**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarterly period ended December 31, 2005**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the transition period from              to            **

 

**Commission file number   1-13550**

 

**HAUPPAUGE DIGITAL, INC.**

(Exact name of registrant as specified in itscharter)

 

| **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 reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.**

 

**ýYES         ****oNO**

 

**Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer (See definition of “acceleratedfiler and large accelerated filer’ in Rule 12b-2 of the Exchange Act).**

 

**o  LARGE ACCELERATED FILER ****o  ACCELERATED FILER ****ý NON-ACCELERATEDFILER**

 

**Indicateby check mark whether the registrant is a shell company  (as defined in Rule12b-2 of the Exchangeact).**

 

**oYES         ****ý  NO**

 

**As of February 6, 2006, 9,559,757 shares of  .01 par valueCommon Stock of the registrant were outstanding.**

 

 

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## **HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES**

 

## **INDEX**

 
|                                                                                                    | **Page No.** |
|---------------------------------------------------------------------------------------------------------|--------------|
| **PART I. FINANCIAL INFORMATION**                                                                       | 2            |
|                                                                                                    |         |
| **Item 1. Financial Statements**                                                                        | 2            |
|                                                                                                    |         |
| **Condensed Consolidated Balance Sheets -**                                                             | 2            |
| **December 31, 2005 (unaudited) and September 30, 2005  (audited)**                                     |         |
| ** **                                                                                              |         |
| **Condensed Consolidated Statements of Income  -**                                                      | 3            |
| **Three Months ended December 31, 2005 (unaudited) and 2004  (unaudited)**                              |         |
|                                                                                                    |         |
| **Condensed Consolidated Statements of Other  Comprehensive Income -**                                  | 4            |
| **Three months ended December 31, 2005 (unaudited) and 2004  (unaudited)**                              |         |
| ** **                                                                                              |         |
| **Condensed Consolidated Statements of Cash Flows -**                                                   | 5            |
| **Three Months ended December 31, 2005 (unaudited) and 2004  (unaudited)**                              |         |
|                                                                                                    |         |
| **Notes to Condensed Consolidated Financial Statements**                                                | 6-14         |
| ** **                                                                                              |         |
| **Item 2. Management’s Discussion  and Analysis of Financial Condition and Results of Operations** | 15-27        |
| ** **                                                                                              |         |
| **Item 3. Quantitative and  Qualitative Disclosures about Market Risks**                                | 28-29        |
| ** **                                                                                              |         |
| **Item 4. Controls  and Procedures**                                                                    | 30           |
|                                                                                                    |         |
| **PART II. OTHER INFORMATION**                                                                          | 30           |
| ** **                                                                                              |         |
| **Item 2. Unregistered  Sales of Equity Securities and Use of Proceeds**                                | 30           |
| ** **                                                                                              |         |
| **Item 6. Exhibits**                                                                                    | 31           |
|                                                                                                    |         |
| **SIGNATURES**                                                                                          | 32           |

 

----

 

**PART I. FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                     | ** ** | **December 31, 2005** | ** **     | **September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------------|----------------|----------------------------------|------------|
| ** **                                                                                                     | ** ** | **(unaudited)**                 | ** **     | **(audited)**                    | ** ** |
| **Assets:**                                                                                                    |       |                            |           |                             |       |
| ** **                                                                                                     |       |                            |           |                             |       |
| **Current Assets:**                                                                                            | ** ** | ** **                      | ** **     | ** **                       | ** ** |
| **Cash and cash equivalents**                                                                                  | ** ** | **$**                           | **6,192,989**  | ** **                       | **$**      | **7,567,393** | ** ** |
| **Receivables, net of various  allowances**                                                                    | ** ** | **20,484,559**                  | ** **     | **13,048,076**                   | ** ** |
| **Inventories**                                                                                                | ** ** | **10,398,235**                  | ** **     | **9,806,785**                    | ** ** |
| **Prepaid expenses and other  current assets**                                                                 | ** ** | **1,037,052**                   | ** **     | **1,087,453**                    | ** ** |
| **Total current assets**                                                                                       | ** ** | **38,112,835**                  | ** **     | **31,509,707**                   | ** ** |
|                                                                                                           |       |                            |           |                             |       |
| **Property, plant and  equipment, net**                                                                        | ** ** | **521,618**                     | ** **     | **525,108**                      | ** ** |
| **Security deposits and other  non current assets**                                                            | ** ** | **80,142**                      | ** **     | **81,529**                       | ** ** |
| **Total assets**                                                                                               | ** ** | **$**                           | **38,714,595** | ** **                       | **$**      | **32,116,344** | ** ** |
| ** **                                                                                                     | ** ** | ** **                      | ** **     | ** **                       | ** ** |
| **Liabilities and Stockholders’  Equity :**                                                               | ** ** | ** **                      | ** **     | ** **                       | ** ** |
| ** **                                                                                                     | ** ** | ** **                      | ** **     | ** **                       | ** ** |
| **Current Liabilities:**                                                                                       | ** ** | ** **                      | ** **     | ** **                       | ** ** |
| **Accounts payable**                                                                                           | ** ** | **$**                           | **16,062,743** | ** **                       | **$**      | **10,750,560** | ** ** |
| **Accrued expenses-licensing  fees**                                                                           | ** ** | **4,794,451**                   | ** **     | **4,126,506**                    | ** ** |
| **Accrued expenses**                                                                                           | ** ** | **1,438,627**                   | ** **     | **1,121,842**                    | ** ** |
| **Income taxes payable**                                                                                       | ** ** | **179,260**                     | ** **     | **175,944**                      | ** ** |
| **Total current liabilities**                                                                                  | ** ** | **22,475,081**                  | ** **     | **16,174,852**                   | ** ** |
| ** **                                                                                                     | ** ** | ** **                      | ** **     | ** **                       | ** ** |
| **Stockholders’ Equity:**                                                                                 | ** ** | ** **                      | ** **     | ** **                       | ** ** |
| **Common stock $.01 par value; 25,000,000  shares authorized, 10,121,378 and 10,107,936 issued, respectively** | ** ** | **101,214**                     | ** **     | **101,080**                      | ** ** |
| **Additional paid-in capital**                                                                                 | ** ** | **13,728,530**                  | ** **     | **13,603,705**                   | ** ** |
| **Retained earnings**                                                                                          | ** ** | **4,332,360**                   | ** **     | **3,311,888**                    | ** ** |
| **Accumulated other  comprehensive (loss) income**                                                             | ** ** | **(164,639**                    | **)**          | **682,770**                      | ** ** |
| **Treasury Stock, at cost,  607,547 and 567,067 shares**                                                       | ** ** | **(1,757,951**                  | **)**          | **(1,757,951**                   | **)**      |
| **Total stockholders’ equity**                                                                            | ** ** | **16,239,514**                  | ** **     | **15,941,492**                   | ** ** |
| **Total liabilities and stockholders’  equity**                                                           | ** ** | **$**                           | **38,714,595** | ** **                       | **$**      | **32,116,344** | ** ** |

 

***See accompanying notes tocondensed consolidated financial statements***

 

2

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**HAUPPAUGEDIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

**(UNAUDITED)**

 
| ** **                                        | ** ** | **Three months ended December 31,** | ** **     |
|---------------------------------------------------|------------|---------------------------------------------------------|----------------|
| ** **                                        | ** ** | **2005**                                                | ** **     | **2004** | ** ** |
| ** **                                        | ** ** | ** **                                              | ** **     | ** ** | ** ** |
| **Net sales**                                     | ** ** | **$**                                                   | **25,044,990** | ** ** | **$** | **23,360,442** | ** ** |
| **Cost of sales**                                 | ** ** | **19,813,206**                                          | ** **     | **18,049,079** | ** ** |
| **Gross profit**                                  | ** ** | **5,231,784**                                           | ** **     | **5,311,363** | ** ** |
| ** **                                        | ** ** | ** **                                              | ** **     | ** ** | ** ** |
| **Selling, general and  administrative expenses** | ** ** | **3,381,070**                                           | ** **     | **3,427,055** | ** ** |
| **Research & development  expenses**          | ** ** | **794,001**                                             | ** **     | **557,530** | ** ** |
| **Income from operations**                        | ** ** | **1,056,713**                                           | ** **     | **1,326,778** | ** ** |
| ** **                                        | ** ** | ** **                                              | ** **     | ** ** | ** ** |
| **Other income (expense):**                       | ** ** | ** **                                              | ** **     | ** ** | ** ** |
| **Interest income**                               | ** ** | **5,206**                                               | ** **     | **1,511** | ** ** |
| **Foreign currency**                              | ** ** | **964**                                                 | ** **     | **(8,600** | **)** |
| **Other income (expense)**                        | ** ** | **6,170**                                               | ** **     | **(7,089** | **)** |
| **Income before taxes on income**                 | ** ** | **1,062,883**                                           | ** **     | **1,319,689** | ** ** |
| **Tax provision**                                 | ** ** | **42,411**                                              | ** **     | **56,000** | ** ** |
| **Net income**                                    | ** ** | **$**                                                   | **1,020,472**  | ** ** | **$** | **1,263,689** | ** ** |
| ** **                                        | ** ** | ** **                                              | ** **     | ** ** | ** ** |
| **Net income per share:**                         | ** ** | ** **                                              | ** **     | ** ** | ** ** |
| **Basic**                                         | ** ** | **$**                                                   | **0.11**       | ** ** | **$** | **0.14** | ** ** |
| **Diluted**                                       | ** ** | **$**                                                   | **0.10**       | ** ** | **$** | **0.13** | ** ** |

 

***See accompanying notes tocondensed consolidated financial statements***

 

3

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**HAUPPAUGEDIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OTHERCOMPREHENSIVE INCOME**

**(UNAUDITED)**

 
| ** **                                      | ** ** | **Three months ended December 31****,** | ** **    |
|-------------------------------------------------|------------|-------------------------------------------------------------|---------------|
| ** **                                      | ** ** | **2005**                                                    | ** **    | **2004** | ** ** |
| **Net income**                                  | ** ** | **$**                                                       | **1,020,472** | ** ** | **$** | **1,263,689** | ** ** |
| **Foreign currency translation (loss)**         | ** ** | **(743,271**                                                | **)**         | **(279,791** | **)** |
| **Forward exchange contracts marked to market** | ** ** | **(104,138**                                                | **)**         | **584,261** | ** ** |
| **Other comprehensive income**                  | ** ** | **$**                                                       | **173,063**   | ** ** | **$** | **1,568,159** | ** ** |

 

***See accompanying notes to condensedconsolidated financial statements***

 

4

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**HAUPPAUGEDIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Three months ended December 31,** | ** **    |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|---------------|
| ** **                                                                         | ** ** | **2005**                                                | ** **    | **2004** | ** ** |
| **Net income**                                                                     | ** ** | **$**                                                   | **1,020,472** | ** ** | **$** | **1,263,689** | ** ** |
| **Adjustments to reconcile net  income to net cash used in operating activities:** | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Depreciation and amortization**                                                  | ** ** | **45,070**                                              | ** **    | **54,324** | ** ** |
| **Non cash stock compensation  expense**                                           | ** ** | **100,878**                                             | ** **    | **—** | ** ** |
| **Other non cash items**                                                           | ** ** | **1,387**                                               | ** **    | **—** | ** ** |
| **Changes in current assets and  liabilities:**                                    | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Accounts receivable**                                                            | ** ** | **(7,436,483**                                          | **)**         | **(1,612,908** | **)** |
| **Inventories**                                                                    | ** ** | **(591,450**                                            | **)**         | **(2,273,237** | **)** |
| **Prepaid expenses and other  current assets**                                     | ** ** | **50,401**                                              | ** **    | **(11,665** | **)** |
| **Accounts payable**                                                               | ** ** | **5,312,183**                                           | ** **    | **1,450,848** | ** ** |
| **Accrued expenses and other  current liabilities**                                | ** ** | **988,046**                                             | ** **    | **491,287** | ** ** |
| **Total adjustments**                                                              | ** ** | **(1,529,968**                                          | **)**         | **(1,901,351** | **)** |
| **Net cash used in operating  activities**                                         | ** ** | **(509,496**                                            | **)**         | **(637,662** | **)** |
| ** **                                                                         | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Cash Flows From Investing  Activities:**                                         | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Purchases of property, plant  and equipment**                                    | ** ** | **(41,580**                                             | **)**         | **(82,723** | **)** |
| **Net cash used in investing  activities**                                         | ** ** | **(41,580**                                             | **)**         | **(82,723** | **)** |
| ** **                                                                         | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Cash Flows From Financing  Activities:**                                         | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Proceeds from exercise of  stock options and employee stock purchases**          | ** ** | **24,081**                                              | ** **    | **199,359** | ** ** |
| **Purchase of treasury stock**                                                     | ** ** | **—**                                              | ** **    | **(17,448** | **)** |
| **Net cash provided by  financing activities**                                     | ** ** | **24,081**                                              | ** **    | **181,911** | ** ** |
| **Effect of exchange rates on  cash**                                              | ** ** | **(847,409**                                            | **)**         | **304,470** | ** ** |
| **Net decrease in cash and cash  equivalents**                                     | ** ** | **(1,374,404**                                          | **)**         | **(234,004** | **)** |
| **Cash and cash equivalents,  beginning of period**                                | ** ** | **7,567,393**                                           | ** **    | **8,661,589** | ** ** |
| **Cash and cash equivalents,  end of period**                                      | ** ** | **$**                                                   | **6,192,989** | ** ** | **$** | **8,427,585** | ** ** |
| ** **                                                                         | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Supplemental disclosures:**                                                      | ** ** | ** **                                              | ** **    | ** ** | ** ** |
| **Income taxes paid**                                                              | ** ** | **$**                                                   | **16,776**    | ** ** | **$** | **38,863** | ** ** |

 

***See accompanying notes to condensedconsolidated financial statements***

 

5

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###### **HAUPPAUGE DIGITAL, INC.****AND SUBSIDIARIES**

######  

###### **NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

######  

###### **(Unaudited)**

 

**Note1. Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementsincluded herein have been prepared in accordance with generally acceptedaccounting principles for interim period reporting in conjunction with theinstructions to Form 10-Q. Accordingly, these statements do not include all ofthe information required by generally accepted accounting principles for annualfinancial statements. In the opinion of management, all known adjustments(consisting of normal recurring accruals and reserves) necessary to presentfairly the Company’s consolidated financial position,  results of operations and cash flows as ofand for the interim periods have been included. It is suggested that theseinterim statements be read in conjunction with the financial statements andrelated notes included in the Company’s September 30, 2005 Form 10-K.

 

The operating results for the three months ended December  31, 2005 are not necessarily indicative ofthe results to be expected for the September 30, 2006 year end.

 

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

 

**Note2. Receivables**

 

Accounts and other receivables as of December 31, 2005 and September30, 2005 consisted of: 

 
| ** **                                  | ** ** | **December 31,** | ** **     | **September 30,** | ** ** |
|---------------------------------------------|------------|-----------------------|----------------|------------------------|------------|
| ** **                                  | ** ** | **2005**              | ** **     | **2005**               | ** ** |
| **Trade receivables**                       | ** ** | **$**                 | **14,564,411** | ** **             | **$**      | **10,186,232** | ** ** |
| **Receivable from contract  manufacturers** | ** ** | **8,309,277**         | ** **     | **5,491,524**          | ** ** |
| **GST and VAT taxes receivables**           | ** ** | **812,647**           | ** **     | **567,820**            | ** ** |
| **Allowances and reserves**                 | ** ** | **(3,257,000**        | **)**          | **(3,257,000**         | **)**      |
| **Other**                                   | ** ** | **55,224**            | ** **     | **59,500**             | ** ** |
| ** **                                  | ** ** | **$**                 | **20,484,559** | ** **             | **$**      | **13,048,076** | ** ** |

 

**Note3. Derivative Financial   Instruments**

 

For each of the past three fiscal years, at least 50 % of the Company’ssales were generated by our European subsidiary and were:

 

•                  Invoiced inlocal currency-primarily the Euro

 

•                  Collected inlocal currency-primarily the Euro

 

6

----

 

On the supply side, since the Company predominantly deals with NorthAmerican and Asian suppliers and contract manufacturers, approximately 75% ofthe Company’s inventory required to support the Company’s European sales arepurchased and paid in U.S. Dollars.

 

The combination of sales billed in Euros supported by inventorypurchased in U.S. dollars results in an absence of a natural local currencyhedge. Consequently, the Company’s financial results are subject to marketrisks resulting from the fluctuations in the Euro to U.S. Dollar exchangerates.

 

The Company attempts to reduce these risks by entering into foreignexchange forward contracts with financial institutions. The purpose of theseforward contracts is to hedge the foreign currency market exposures underlyingthe U.S. Dollar denominated inventory purchases required to support theCompany’s European sales.

 

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

 

•                                          volatility of the currency markets

 

•                                          availability of hedging instruments

 

•                                          accuracy of our inventory forecasts

 

Additionally, there is the risk that foreign exchange fluctuations willmake our products less competitive in foreign markets, which wouldsubstantially reduce our sales.

 

As of December 31, 2005, the Company had foreign currency contractsoutstanding of approximately $1,928,150 against the delivery of the Euro. Thecontracts expire from January 2006 through February 2006. The Company’saccounting policies for these instruments designate such instruments as cashflow hedging transactions. The Company does not enter into such contracts forspeculative purposes. The Company records all derivative gains and losses onthe balance sheet as a component of stockholders’ equity under the caption“Accumulated other comprehensive income (loss)”. The Company

 

7

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recorded a loss of $104,138 for the three ended December 31, 2005 onits statement of other comprehensive income. As of December 31, 2005, adeferred gain of $32,280 reflecting the cumulative mark to market gains of theCompany’s derivatives, was recorded on the Company’s balance sheet as acomponent of accumulated other comprehensive income in our equity section.

 

The Company uses the average monthly forward contract exchange rate totranslate our Euro denominated sales into the Company’s U.S. dollar reportingcurrency. For the three months ended December 31, 2005, the use of the monthlyaverage spot rate instead of the average monthly forward contract exchangerate to value Euro denominated sales would have resulted in a decreasein sales of $628,789 for the three months ended December 31, 2005. These salesincreases are related to contracts that closed during these periods andthe changes in the fair value of our derivative contracts. For the three monthsended December 31, 2004, the use of the monthly average spot rate instead ofthe average monthly forward contract exchange rate to value Eurodenominated sales would have resulted in a sales increase of $640,815.

 

**Note 4.Inventories**

 

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

 
| ** **          | ** ** | **December 31,** | ** **     | **September 30,** | ** ** |
|---------------------|------------|-----------------------|----------------|------------------------|------------|
| ** **          | ** ** | **2005**              | ** **     | **2005**               | ** ** |
|                |       |                  |           |                   |       |
| **Component Parts** | ** ** | **$**                 | **4,712,845**  | ** **             | **$**      | **4,131,732** | ** ** |
| **Finished Goods**  | ** ** | **5,685,390**         | ** **     | **5,675,053**          | ** ** |
| ** **          | ** ** | **$**                 | **10,398,235** | ** **             | **$**      | **9,806,785** | ** ** |

 

**Note 5.Net Income Per Share**

 

Basic net income per share includes no dilution and is computed bydividing net income by the weighted average number of shares of common stockoutstanding for the period. Diluted net income per share reflects, in theperiods in which they have a dilutive effect, the dilution which would occurupon the exercise of stock options. A reconciliation of the shares used incalculating basic and diluted net income per share is as follows:

 
| ** **                                                            | ** ** | **Three Months Ended  December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| **Weighted average shares outstanding-basic**                         | ** ** | **9,508,100**                                       | ** ** | **9,277,944** | ** ** |
| **Number of shares issued on the assumed  exercise of stock options** | ** ** | **507,157**                                         | ** ** | **671,437** | ** ** |
| **Weighted average shares outstanding-diluted**                       | ** ** | **10,015,257**                                      | ** ** | **9,949,381** | ** ** |

 

8

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Options to purchase 92,876 and 98,757 shares of common stock, at pricesranging $3.88 to $ 8.75 and $5.25 to $10.06, were outstanding for the threemonths ended December 31, 2005 and 2004, respectively, but were not included inthe computation of diluted earnings per share because they were anti-dilutive.

 

**Note 6. Accumulated other comprehensive income**

 

The Euro is the functional currency of the Company’s Europeansubsidiary, Hauppauge Digital Europe Sarl. Assets and liabilities of thissubsidiary are translated to U.S. Dollars at the spot exchange rate in effectat the end of each reporting period, while equity accounts are translated toU.S. Dollars at the historical rate in effect at the date of the contribution.Operating results are translated to U.S. Dollars at the average prevailingexchange rate for the period, with the exception of sales, which are translatedto U.S. Dollars at the average monthly forward exchange contract rate. The useof translating accounts at the spot, historical and average exchange ratesresults in foreign currency translation gains or losses. These translationgains or losses are recorded on the balance sheet under accumulated othercomprehensive income.

 

The Company uses forward exchange contracts to reduce its exposure tofluctuations in foreign currencies. Mark to market gains and losses on theseopen contracts result from the difference between the USD value of the openforeign currency forward contracts at the average contract rate as opposed tothe same contracts translated at the month end spot rate. The Company qualifiesfor cash flow hedge accounting as prescribed under FAS 133, which allows theCompany to record the mark to market gains and losses in the equity section ofthe Company’s balance sheet under accumulated other comprehensive income.

 

As of December 31, 2005, appearing in the equity section under “Accumulated other comprehensive income” was a loss of $164,639, which consistedof a deferred translation loss of $196,919 and a deferred gain of $32,280 dueto the mark to market gains on the difference between the value of theCompany’s open forward exchange contracts at the contract rates versus the samecontracts valued at the period ending forward rate.

 

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

 

9

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**Note7. Revenue Recognition**

 

The Company sells through a sales channel which consist of retailers ,distributors and original equipment manufacturers (OEM’s). The Company’s pricesare fixed consistently over the entire sales channel. The majority of theCompany’s customers are granted lines of credit. The product is shipped on openaccount with the majority of the Company’s customers given 30 to 60 day paymentterms. Those customers deemed as large credit risks either pay in advance orissue us a letter of credit.

 

The Company requires the customer to submit a purchase order to theCompany. The price of the product and payment terms are fixed per the terms ofthe purchase order. Upon shipment of the order to the customer, the title tothe goods is passed to the customer. The customer is legally obligated to payfor 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 inthe customer’s possession is the responsibility of the customer. The Companysells analog, hybrid video recorders and digital computer boards that are stockedon the shelves of retailers, and are subject to the normal consumer trafficthat retail stores attract. Aside from normal store promotions such as end-capsand advertisements in the store’s circular, the Company has no furtherobligation to assist in the resale of the product.

 

The Company offers its customers a right of return, but does not offerstock balancing. The Company’s accounting method complies with SFAS 48 astypically at the end of every quarter the Company, based on historical data,evaluates its sales reserve level based on the previous six months sales. Dueto seasonal nature of the business coupled with the changing economicenvironment, management exercises some judgment with regard to the historicaldata to arrive at the reserve.

 

**Note8. Product segment and Geographic Information**

 

The Company offers three primary types of analog products. TheCompany’s WinTV® analog TV receivers allow PC users to watch television ontheir PC screen in a resizable window, and also enable recording of TV shows toa hard disk. The Company’s WinTV®-PVR TV personal video recorder productsinclude hardware MPEG encoders, which improve the performance of TV recordingand add instant replay and program pause functions, plus also enable the ‘burning’of TV recordings onto DVD or CD media. The Company’s EskapeTM Labs myTV.PVRproducts allow users of Apple®Macintosh® computers to watch and recordtelevision on their computer screen.

 

The Company offers four types of digital TV receivers. The Company’sWinTV-NOVA digital receivers can receive digital TV transmissions and displaythe digital TV show in a re-sizeable window on a user’s PC screen. TheCompany’s

 

10

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WinTV-HVR series allow users to watch analog or digital TV on a PCscreen. The Company’s Digital Entertainment Center products (“DEC”) allow usersto receive digital TV broadcasts and display the digital TV on either a TV setor a PC screen. The Company’s MediaMVPTM product was designed to allow PC usersto play digital media such as digital music, digital pictures and digitalvideos on a TV set via a home network.

 

The Company’s products are either sold, or can be sold, by the sameretailers and distributors in our marketing channel. The Company also sellsproduct directly to OEM customers. The Company evaluates its product linesunder the functional categories of analog and digital products. Sales byfunctional category are as follows:

 
| ** **             | ** ** | **Three months ended December 31,** | ** **     |
|------------------------|------------|---------------------------------------------------------|----------------|
| ** **             | ** ** | **2005**                                                | ** **     | **2004** | ** ** |
| **Product line sales** | ** ** | ** **                                              | ** **     | ** ** | ** ** |
| **Analog sales**       | ** ** | **$**                                                   | **15,457,032** | ** ** | **$** | **18,401,809** | ** ** |
| **Digital sales**      | ** ** | **9,587,958**                                           | ** **     | **4,958,633** | ** ** |
| ** **             | ** ** | **$**                                                   | **25,044,990** | ** ** | **$** | **23,360,442** | ** ** |

 

The Company sells its products through an international network of distributorsand retailers. Sales percent by geographic region are as follows: 
| ** **                              | ** ** | **Three months ended December 31 ,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                                      | ** ** | **2004** | ** ** |
| **Sales percent by geographic  region** | ** ** | ** **                                                    | ** ** | ** ** | ** ** |
| **United States**                       | ** ** | **41**                                                        | **%**      | **38** | **%** |
| **Europe**                              | ** ** | **56**                                                        | **%**      | **60** | **%** |
| **Asia**                                | ** ** | **3**                                                         | **%**      | **2** | **%** |
| **Total**                               | ** ** | **100**                                                       | **%**      | **100** | **%** |

 

**Note 9.Stock-Based Compensation**

 

Prior to October 1, 2005, the Company accounted for employee stockoption plans based on the intrinsic value method in accordance with AccountingPrinciples Board  (APB) Opinion No. 25, *“ Accounting for Stock Issued to Employees,”*and related Interpretations and had adopted the disclosure requirements of SFASNo. 123, *“ Accounting for Stock-BasedCompensation”* (SFAS No.123). Accordingly, compensation cost forstock options was measured as the excess, if any, of the quoted market price ofthe Company’s stock at the grant date over the amount an employee must pay toacquire the stock. The Company  grantedstock options with exercise prices equal to the market price of the underlyingstock on the date of grant, therefore, the Company did not record stock-basedcompensation expense under APB Opinion No. 25.

 

In December 2004, the Financial Accounting Standards Board (FASB)issued SFAS No. 123R, *“ Share-BasedPayments”* to requirethat compensation cost relating to share-based payment arrangements berecognized in the financial statements.

 

11

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Effective October 1, 2005, the Company adopted SFAS No. 123R using themodified prospective method, which requires measurement of compensation costfor all stock-based awards at fair value on date of grant and recognition ofcompensation over the service period for awards expected to vest. Therefore,prior period financial statements have not been restated. The fair value ofstock options were determined using the Black-Scholes valuation model, which isconsistent with our valuation techniques previously utilized for stock optionsin footnote disclosures required under SFAS No. 123. Such fair value isrecognized as expense over the service period, net of estimated forfeitures.The adoption of SFAS No.123R resulted in no cumulative change in accounting asof the date of adoption.

 

The weighted average fair value of options outstanding during the threemonths ended December 31, 2005 was $2.15. These options vest over a period offive years. The fair value for these options was estimated at the date of grantusing a Black-Scholes option pricing model with the following weighted averageassumptions for the three months ended December 31, 2005: risk-free interestrates of 4.25%, volatility factor of the expected market price of the Company’sCommon Stock of 50%, assumed dividend yield of 0%, and a weighted-averageexpected life of the option of 5 years.

 

Forthe three months ended December 31, 2005, stock compensation expense of$100,878 was charged to operations, consisting of $20,945 for options grantedduring the first quarter of fiscal 2006 and $79,333 for non vested optionsgranted prior to October 1, 2005. As of December 31, 2005, there was$1,091,678 of total unrecognized compensation cost, net of estimatedforfeitures, related to nonvested share-based compensation arrangements, whichis expected to be recognized over a weighted-average period of 3.75 years.

 

The following table illustrates the effect on net income and net incomeper share for the three months ended December 31, 2004 as if the Company hasconsistently measured the compensation cost for the Company’s stock optionprograms under the fair value method adopted on October 1, 2005:

 
| ** **                                                                                                            | ** ** | **December 31,** | ** **    |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|---------------|
| ** **                                                                                                            | ** ** | **2004**              | ** **    |
| **Net income as reported**                                                                                            | ** ** | **$**                 | **1,263,689** | ** ** |
| **Deduct: Total stock-based employee  compensation expense determined under fair value method, net of related taxes** | ** ** | **(8,924**            | **)**         |
| **Pro forma net income**                                                                                              | ** ** | **$**                 | **1,254,765** | ** ** |
| ** **                                                                                                            | ** ** | ** **            | ** **    |
| **Net income per share - as reported:**                                                                               | ** ** | ** **            | ** **    |
| **Basic**                                                                                                             | ** ** | **$**                 | **0.14**      | ** ** |
| **Diluted**                                                                                                           | ** ** | **$**                 | **0.13**      | ** ** |
| **Net income per share - pro forma:**                                                                                 | ** ** | ** **            | ** **    |
| **Basic**                                                                                                             | ** ** | **$**                 | **0.14**      | ** ** |
| **Diluted**                                                                                                           | ** ** | **$**                 | **0.13**      | ** ** |

 

12

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

 

FASB Interpretation No. 45 (FIN 45),Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of the Indebtedness of Others, clarified the requirementsof SFAS No. 5, Accounting for Contingencies, relating to a guarantor’saccounting for and disclosures of certain guarantees issued. FIN 45 requiresenhanced disclosures for certain guarantees. It also requires certainguarantees that are issued or modified after December 31, 2002, includingcertain third-party guarantees, to be initially recorded on the balance sheetat fair value. For guarantees issued on or before December 31, 2002,liabilities are recorded when and if payments become probable and estimable.FIN 45 has the general effect of delaying recognition for a portion of the revenuefor product sales that are accompanied by certain third-party guarantees. Thefinancial statement recognition provisions became effective prospectivelybeginning January 1, 2003. The Company has not entered into any new guarantees andthe Company has been released from the one guarantee it was subject to prior toFebruary 17, 2004.

 

The Company occupies a facility located in Hauppauge New York which isused for its executive offices and for the testing, storage and shipping of theCompany’s products. In February 1990, Hauppauge Computer Works, Inc., awholly-owned subsidiary of the Company (“HCW”), entered into a lease (the “1990Lease”), with Ladokk Realty Co., a real estate partnership which is principallyowned by Kenneth Plotkin, the Company’s Chairman of the Board, Chief ExecutiveOfficer, President, Chief Operating Officer and Vice President of Marketing andthe holder of approximately 8.8% of the Company’s Common Stock as of December31, 2005, Dorothy Plotkin, the wife of Kenneth Plotkin, holder of approximately5.9% of the Company’s Common Stock as of December 31, 2005 and Laura Aupperle,believed by the Company to be the holder of approximately 10.5% of theCompany’s Common Stock, including Common Stock attributed to the Estate ofKenneth R. Aupperle. Ladokk Realty Co., LLC is the successor to Ladokk RealtyCo. As of February 2004, the 1990 Lease provided for annual rent ofapproximately $454,000, payable monthly, and subject to 5% annual increaseseffective February 1st of each year. The Company was also obligatedto pay real estate taxes and operating costs of maintaining the premisessubject to the 1990 Lease. Until February 17, 2004, the premises subject tosuch lease were subject to two mortgages guaranteed by us.

 

On February 17, 2004, HCW and Ladokk terminated the 1990 Lease and HCWentered into a new lease agreement with Ladokk Realty Co., LLC (the “2004Lease”). The 2004 Lease term is for five years and terminates on February 16,2009. The annual rent under the 2004 Lease is $360,000, payable monthly. TheCompany was also obligated to pay real estate taxes and operating costs ofmaintaining the premises subject to such lease. Concurrently with the newlease, Ladokk completed a refinancing of its mortgages, and the new lender didnot require HCW to sign a guarantee. Accordingly, the Company no longerguarantees the landlord’s mortgages.

 

13

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Our audit committee is in the process of evaluating the 2004 lease.

 

 

 

 

 

 

 

 

 

 

14

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###### **Item 2. Management’s Discussionand Analysis of   Financial Conditionand  Results of Operations**

######  

###### **ThreeMonth Period ended December  31, 2005Compared to December 31, 2004**

######  

Results of operations for the three months ended December 31, 2005compared to December  31, 2004  are as follows:

 
| ** **                                               | ** ** | **Three**      | ** **     | **Three**      | ** ** | ** **     | ** ** | ** **                        | ** **    | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|----------------|----------------|----------------|------------|----------------|------------|-----------------------------------|---------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **Months**     | ** **     | **Months**     | ** ** | ** **     | ** ** | ** **                        | ** **    | ** ** | ** ** | ** **   | ** ** |
| ** **                                               | ** ** | **Ended**      | ** **     | **Ended**      | ** ** | **Variance**   | ** ** | **Percentage of sales** | ** **    |
| ** **                                               | ** ** | **12/31/05**   | ** **     | **12/31/04**   | ** ** | **$**          | ** ** | **2005**                          | ** **    | **2004**   | ** ** | **Variance** | ** ** |
|                                                     |       |           |           |           |       |           |       |                              |          |       |       |         |       |
| **Net sales**                                            | ** ** | **$**          | **25,044,990** | ** **     | **$**      | **23,360,442** | ** ** | **$**                             | **1,684,548** | ** ** | **100.00** | **%**        | **100.00** | **%** | **—** | ** ** |
| **Cost of sales**                                        | ** ** | **19,813,206** | ** **     | **18,049,079** | ** ** | **1,764,127**  | ** ** | **79.11**                         | **%**         | **77.26**  | **%**      | **1.85**     | **%**      |
| **Gross profit**                                         | ** ** | **5,231,784**  | ** **     | **5,311,363**  | ** ** | **(79,579**    | **)**      | **20.89**                         | **%**         | **22.74**  | **%**      | **-1.85**    | **%**      |
| **Gross profit %**                                       | ** ** | **20.89**      | **%**          | **22.74**      | **%**      | **-1.85**      | **%**      | ** **                        | ** **    | ** ** | ** ** | ** **   | ** ** |
| ** **                                               | ** ** | ** **     | ** **     | ** **     | ** ** | ** **     | ** ** | ** **                        | ** **    | ** ** | ** ** | ** **   | ** ** |
| **Expenses:**                                            | ** ** | ** **     | ** **     | ** **     | ** ** | ** **     | ** ** | ** **                        | ** **    | ** ** | ** ** | ** **   | ** ** |
| **Sales & marketing**                                | ** ** | **2,356,572**  | ** **     | **2,431,591**  | ** ** | **(75,019**    | **)**      | **9.41**                          | **%**         | **10.41**  | **%**      | **-1.00**    | **%**      |
| **Technical support**                                    | ** ** | **132,079**    | ** **     | **120,324**    | ** ** | **11,755**     | ** ** | **0.52**                          | **%**         | **0.52**   | **%**      | **0.00**     | **%**      |
| **General & administrative**                         | ** ** | **824,818**    | ** **     | **875,140**    | ** ** | **(50,322**    | **)**      | **3.29**                          | **%**         | **3.75**   | **%**      | **-0.46**    | **%**      |
| **SG&A stock compensation expense**                  | ** ** | **67,601**     | ** **     | **—**     | ** ** | **67,601**     | ** ** | **0.28**                          | **%**         | **0.00**   | **%**      | **0.28**     | **%**      |
| **Total selling, general and administrative  expenses**  | ** ** | **3,381,070**  | ** **     | **3,427,055**  | ** ** | **(45,985**    | **)**      | **13.50**                         | **%**         | **14.68**  | **%**      | **-1.18**    | **%**      |
| **Research & development**                           | ** ** | **760,724**    | ** **     | **557,530**    | ** ** | **203,194**    | ** ** | **3.04**                          | **%**         | **2.39**   | **%**      | **0.65**     | **%**      |
| **Research and development stock compensation  expense** | ** ** | **33,277**     | ** **     | **—**     | ** ** | **33,277**     | ** ** | **0.13**                          | **%**         | **0.00**   | **%**      | **0.13**     | **%**      |
| **Total operating expenses**                             | ** ** | **4,175,071**  | ** **     | **3,984,585**  | ** ** | **190,486**    | ** ** | **16.67**                         | **%**         | **17.07**  | **%**      | **-0.40**    | **%**      |
| **Net operating income**                                 | ** ** | **1,056,713**  | ** **     | **1,326,778**  | ** ** | **(270,065**   | **)**      | **4.22**                          | **%**         | **5.67**   | **%**      | **-1.45**    | **%**      |
| **Other income**                                         | ** ** | ** **     | ** **     | ** **     | ** ** | ** **     | ** ** | ** **                        | ** **    | ** ** | ** ** | ** **   | ** ** |
| **Interest income**                                      | ** ** | **5,206**      | ** **     | **1,511**      | ** ** | **3,695**      | ** ** | **0.02**                          | **%**         | **0.01**   | **%**      | **0.01**     | **%**      |
| **Foreign currency**                                     | ** ** | **964**        | ** **     | **(8,600**     | **)**      | **9,564**      | ** ** | **0.00**                          | **%**         | **-0.04**  | **%**      | **0.04**     | **%**      |
| **Total other income (loss)**                            | ** ** | **6,170**      | ** **     | **(7,089**     | **)**      | **13,259**     | ** ** | **0.02**                          | **%**         | **-0.03**  | **%**      | **0.05**     | **%**      |
| **Income before taxes**                                  | ** ** | **1,062,883**  | ** **     | **1,319,689**  | ** ** | **(256,806**   | **)**      | **4.25**                          | **%**         | **5.64**   | **%**      | **-1.39**    | **%**      |
| **Taxes on income**                                      | ** ** | **42,411**     | ** **     | **56,000**     | ** ** | **(13,589**    | **)**      | **0.17**                          | **%**         | **0.24**   | **%**      | **-0.07**    | **%**      |
| **Net income**                                           | ** ** | **$**          | **1,020,472**  | ** **     | **$**      | **1,263,689**  | ** ** | **$**                             | **(243,217**  | **)**      | **4.08**   | **%**        | **5.40**   | **%** | **-1.32** | **%** |

 

15

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Net sales for the  three  months ended December 31, 2005  increased $1,684,548 over the three monthsended December 31, 2004 as shown in the table below.

 
| ** **   | ** ** | **Three Months**       | ** **     | **Three Months**       | ** ** | **Increase (Decrease)** | ** ** | **Increase  (Decrease)** | ** **    | **Sales by Geographic  region** | ** ** |
|--------------|------------|-----------------------------|----------------|-----------------------------|------------|------------------------------|------------|--------------------------|---------------|-------------------------------------------|------------|
| **Location** | ** ** | **E****nded 12/31/05** | ** **     | **E****nded 12/31/04** | ** ** | **Dollar ****Variance** | ** ** | **Variance %**      | ** **    | **2005**                                  | ** ** | **2004** | ** ** |
| **Domestic** | ** ** | **10,204,935**              | ** **     | **8,853,575**               | ** ** | **1,351,360**                | ** ** | **15**                   | **%**         | **41**                                    | **%**      | **38** | **%** |
| **Europe**   | ** ** | **14,176,926**              | ** **     | **14,149,483**              | ** ** | **27,443**                   | ** ** | **0**                    | **%**         | **56**                                    | **%**      | **60** | **%** |
| **Asia**     | ** ** | **663,129**                 | ** **     | **357,384**                 | ** ** | **305,745**                  | ** ** | **86**                   | **%**         | **3**                                     | **%**      | **2** | **%** |
| **Total**    | ** ** | **$**                       | **25,044,990** | ** **                  | **$**      | **23,360,442**               | ** ** | **$**                    | **1,684,548** | ** **                                | **7**      | **%** | **100** | **%** | **100** | **%** |
|              |            |                             |                |                             |            |                              |            |                          |               |                                           |            |  |  |  |  |  |

 

The primary factors contributing to the sales increase were:

 

•                  Sales of hybrid video recorder retail product

 

•                  Sales of hybrid video recorder OEM product

 

•                  Introduction of the hybrid video recorder stick

 

•                  Increase in Nova-T-PCI/USB digital product sales

 

•                  Increase in PVR-PCI retail  sales

 

•                  Increase in our average  Euro to USD contract  rate of about 4.36% (1.2731 versus 1.2199)for the three  months ended December 31,2005 compared to the three months ended December 31, 2004, which yielded higher converted Euro to USD sales

 

Offsettingsome of the sales increases were:

 

•                  Decrease in Digital entertainment center (DEC)sales

 

•                  Decrease in PVR-PCI-OEM sales

 

•                  Decrease in USB analog sales

 

•                  Decrease in PCI analog  sales

 

•                  Decrease in PVR-USB sales

 

•                  Decrease in Media MVP sales

 

Net sales to domestic customers were 41% of net sales for the threemonths ended December 31, 2005 compared to 38% for the three months ended December31, 2004. Net sales to European customers were 56% of net sales compared to 60%for the same period of last year. Net sales to Asian  customers were 3% for the three months endedDecember 31, 2005 compared to  2% for thethree months ended December 31,  2004.

 

16

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Gross profit decreased  $79,579for the three months ended December  31,2005 compared to the prior year’s first quarter.

 

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

 
| ** **                                                | ** ** | **Increase**   | ** **  |
|-----------------------------------------------------------|------------|----------------|-------------|
| ** **                                                | ** ** | **(decrease)** | ** **  |
| **Increased sales**                                       | ** ** | **$**          | **499 225** | ** ** |
| **Higher gross profit on retail sales mix**               | ** ** | **114,883**    | ** **  |
| **Effect on gross profit due to sales mix of  OEM sales** | ** ** | **(431,484**   | **)**       |
| **Due to increases in labor related and other  costs**    | ** ** | **(262,203**   | **)**       |
| **Total decrease in gross profit**                        | ** ** | **$**          | **(79,579** | **)** |

 

Gross profit percentage for the three months ended  December  31, 2005 was  20.89% compared to 22.74% forthe  three months ended December 31,2004, a decrease of 1.85%.

 

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

 
| ** **                                                | ** ** | **Increase**   | ** ** |
|-----------------------------------------------------------|------------|----------------|------------|
| ** **                                                | ** ** | **(decrease)** | ** ** |
| **Higher gross profit on retail sales mix**               | ** ** | **0.62**       | **%**      |
| **Effect on gross profit due to lower margin  OEM sales** | ** ** | **(1.89**      | **)%**     |
| **Labor related and other costs**                         | ** ** | **(0.58**      | **)%**     |
| **Net decrease in gross profit %**                        | ** ** | **(1.85**      | **)%**     |

 

The decrease  in the gross profitpercent of 1.85 % for the three months ended December 31, 2005 compared to thethree months ended  December 31, 2004 wasprimarily due to:

 

•                                          Sales growth of lower gross profit OEM salescontributed to a 1.89% decrease in gross profit. The percentage of OEM salesfor the three months ended December 31, 2005 increased  over the three months ended December 31, 2004.OEM sales require less sales, advertising and product support than retailsales, but the  gross profit for OEM salesis lower than our retail products.

 

•                                          Favorable sales mix of higher gross profit retailsales contributed to a 0.62% increase in gross profit.

 

•                                          Labor related and other costs contributed to a  0.58% decrease  in gross profit percent compared to three monthsended December 31,  2004. The increase innet sales was  about 7% while the  increase in labor related and other costs wasabout  16%.

 

17

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

 
| ** **                              | ** ** | **Three months ended December 31,** | ** **    | ** **   | ** ** | ** **                        | ** ** | ** **   | ** **  |
|-----------------------------------------|------------|-------------------------------------|---------------|--------------|------------|-----------------------------------|------------|--------------|-------------|
| ** **                              | ** ** | **Dollar Costs**               | ** **    | **Increase** | ** ** | **Percentage of Sales** | ** ** | **Increase** | ** **  |
| ** **                              | ** ** | **2005**                            | ** **    | **2004**     | ** ** | **(Decrease)**                    | ** ** | **2005**     | ** **  | **2004** | ** ** | **(Decrease)** | ** ** |
| **Sales and marketing**                 | ** ** | **$**                               | **2,356,572** | ** **   | **$**      | **2,431,591**                     | ** ** | **$**        | **(75,019** | **)** | **9.41** | **%** | **10.41** | **%** | **-1.00** | **%** |
| **Technical support**                   | ** ** | **132,079**                         | ** **    | **120,324**  | ** ** | **11,755**                        | ** ** | **0.52**     | **%**       | **0.52** | **%** | **0.00** | **%** |
| **General and administrative**          | ** ** | **824,818**                         | ** **    | **875,140**  | ** ** | **(50,322**                       | **)**      | **3.29**     | **%**       | **3.75** | **%** | **-0.46** | **%** |
| **SG&A stock compensation expense** | ** ** | **67,601**                          | ** **    | **—**   | ** ** | **67,601**                        | ** ** | **0.28**     | **%**       | **0.00** | **%** | **0.28** | **%** |
| **Total**                               | ** ** | **$**                               | **3,381,070** | ** **   | **$**      | **3,427,055**                     | ** ** | **$**        | **(45,985** | **)** | **13.50** | **%** | **14.68** | **%** | **-1.18** | **%** |

 

Selling, general and administrative expenses decreased $45,985 from theprior year’s first quarter. As a percentage of sales, selling, general andadministrative expenses decreased by 1.18% when compared to the three months ended December 31, 2004.

 

The decrease in sales and marketing expense of $75,019,  was mainly due to:

 

•                                          Lower advertising and promotional  expenses of $107,380

 

•                                          Increased commission expense of $8,335 due to highersales

 

•                                          Increased compensation due to increases in  European and Asian  outside sales rep cost  of $32,612

 

The decrease in general and administrative expenses of $50,322 wasprimarily due to:

 

•                                          Lower banking service cost due to higher interest  rates on cash balances lowered costs by $26,270

 

•                                          Lower legal fees of $30,426 as a result of lower nonrecurring  fees

 

Research and development expenses increased $203,194. The increase wasmainly due to

 

•                                          Higher compensation costs of $79,529 due to the hiringof   additional engineering managementand staff personnel

 

•                                          Increased program development  costs of $120,738 due to higher volume of newproduct and product enhancement programs

 

Reflected in operating expenses for the three months ended December 31,2005 was $67,601 charged to sales, general and administrative and $33,277charged to research and development expenses for a total of  $100,878 in stock compensation expensesrelated to the issuance of stock options.

 

18

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**Stock-BasedCompensation costs**

 

Prior to October 1, 2005, the Company accounted for employee stockoption plans based on the intrinsic value method in accordance with AccountingPrinciples Board   (APB) Opinion No. 25, *“ Accounting for Stock Issued to Employees,”*and related  Interpretations and hadadopted 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 ofthe Company’s stock at the grant  dateover the amount an employee must pay to acquire the stock. The Company    granted stock options with exercise pricesequal 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.

 

In December 2004, the Financial Accounting Standards Board (FASB)issued SFAS  No. 123R, *“ Share-Based Payments”* to require thatcompensation cost relating to  share-basedpayment arrangements be recognized in the financial statements. EffectiveOctober 1, 2005, the Company adopted SFAS No. 123R using the modifiedprospective method, which requires measurement of compensation cost for allstock-based awards at fair value on date of grant and recognition ofcompensation over the  service period forawards expected to vest. Therefore, prior period financial statements have notbeen restated. The fair value of stock options were determined using theBlack-Scholes valuation model, which is consistent with our valuationtechniques previously utilized for stock options in footnote disclosuresrequired under SFAS No. 123. Such fair value is recognized as expense over theservice period, net of estimated forfeitures. The adoption of SFAS No.123R resulted in no cumulativechange in  accounting as of the date ofadoption.

 

Reflected in operating expenses for the three months ended December 31,2005 was $67,601 charged to sales, general and administrative and $33,277charged to research and development expenses for a total of  $100,878 in stock compensation expenserelated to the issuance of stock options.

 

**Otherincome (expense)**

 

Net other income for the three months ended December 31, 2005  was $6,170 compared to net other expense of $7,089 for the three months ended December 31, 2004 as detailed below:

 

 
| ** **                                      | ** ** | **Three months ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                                | ** ** | **2004** | ** ** |
| **Interest income**                             | ** ** | **5,206**                                               | ** ** | **1,511** | ** ** |
| **Foreign currency transaction gains (losses)** | ** ** | **964**                                                 | ** ** | **(8,600** | **)** |
| **Total other income (expense)**                | ** ** | **$**                                                   | **6,170**  | ** ** | **$** | **(7,089** | **)** |
|                                                 |            |                                                         |            |  |  |  |  |

 

19

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**Re-measurement  of accountsdenominated in currencies other than the Euro**

 

We follow  the rules  prescribed in paragraph 16 of SFAS 52 “ForeignCurrency Translation”, which states that accounts denominated in a currencyother than an entities functional currency, excluding inter-company accountswhich are long term in nature,  need tobe re-measured into the entities functional currency, and any gain or loss fromthis re-measurement are included in the determination of net income  and are booked as other income (loss)section  under  the description foreign currency transactiongains (losses).

 

**Accumulatedother comprehensive income (loss)**

** **

The Euro is the functional currency ofour  European subsidiary, HauppaugeDigital Europe  Sarl. Assets andliabilities of this subsidiary are translated to U.S. Dollars at the exchangerate in effect at the end of  eachreporting period, while equity accounts are translated to U.S. Dollars at thehistorical rate in effect at the date of the contribution. Operating resultsare translated  to U.S. Dollars at theaverage prevailing exchange rate for the period, with the exception of  sales which are translated to U.S. Dollars at the average monthly forward exchangecontract rate. The use of differing exchange rates results in foreign currencytranslation gains or losses. Since the Euro denominated  accounts on HDE Sarl’s  books result in a net asset position  (total Euro assets are in excess of Euro  liabilities),an  increase in the Euro value results ina deferred gain while a decrease in the Euro value results in a deferred lossfor the translation of   Euro accounts toU.S. Dollars. We had a translation gain of $546,352 recorded on the balancesheet  as of September 30, 2005. For thethree months ended December 31, 2005, we recorded on the balance sheettranslation losses of  $743,271 resultingin a translation loss of $196,919 recorded as a component of accumulated othercomprehensive (loss) as of  December 31,2005.

 

We use forward exchange contracts to reduceour exposure to fluctuations in foreign currencies. Mark to market gains andlosses on these open contracts  resultfrom the difference between the USD value of our open foreign currency forward contractsat the average contract rate as opposed to the same contracts translated at themonth end forward rate. We qualify for cash flow hedge accounting as prescribed under SFAS 133, which allows us to record the mark to market gains andlosses in the equity section of our balance sheet under accumulated othercomprehensive income. We had  mark tomarket losses of $136,418  recorded onthe balance sheet  as of September 30,2005. For the three months ended December 31, 2005, we recorded, as component ofother comprehensive income, a mark to market loss of  $104,138, resulting in a mark to market gainof $32,280  for  contracts open as of  December 31, 2005.

 

As stated above,  accumulatedother comprehensive income (loss) consists of two components:

 

•                                          Translations gains and losses

 

•                                          FAS 133 mark to market gains and losses  on our open foreign exchange contracts

 

20

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The table below  details thegains and losses recorded  for thecomponents that make up accumulated other comprehensive  income (loss):

 
| **Accumulated other comprehensive income (loss)** | ** ** | **Balance as of  Sept. 30, 2005** | ** **  | **Oct. 2005 to Dec. 31  2005 losses** | ** ** | **Balance as of  Dec. 31, 2005** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------------------|-------------|----------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **Translation gains**                                                 | ** ** | **$**                                                 | **546,352** | ** **                                                     | **$**      | **(743,271**                                         | **)**      | **$** | **(196,919** | **)** |
| **FAS 133 mark to market  adjustments**                               | ** ** | **136,418**                                           | ** **  | **(104,138**                                                   | **)**      | **32,280**                                           | ** ** |
| ** **                                                            | ** ** | **$**                                                 | **682,770** | ** **                                                     | **$**      | **(847,409**                                         | **)**      | **$** | **(164,639** | **)** |

 

**Taxprovision**

 

Our net tax provision  for thethree months  ended  December 31, 2005 and 2004 is as follows:

 
| ** **                                 | ** ** | **Three months ended December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                                | ** ** | **2004** | ** ** |
| **AMT Tax attributable to U.S operations** | ** ** | **$**                                                   | **10,000** | ** ** | **$** | **10,000** | ** ** |
| **Tax expense European operations**        | ** ** | **27,411**                                              | ** ** | **41,000** | ** ** |
| **State taxes**                            | ** ** | **5,000**                                               | ** ** | **5,000** | ** ** |
| **Net tax provision**                      | ** ** | **$**                                                   | **42,411** | ** ** | **$** | **56,000** | ** ** |

 

For four out of the  last fivefiscal years, our domestic operation has incurred losses. With the close of ourfiscal first quarter of 2006,  weanalyzed the future realization of our deferred tax assets as of December 31, 2005,  and althoughour domestic operation reported a profit for the three months ended December  31, 2005, due to the seasonal nature of the business it is uncertain at this timewhether our  domestic operation will havea profit for the full year. In light of this, we did not make any  adjustments to our  valuation allowance for the  quarter ended December 31, 2005.

 

As a result of all of the above items mentioned in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations,  we recorded net income of  $1,020,472, for thethree  months ended December 31, 2005,which resulted in basic net income per share of $0.11  and diluted net income per share of$0.10  on weighted average basic  and diluted shares of 9,508,100 and  10,015,547, respectively, compared to a netincome of $1,263,689 for the three months ended December 31, 2004, whichresulted in  basic net income per shareof $0.14  and diluted net income pershare of $0.13 on weighted average  basicand diluted shares of 9,277,944 and 9,949,381, respectively.

 

Options to purchase 92,876 and 98,757 shares of common stock, at pricesranging $3.88 to $ 8.75 and $5.25 to $10.06, were outstanding for the threemonths ended December 31, 2005 and 2004, respectively, but were not included inthe computation of diluted earnings per share because they were anti-dilutive.

 

21

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**Seasonality**

 

As our sales are primarily to the consumer market, we have experiencedcertain seasonal revenue trends. Our peak sales quarter, due to holiday seasonsales of computer equipment, is our first fiscal quarter (October to December),followed by our fourth fiscal quarter (July to September). In addition, ourinternational sales, mostly in the European, market, were 54%, 66% and 68 % ofsales for the years ended September 30, 2005, 2004 and 2003, respectively. Our fiscal fourth quarter sales (Julyto September) can be potentially impacted by the reduction of activityexperienced in Europe during the July and August summer holiday period.

 

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

 

**Liquidityand Capital Resources**

 

Our cash, working capital and stockholders’ equity position as of  December 31, 2005 and September 30, 2005 is set forth below:

 
| ** **                    | ** ** | **December 31, 2005** | ** **    | **September 30, 2005** | ** ** |
|-------------------------------|------------|---------------------------------|---------------|----------------------------------|------------|
|                          |       |                            |          |                             |       |
| **Cash**                      | ** ** | **$**                           | **6,192,989** | ** **                       | **$**      | **7,567,393** | ** ** |
| **Working Capital**           | ** ** | **15,637,754**                  | ** **    | **15,334,855**                   | ** ** |
| **Stockholders’ Equity** | ** ** | **16,239,514**                  | ** **    | **15,941,492**                   | ** ** |
|                               |            |                                 |               |                                  |            |  |  |

 

We had cash and cash equivalents as of  December 31, 2005 of  $6,192,989, a decrease  of $1,374,404 from September 30, 2005.

 

22

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The decrease  in cash was due to:

 
| Sources of cash:                                       | ** ** | ** ** | ** ** |
|--------------------------------------------------------|------------|------------|------------|
| Net income  adjusted for non cash items                |       | $          | 1,167,807  |   |
| Increase in accounts payable and accrued  expenses     |       | 6,300,229  |       |
| Decrease in prepaid expenses and other  current assets |       | 50,401     |       |
| Proceeds from employee stock purchases                 |       | 24,081     |       |
| Less cash used for:                                    | ** ** | ** ** | ** ** |
| Increase in account receivables                        |       | (7,436,483 | )          |
| Effect of exchange rates on cash                       |       | (847,409   | )          |
| Increase in inventories                                |       | (591,450   | )          |
| Capital equipment purchases                            |       | (41,580    | )          |
| Net cash decrease                                      |       | $          | (1,374 404 | ) |

 

Net cash of $509,496 used in operating activities was primarily due to a increases in accountsreceivable and  inventory    of $7,436,483 and $591,450, respectively,required to fund the 51.7% increase in sales between the fourth  quarter of fiscal 2005 and the first quarter of fiscal 2006. These uses of cashwere offset by increases in accounts payable and accrued expenses  of $6,300,229, primarily used to finance the growth in accounts receivable and inventory,   decreases in prepaid expenses and othercurrent assets of $50,401 and  net incomeadjusted for non cash items of $1,167,807.

 

Cash of $41,580 was used to purchase fixed assets. Proceeds from thestock purchased by employees through  theexercise of options and the  employeestock purchase plan  provided  cash of $24,081 and the effect of  exchange rates used cash of $847,409.

 

On November 8, 1996, we approved a stock repurchase program. Theprogram, as amended, authorizes us to repurchase up to 850,000 shares of ourown stock. We intend to use the repurchased shares for certain employee benefitprograms. On December 17, 1997, the stock repurchase program was extended by aresolution of our Board of Directors. As of December 31, 2005, we held 607,547treasury shares purchased for $1,757,951 at an average purchase price ofapproximately $2.89 per share.

 

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**Line of Credit**

 

On December 1, 2005, Hauppauge Computer Works, Inc. (“HCW”), awholly-owned subsidiary of Hauppauge Digital, Inc. (the “Company”), enteredinto a $3,000,000  line of creditborrowing facility with the  JP MorganChase Bank, N.A. (the “Bank”). The line of credit is subject to renewal on March31, 2006. 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 theBank  and has entered into a Share Pledge Agreement among the Company, the Bankand Hauppauge Digital Europe S.àr.l., a wholly owned subsidiary of the Company.

 

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

 

Pursuant to the Share Pledge Agreement, the Company granted a firstpriority right of pledge on approximately two-thirds of the outstanding capitalshares of Digital Europe in favor of the Bank as security for the payment underthe Note or the Share Pledge Agreement.

 

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

 

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

 

**FutureContractual  Obligations**

 

The following table shows our contractual obligations related to leaseobligations as of  December 31 , 2005:

 
| ** **                      | ** ** | **Payments due by period** | ** **    |
|---------------------------------|------------|-------------------------------------------|---------------|
| ** **                      | ** ** | **Total**                                 | ** **    | **Less than 1 year** | ** ** | **1-3 years** | ** ** | **3 to 5 years** | ** ** |
| **Operating lease obligations** | ** ** | **$**                                     | **1,283,295** | ** ** | **$** | **506,222** | ** ** | **$** | **642,073** | ** ** | **$** | **135,000** | ** ** |
|                                 |            |                                           |               |  |  |  |  |  |  |  |  |  |  |

 

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**CriticalAccounting Policies and Estimates**

 

We believe the following critical accounting policies affect thesignificant judgments and estimates used in the preparation of the ourfinancial statements:

 

•                                          Revenue Recognition

 

•                                          Management’s estimates

 

•                                          Hedging program for European subsidiary inventorypurchases denominated in U.S. dollars

 

•                                          Translation of assets and liabilities  denominated in  non functional currencies on our Europeanfinancial statements

 

**RevenueRecognition**

 

Our revenues are primarily derived from the sale of computer boardswhich enable you to view television programs on your personal computer. Salesof computer boards are commonly classified as computer hardware. Our sales areprimarily to retailers, distributors and original equipment manufacturers. Salesto our customers are documented by a purchase order which describes theconditions of sale. Sales are recorded when products are shipped  to our customers, the product price is fixed and determinable, collection of the resulting receivable isprobable and product returns are reasonably estimable. Revenue from freightcharged to customers is recognized when products are shipped. Provisionsfor  customer returns and otheradjustments are provided for in the period the related sales are recorded basedupon historical data.

 

**Management’sEstimates**

 

The discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires  management to make estimates and judgmentsthat affect the reported amounts of assets, liabilities  and related disclosure of contingent assetsand liabilities at the date of the consolidated financial statements and thereported amounts for  revenues andexpenses during the reporting period. On an ongoing basis, management evaluatesestimates, including those related to sales provisions, as described above,income taxes, bad debts, inventory reserves and contingencies. We base  ourestimates on historical data, when available, experience, and on various otherassumptions that are believed to be reasonable under the circumstances, thecombined results of which form the basis for making judgmentsapproximating   the carrying values ofassets and liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates.

 

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**Hedgingprogram for sales denominated in a foreign currency**

 

For each of the past three fiscal years, at least 50 % of  our sales were generated by our Europeansubsidiary and were:

 

•                                          Invoiced in local currency-primarily the Euro

 

•                                          Collected in local currency-primarily the Euro

 

On the supply side, since we predominantly deal with North American andAsian suppliers and contract manufacturers, approximately 75% of our inventoryrequired to support our European sales are purchased and paid in U.S. Dollars.

 

The combination of sales billed in Euros supported by inventorypurchased in U.S. dollars results in an absence of a natural local currencyhedge. Consequently, our financial results are subject to market risksresulting from the fluctuations in the Euro to  U.S. Dollar exchange rates.

 

We attempt to reduce these risks by entering into foreign exchangeforward contracts with financial institutions. The purpose of these forwardcontracts is to hedge the foreign currency market exposures underlying the U.S.Dollar denominated inventory purchases required  to support our Europeansales.

 

We do not try to hedge against all possible foreign currency exposuresbecause of the inherent difficulty in estimating   the volatility of the Euro. The contracts weprocure are specifically entered into to as a hedge against forecasted or  existing or foreign currency exposure. We do not enter into contracts forspeculative purposes. Although we maintain these programs to reduce the shortterm impact of changes in currency exchange rates,  long term strengthening or weakening of theU.S. dollar  against the Euroimpacts  our  sales, our gross profit, operating income andretained earnings. Factors that could impact the effectiveness of our hedging programare:

 

•                                          volatility of the currency markets

 

•                                          availability of hedging instruments

 

•                                          accuracy of our inventory forecasts

 

26

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Additionally, there is the risk that foreign exchange fluctuations willmake our products less competitive in foreign markets, which wouldsubstantially reduce our sales.

 

**Translation  of assets and liabilities denominated in nonfunctional currencies on our European financial statements**

** **

The functional currency of our European subsidiary is the Euro. Inpreparing our consolidated  financialstatements,  we are required totranslate  assets and liabilitiesdenominated in a non functional currency, mainly U.S. Dollars,  to Euros onthe books of our European subsidiary. This process results in exchange gainsand losses  depending on the changes inthe Euro to U.S. Dollar exchange rate. Under the relevant accounting guidance,with the exception of gains and losses that are attributable to inter-companyaccounts which are long term in nature, we are obligated to include these gains and losses on our  statement of operations, which  we report in other income or expense under  the description “foreign currency”. Theextent of these gains and losses can fluctuate greatly from month to month depending on the change in the exchangerate, causing results to vary widely. Due to the  past  volatility of the Euro, it is difficult toforecast the long term trend of these gains and losses.

 

**Inflation**

** **

While inflation has not had a material effect on our operations in thepast, there can be no assurance that we will be able to continue to offset theeffects of inflation on the costs of our products or services through priceincreases to our customers without experiencing a reduction in the demand forour products; or that inflation will not have an overall effect on the computerequipment market that would have a material affect on us.

 

**Euro**

** **

On January 1, 1999, the Euro was adopted in Europe as the common legalcurrency among 11 of the 15 member countries of the European Community. On thatdate, the participating countries established fixed Euro conversion rates (i.e.the conversion exchange rate between their existing currencies and the Euro). TheEuro now trades on currency exchanges and is available for non-cashtransactions. A new European Central Bank was established to direct monetarypolicy for the participating countries.

 

27

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Prior to the adoption of the Euro, we billed our European customers inGerman Marks or British Pounds, depending upon which currency the customerpreferred to be billed in. Effective January 1, 1999, we began invoicing ourcustomers who are located in the eleven member countries in Euros. We continueto bill customers located in the United Kingdom in British Pounds. The benefitsto billing customers in Euros were twofold:

 

•                                          Our foreign currency hedging program was streamlinedto the Euro and the British Pound

 

•                                          The pricing from country to country was harmonized,eliminating price differences between countries due to the fluctuating localcurrencies

 

We handled the conversion to the Euro without any material disruptionsto our operations.

 

**Item  3. Quantitative and Qualitative Disclosuresabout Market Risks**

 

For each of the past three fiscal years, at least 50 % of our saleswere generated by our European subsidiary and were:

 

•                                          Invoiced in local currency-primarily the Euro

 

•                                          Collected in local currency-primarily theEuro

 

On the supply side, since we predominantly deal with North American andAsian suppliers and contract manufacturers, approximately  75% of ourinventory required to support  ourEuropean sales are purchased and paid in U.S. Dollars.

 

The combination of sales billed in Euros supported by inventory purchasedin U.S. dollars results in an absence of a natural local currency hedge.Consequently, our financial results are subject to market risks resulting fromthe fluctuations in the Euro  to  U.S. Dollar exchange rates.

 

We attempt to reduce these risks by entering into foreign exchangeforward contracts with financial institutions. The purpose of these forwardcontracts is to hedge the foreign currency market exposures underlying the U.S.Dollar denominated inventory purchases required  to support our Europeansales.

 

We do not try to hedge against all possible foreign currency exposuresbecause of the inherent difficulty in estimating   the volatility of the Euro. The contracts weprocure are specifically entered into to as a hedge against forecasted or  existing or foreign currency exposure. We do not enter into contracts forspeculative purposes. Although we maintain these programs

 

28

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to reduce the short term impact of changes in currency exchangerates,  long term strengthening orweakening of the U.S. dollar  against theEuro impacts  our  sales, our gross profit, operating income andretained earnings. Factors that could impact the effectiveness of our hedgingprogram are:

 

•                                          volatility of the currency markets

 

•                                          availability of hedging instruments

 

•                                          accuracy of our inventory forecasts

 

Additionally, there is the risk that foreign exchange fluctuations willmake our products less competitive in foreign markets, which wouldsubstantially reduce our sales.

 

As of December 31, 2005, the we had foreign currency contractsoutstanding of approximately $1,928,150 against the delivery of the Euro. Thecontracts expire from January 2006 through February 2006. Our  accounting policy for these instrumentsdesignate such instruments as cash flow hedging transactions. We do not enterinto such contracts for speculative purposes. We record all derivative gainsand losses on the balance sheet as a component of stockholders’ equity underthe caption “Accumulated other comprehensive income (loss)”. We recorded a  loss of $104,138 for the three  monthsended December 31, 2005 on our statement of other comprehensive income. Asof  December 31,  2005, a deferred gain of $32,280 reflectingthe cumulative  mark to market gains ofour derivatives was recorded on the Company’s balance sheet as a component ofaccumulated other comprehensive income in our equity section.

 

We  use the average monthlyforward contract exchange rate to translate our Euro denominated sales into theCompany’s U.S. dollar reporting currency. For the three months ended  December 31, 2005, the use of the monthlyaverage spot rate instead of the average monthly forward contract exchangerate to value Euro denominated sales would have resulted in a decreasein sales of $628,789 for the three months ended December 31, 2005. These  sales increases  are related to contracts that closed duringthese periods and the changes in the fair value of our derivativecontracts.  For the three months ended  December 31, 2004, the useof the monthly average spot rate instead of the average monthly forwardcontract exchange rate to value Euro denominated sales would have resultedin a sales increase of $640,815.

 

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## **Item 4. Controls andProcedures**

 

Our Chief Executive Officer and Chief Financial Officer conducted anevaluation of the effectiveness of our disclosure controls and procedures. Basedon this evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective as of  December 31, 2005 in alerting them in atimely manner to material information required to be included in our SECreports. In addition, no change in our internal control over financial reportingoccurred during the fiscal quarter ended December 31, 2005 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**SpecialNote Regarding Forward Looking Statements**

** **

This Quarterly Report contains forward-looking statements as that termis defined in the federal securities laws. The events described inforward-looking statements contained in this Quarterly Report may not occur. Generallythese statements relate to business plans or strategies, projected oranticipated benefits or other consequences of our plans or strategies,projected or anticipated benefits from acquisitions to be made by us, orprojections involving anticipated revenues, earnings or other aspects of ouroperating results. The words “may,” “will,” “expect,” “believe,” “anticipated,”“project,” “plan,” “intend,” “estimate,” and “continue,” and their oppositesand similar expressions are intended to identify forward-looking statements. Wecaution you that these statements are not guarantees of future performance orevents 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 Form10-K for the year ended September 30, 2005), many of which are beyond ourcontrol, that may influence the accuracy of the statements and the projectionsupon which the statements are based. Any one or more of these uncertainties,risks and other influences could materially affect our results of operations andwhether forward looking statements made by us ultimately prove to be accurate. Ouractual results, performance and achievements could differ materially from thoseexpressed or implied in these forward-looking statements. We undertake noobligation to publicly update or revise any forward-looking statements, whetherfrom new information, future events or otherwise. All cautionary statementsmade in this Annual Report should be read as being applicable to all relatedforward-looking statements wherever they appear.

 

## **PARTII. OTHER INFORMATION**

 

**Item 2. UnregisteredSales of Equity Securities and Use of Proceeds**

 

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

 

30

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The table below summarized repurchases of our common stock under ourstock repurchase program:

 
| ** **                          | ** ** | ** **         | ** ** | ** **        | ** ** | ** **                     | ** ** | **Maximum**                  | ** ** |
|-------------------------------------|------------|--------------------|------------|-------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                          | ** ** | ** **         | ** ** | ** **        | ** ** | **Total Number**          | ** ** | **Number**                   | ** ** |
| ** **                          | ** ** | **Total**          | ** ** | **Average**       | ** ** | **of Shares**             | ** ** | **of Shares**           | ** ** |
| ** **                          | ** ** | **Number**         | ** ** | **Price**         | ** ** | **Purchased as**          | ** ** | **that May Yet**   | ** ** |
| ** **                          | ** ** | **of Shares** | ** ** | **Paid per** | ** ** | **Part of Publicly** | ** ** | **Be Purchased**        | ** ** |
| **Period**                          | ** ** | **Purchased**      | ** ** | **Share**         | ** ** | **Announced Plan**        | ** ** | **Under the Plan** | ** ** |
| Purchases as of September 30,  2005 |       | 607,547            |       | $                 | 2.89       |                           | 607,547    |                         | 242,453    |   |
| October 1 to December 31, 2005      |       | -0-                |       | -0-               |       | -0-                            |       | -0-                          |       |
| Purchases as of December 31,  2005  |       | 607,547            |       | $                 | 2.89       |                           | 607,547    |                         | 242,453    |   |

 

**Item 6. Exhibits**

** **

**(c)Exhibits**

** **

31.1 Certification of Chief Executive Officer pursuant to Rule13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

31.2 Certification of the Chief Financial Officer pursuant to Rule13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

32   Certification of ChiefExecutive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

31

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**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 theundersigned thereunto duly authorized.

 

 
| HAUPPAUGE  DIGITAL INC. |              |
|-------------------------|-------------------|
| Registrant              |              |
|                    |              |
|                    |              |
| Date:                   | February 14, 2006 |   |   | By | /s/ Kenneth Plotkin |   |
|                    | KENNETH PLOTKIN   |
|                    |              | Chief Executive Officer, Chairman of the Board, Vice |
|                    |              | President of Marketing (Principal Executive  Officer) |
|                    |              | and Director |
|                    |              |
|                    |              |
| Date:                   | February 14, 2006 |   |   | By | /s/ Gerald Tucciarone |   |
|                    |              | GERALD TUCCIARONE |
|                    |              | Treasurer, Chief Financial Officer and  Secretary |
|                         |                   |  |  |  |  |  |  |

 

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