease) |                     | 2006     |          | 2005 |  | (Decrease) |  
|                                  |  |                            |           |      |   |            |                     |          |          |      |  |            |  
|Sales and
  marketing             |  | $                          | 4,671,985 |      | $ | 4,782,013  |                     | $        | (110,028 | )    |  | 9.03       | % |  | 10.94 | %        |  | -1.91 | %
|Technical
  support               |  |                            | 286,850   |      |   | 244,742    |                     |          | 42,108   |      |  | 0.55       | % |  | 0.56  | %        |  | -0.01 | %
|General and
  administrative      |  |                            | 1,726,236 |      |   | 1,727,115  |                     |          | (879     | )    |  | 3.34       | % |  | 3.95  | %        |  | -0.61 | %
|SG&A stock
  compensation expense |  |                            | 125,855   |      |   |           |                     |          | 125,855  |      |  | 0.24       | % |  | 0.00  | %        |  | 0.24  | %
|                                  |  |                            |           |      |   |            |                     |          |          |      |  |            |   |  |       |          |  |       |  
|Total                             |  | $                          | 6,810,926 |      | $ | 6,753,870  |                     | $        | 57,056   |      |  | 13.16      | % |  | 15.45 | %        |  | -2.29 | %
|                                  |  |                            |           |      |   |            |                     |          |          |      |  |            |   |  |       |          |  |       |  

Selling, general and administrative expenses increased
$57,056 from the prior year. As a percentage of sales, selling, general and
administrative expenses decreased by 2.29% when compared to the six months
ended March 31, 2005.

The decrease in sales and marketing expense of
$110,028, was mainly due to:

| |   |                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------
| |  | Lower advertising and promotional expenses of
  $282,584                                            
| |   |                                                                                                     
| |  | Increased compensation expenses of 159,951 due to
  higher sales commissions and mid year incentives

26

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The increase
in technical support expenses of $42,108 was primarily due to:

| |   |                                                                                    
| | - | -----------------------------------------------------------------------------------
| |  | Increased
  personnel required to handle increased phone volume due expanding sales

The increase
in general and administrative decrease of $ 879 was primarily due to:

| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | Compensation
  increases of for additional managerial staff offset by lower legal fees of as
  a result of lower non recurring fees

Reflected
selling, general and administrative expenses for the six months ended March 31,
2006 was $125,855 in stock compensation expenses related to the issuance of
stock options.

Research and
development expenses increased $311,897. The increase was mainly due to:

| |   |                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------
| |  | Higher
  compensation costs of $155,184 due to the hiring of additional engineering
  management and staff personnel    
| |   |                                                                                                                         
| |  | Increased
  program development costs of $141,471 due to higher volume of new product and
  product enhancement programs

Reflected in
research and development expenses for the six months ended March 31, 2006 was
$61,969 in stock compensation expenses related to the issuance of stock
options.

Other income (expense)

Net other
income for the six months ended March 31, 2006 was $25,932 compared to net
other income of $3,733 for the three months ended March 31, 2005 as detailed
below:

|                                            |  |                            |        |      |   |       |  
|------------------------------------------- |  | -------------------------- | ------ | ---- | - | ----- | -
|                                            |  | Six months ended March 31, |       
|                                            |  |                            |       
|                                            |  | 2006                       |        | 2005 |  
|                                            |  |                            |        |      |  
|Interest income                             |  |                            | 11,481 |      |   | 4,661 |  
|Foreign currency transaction gains (losses) |  |                            | 14,451 |      |   | (928  | )
|                                            |  |                            |        |      |   |       |  
|Total other income (expense)                |  | $                          | 25,932 |      | $ | 3,733 |  
|                                            |  |                            |        |      |   |       |  

Accumulated other comprehensive income (loss)

As of March
31, 2006, appearing in the equity section under  Accumulated other
comprehensive income (loss) was a loss of $379,818, which consisted of a
deferred translation loss of $372,570 and a deferred loss of $7,248 due to the
mark

27

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to market loss
on the difference 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.

Accumulated
other comprehensive income (loss) consists of two components translation gains
and losses and FAS 133 mark to market gains and losses on our open foreign
exchange contracts. The table below details the gains and losses that make up
the accumulated other comprehensive loss of $379,818 recorded on our balance
sheet as of March 31, 2006:

|                                                                     |  |                                |         |                               |   |                                 |   |   |          |  
|-------------------------------------------------------------------- |  | ------------------------------ | ------- | ----------------------------- | - | ------------------------------- | - | - | -------- | -
|Accumulated Other Comprehensive Income (Loss)
  Fiscal 2006 activity |  | Balance as
  of
  Sept 30 2005 |         | Oct 05 to
  Mar 06
  (losses) |   | Balance as
  of
  March 31 2006 |  
|                                                                     |  |                                |         |                               |   |                                 |  
|Translation gains and losses                                         |  | $                              | 546,352 |                               | $ | (918,922                        | ) | $ | (372,570 | )
|FAS 133 mark to market adjustment                                    |  |                                | 136,418 |                               |   | (143,666                        | ) |   | (7,248   | )
|                                                                     |  |                                |         |                               |   |                                 |   |   |          |  
|                                                                     |  | $                              | 682,770 |                               | $ | (1,062,588                      | ) | $ | (379,818 | )
|                                                                     |  |                                |         |                               |   |                                 |   |   |          |  

Tax provision

Our net tax
provision for the six months ended March 31, 2006 and 2005 is as follows:

|                                       |  |                            |        |      |   |         | 
|-------------------------------------- |  | -------------------------- | ------ | ---- | - | ------- | 
|                                       |  | Six months ended March 31, |       
|                                       |  |                            |       
|                                       |  | 2006                       |        | 2005 |  
|                                       |  |                            |        |      |  
|AMT Tax attributable to U.S operations |  | $                          | 30,000 |      | $ | 20,000  | 
|Tax expense European operations        |  |                            | 47,139 |      |   | 71,000  | 
|State taxes                            |  |                            | 10,000 |      |   | 10,000  | 
|                                       |  |                            |        |      |   |         | 
|Net tax provision                      |  | $                          | 87,139 |      | $ | 101,000 | 
|                                       |  |                            |        |      |   |         | 

For four out
of the last five fiscal years, our domestic operation has incurred losses. With
the close of our fiscal first quarter of 2006, we analyzed the future
realization of our deferred tax assets as of March 31, 2006, and although our
domestic operation reported a profit for the six months ended March 31, 2006,
due to the seasonal nature of the business it is uncertain at this time whether
our domestic operation will have a profit for the full year. In light of this,
we did not make any adjustments to our valuation allowance for the six months
ended March 31, 2006.

As a result of
all of the above items mentioned in this Managements Discussion and Analysis
of Financial Condition and Results of Operations, we recorded net income of
$1,978,352, for the six months ended March 31, 2006, which resulted in basic
net income per share of $0.21 and diluted net income per share of $0.20 on
weighted average basic and diluted shares of 9,541,935 and 9,989,699, respectively,
compared to a net income of $2,091,155 for the six months ended March 31, 2005,
which resulted in basic net income per share of $0.22 and diluted net income
per share of $0.21 on weighted average basic and diluted shares of 9,368,428
and 9,999,405, respectively.

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

28

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our
fourth fiscal quarter (July to September). In addition, our international
sales, mostly in the European, market, were 54%, 66% and 68 % of sales for the
years ended September 30, 2005, 2004 and 2003, respectively. Our fiscal fourth
quarter sales (July to September) can be potentially impacted by the reduction
of activity experienced in Europe during the July and August 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 March 31, 2006 and
September 30, 2005 is set forth below:

|                     |  |                |            |                    |   |            | 
|-------------------- |  | -------------- | ---------- | ------------------ | - | ---------- | 
|                     |  | March 31, 2006 |            | September 30, 2005 |  
|                     |  |                |            |                    |  
|Cash                 |  | $              | 4,555,518  |                    | $ | 7,567,393  | 
|Working Capital      |  |                | 16,624,979 |                    |   | 15,334,855 | 
|Stockholders Equity |  |                | 17,250,388 |                    |   | 15,941,492 | 

We had cash
and cash equivalents as of March 31, 2006 of $4,555,518, a decrease of
$3,111,875 from September 30, 2005.

The decrease
in cash was due to:

|                                                        |  |   |              |  
|------------------------------------------------------- |  | - | ------------ | -
|Sources of cash:                                        |  |   |              |  
|Net income adjusted for non
  cash items                |  | $ | 2,255,074    |  
|Increase in accounts
  payable and accrued expenses     |  |   | 13,408,296   |  
|Proceeds from employee
  stock purchases                |  |   | 205,308      |  
|Less cash used for:                                     |  |   |              |  
|Increase in account
  receivables                       |  |   | (14,813,398  | )
|Increase in inventories                                 |  |   | (2,946,148   | )
|Effect of exchange rates on
  cash                      |  |   | (1,062,588   | )
|Increase in prepaid
  expenses and other current assets |  |   | (50,749      | )
|Capital equipment purchases                             |  |   | (107,670     | )
|                                                        |  |   |              |  
|Net cash decrease                                       |  | $ | (3,111
  875 | )
|                                                        |  |   |              |  

Net cash of
$2,146,925 used in operating activities was primarily due to a increases in
accounts receivable and inventory of $14,813,398 and $2,946,148, respectively,
required to fund the 49% increase in sales between the last six months of
fiscal 2005 and the first six months of fiscal 2006 in addition to increases in
prepaid expenses and other current assets of

29

---



$50,749.
These uses of cash were offset by increases in accounts payable and accrued
expenses of $13,408,296, primarily used to finance the growth in accounts
receivable and inventory to fund the increase in sales. Net income adjusted for
non cash items of $2,255,074 provided another source of cash.

Cash of
$107,670 was used to purchase fixed assets. Proceeds from the stock purchased
by employees through the exercise of options and the employee stock purchase
plan provided cash of $205,308 and the effect of exchange rate changes used
cash of $1,062,588.

On November 8,
1996, we approved a stock repurchase program. The program, as amended,
authorizes us to repurchase up to 850,000 shares of our own stock. We intend to
use the repurchased shares for certain employee benefit programs. On December
17, 1997, the stock repurchase program was extended by a resolution of our
Board of Directors. As of March 31, 2006, we held 607,547 treasury shares
purchased for $1,757,951 at an average purchase price of approximately $2.89
per share.

Line of Credit

On December 1,
2005, Hauppauge Computer Works, Inc. (HCW), a wholly-owned subsidiary of
Hauppauge Digital, Inc. (the Company), entered into a $3,000,000 line of
credit borrowing facility with the JP Morgan Chase Bank, N.A. (the Bank). The
line of credit is subject to renewal on March 31, 2006. On March 17, 2006, the bank
renewed our line of credit through March 31, 2007. The Company, at its option,
may borrow money at the Prime Rate minus one percent (1.0%) or the adjusted
Eurodollar Rate plus one and 85/100 percent (1.85%). In accordance with the
terms of the line, the Company has entered into a Guaranty with the Bank and
has entered into a Share Pledge Agreement among the Company, the Bank and
Hauppauge Digital Europe S.àr.l., a wholly owned subsidiary of the Company.

Pursuant to
the Guaranty, the Company guarantees to the Bank the payment of all liabilities
of HCW to the Bank, secured by a continuing lien and right of set-off for the
amount of the liabilities of HCW to the Bank upon any and all monies,
securities, property, deposits and credits of the Company with the Bank, J.P.
Morgan Securities Inc. or any other affiliate of the Bank.

Pursuant to
the Share Pledge Agreement, the Company granted a first priority right of
pledge on approximately two-thirds of the outstanding capital shares of
Hauppauge Digital Europe in favor of the Bank as security for the payment under
the Note or the Share Pledge Agreement.

There were no
borrowings outstanding as of the filing date of this Quarterly Report on Form
10-Q.

30

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We believe
that our cash and cash equivalents as of March 31, 2006, our internally
generated cash flow and the line of credit we entered into on December 1, 2005
will provide us with sufficient liquidity to meet our currently foreseeable
short-term and long-term capital needs.

Future Contractual Obligations

The following
table shows our contractual obligations related to lease obligations as of
March 31, 2006:

|                            |  |                        |           |                  |   |           |  |              |         |  |   |        | 
|--------------------------- |  | ---------------------- | --------- | ---------------- | - | --------- |  | ------------ | ------- |  | - | ------ | 
|                            |  | Payments due by period |          
|                            |  | Total                  |           | Less than 1 year |   | 1-3 years |  | 3 to 5 years |        
|                            |  |                        |           |                  |   |           |  |              |        
|Operating lease obligations |  | $                      | 1,471,044 |                  | $ | 519,516   |  | $            | 906,528 |  | $ | 45,000 | 
|                            |  |                        |           |                  |   |           |  |              |         |  |   |        | 

Inflation

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

Item 3. Quantitative and Qualitative
Disclosures about Market Risks

Sales for the
Companys European subsidiary are primarily invoiced and collected in Euros. On
the supply side the Company predominantly deals with North American and Asian
suppliers and contract manufacturers. Due to this, a large percentage of the
inventory required to support the Companys 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, subjecting the
Company to market risks resulting from the fluctuations in the Euro to U.S.
Dollar exchange rates. The Company attempts to reduce the 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 Companys U.S. Dollar denominated inventory purchases.

As of March
31, 2006, the Company had foreign currency contracts outstanding of
approximately $2,911,400 against the delivery of the Euro. The contracts expire
from April 2006 through June 2006. The Companys accounting policies for these
instruments designate such instruments as cash flow hedging transactions. The Company
does not enter into such contracts for speculative purposes. The Company
records all derivative gains and losses on the balance sheet as a component of
stockholders equity under the caption Accumulated other comprehensive income
(loss). The Company recorded a loss of $143,666 for the six months ended March
31, 2006 on its statement of other comprehensive income. As of March 31, 2006,
a deferred loss of $7,248 reflecting the cumulative mark to market losses of
the Companys derivatives, was recorded on the Companys balance sheet as a
component of accumulated other comprehensive income (loss) in our equity
section.

31

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Item 4. Controls and Procedures

Our Chief
Executive Officer and Chief Financial Officer conducted an evaluation of the
effectiveness of our disclosure controls and procedures. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective as of March 31, 2006
in alerting them in a timely manner to material information required to be
included in our SEC reports. In addition, no change in our internal control
over financial reporting occurred during the fiscal quarter ended March 31,
2006 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.

Special Note Regarding Forward Looking
Statements

This Quarterly
Report contains forward-looking statements as that term is defined in the
federal securities laws. The events described in forward-looking statements
contained in this Quarterly Report may not occur. Generally these statements
relate to 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, 2005), 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 Annual Report should be read as being applicable to all related
forward-looking statements wherever they appear.

32

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PART II. OTHER INFORMATION

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

On November 8,
1996, we approved a stock repurchase program. The program authorizes us to
repurchase up to 850,000 shares of our own stock. The stock repurchase program
was extended by a resolution of our Board of Directors on December 17, 1997.

The Company
did not repurchase any of its common stock our stock repurchase program during
the quarter ended March 31, 2006.

Item 6. Exhibits

(c) Exhibits

31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule
15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule
15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32
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

33

---



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.
Registrant

|                   |                   |                                                                                                                           
|------------------ | ----------------- | --------------------------------------------------------------------------------------------------------------------------
|Date: May
12, 2006 | By                | /s/ Kenneth
  Plotkin                                                                                                     
|                   |                   |                                                                                                                           
|                   | KENNETH
  PLOTKIN
|                   |                   | Chief
  Executive Officer, Chairman of the Board, Vice President of Marketing (Principal
  Executive Officer) and Director
|                   |                   |                                                                                                                           
|Date: May
12, 2006 | By                | /s/ Gerald
  Tucciarone                                                                                                   
|                   |                   |                                                                                                                           
|                   |                   | GERALD
  TUCCIARONE                                                                                                       
|                   |                   | Treasurer,
  Chief Financial Officer,  (Principal Accounting officer) and Secretary                                       

34

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