**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 endedJune 30, 2005**

 

**OR**

 

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

 

**For the transition period from             to            **

 

**Commissionfile number     1-13550**

 

**HAUPPAUGE DIGITAL, INC.**

(Exact name ofregistrant as specified in its charter)

 
| **Delaware**                                               | ** ** | **11-3227864**       |
|------------------------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of                           |       | (I.R.S. Employer     |
| incorporation or  organization)                            |       | Identification  No.) |
| ** **                                                 | ** ** | ** **           |
| **91  Cabot Court, Hauppauge, New York 11788**             |
| (Address of  principal executive offices)                  |
|                                                       |       |                 |
| **(631)  434-1600**                                        |
| (Registrant’s  telephone number, including area code) |

 

**Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.**

 

**Yes  ****ý       No  ****o**

 

**Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act)**

 

**Yes  ****o       No  ****ý**

 

**As of August 8, 2005,9,499,669 shares of .01 par value Common Stock of the registrant wereoutstanding, not including treasury shares.**

 

 

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

## **INDEX**

 
| **PART I. FINANCIAL INFORMATION**                                                                                                                        | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                               | ** ** |
| **Item 1. Financial Statements**                                                                                                                         | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Condensed  Consolidated Balance Sheets -  June 30, 2005 (unaudited) and September 30, 2004 (audited)**                                       | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Condensed  Consolidated Statements of Income -  Three Months ended June 30, 2005 (unaudited) and 2004 (unaudited)**                               | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Condensed Consolidated  Statements of Income -  Nine Months ended June 30, 2005 (unaudited) and 2004 (unaudited)**                                | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Condensed  Consolidated Statements of Other Comprehensive Income -  Three and nine months ended June 30, 2005 (unaudited) and 2004  (unaudited)** | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Condensed  Consolidated Statements of Cash Flows -  Nine Months ended June 30, 2005 (unaudited) and 2004 (unaudited)**                            | ** ** |
|                                                                                                                                                     |       |
| **Notes  to Condensed Consolidated Financial Statements**                                                                                                | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations**                                                 | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Item  3. Quantitative and Qualitative Disclosures about Market Risks**                                                                                 | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Item  4. Controls and Procedures**                                                                                                                     | ** ** |
|                                                                                                                                                     |       |
| **PART II.  OTHER INFORMATION**                                                                                                                     | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Item  2. Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                                | ** ** |
| ** **                                                                                                                                               | ** ** |
| **Item  6. Exhibits**                                                                                                                                    | ** ** |
|                                                                                                                                                     |       |
| **SIGNATURES**                                                                                                                                           | ** ** |

 

2

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## **PART I. FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**HAUPPAUGEDIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                     | ** ** | **June 30, 2005** | ** **     | **September 30, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------|----------------|-----------------------------|------------|
| ** **                                                                                                     | ** ** | **(unaudited)**        | ** **     | **(audited)**               | ** ** |
| **Assets:**                                                                                                    |       |                   |           |                        |       |
| ** **                                                                                                     |       |                   |           |                        |       |
| **Current Assets:**                                                                                            | ** ** | ** **             | ** **     | ** **                  | ** ** |
| **Cash and cash equivalents**                                                                                  | ** ** | **$**                  | **7,448,615**  | ** **                  | **$**      | **8,661,589** | ** ** |
| **Receivables, net of various allowances**                                                                     | ** ** | **12,745,618**         | ** **     | **13,593,907**              | ** ** |
| **Inventories**                                                                                                | ** ** | **11,583,911**         | ** **     | **8,477,254**               | ** ** |
| **Prepaid expenses and other current assets**                                                                  | ** ** | **1,249,053**          | ** **     | **770,745**                 | ** ** |
| **Total current assets**                                                                                       | ** ** | **33,027,197**         | ** **     | **31,503,495**              | ** ** |
|                                                                                                           |       |                   |           |                        |       |
| **Property, plant and equipment, net**                                                                         | ** ** | **554,565**            | ** **     | **489,370**                 | ** ** |
| **Security deposits and other non current assets**                                                             | ** ** | **80,332**             | ** **     | **77,934**                  | ** ** |
| ** **                                                                                                     | ** ** | **$**                  | **33,662,094** | ** **                  | **$**      | **32,070,799** | ** ** |
| ** **                                                                                                     | ** ** | ** **             | ** **     | ** **                  | ** ** |
| **Liabilities and Stockholders’ Equity :**                                                                | ** ** | ** **             | ** **     | ** **                  | ** ** |
| ** **                                                                                                     | ** ** | ** **             | ** **     | ** **                  | ** ** |
| **Current Liabilities:**                                                                                       | ** ** | ** **             | ** **     | ** **                  | ** ** |
| **Accounts payable**                                                                                           | ** ** | **$**                  | **11,343,991** | ** **                  | **$**      | **13,243,966** | ** ** |
| **Accrued expenses**                                                                                           | ** ** | **4,926,167**          | ** **     | **4,256,970**               | ** ** |
| **Income taxes payable**                                                                                       | ** ** | **182,516**            | ** **     | **242,438**                 | ** ** |
| **Total current liabilities**                                                                                  | ** ** | **16,452,674**         | ** **     | **17,743,374**              | ** ** |
| ** **                                                                                                     | ** ** | ** **             | ** **     | ** **                  | ** ** |
| **Stockholders’ Equity:**                                                                                 | ** ** | ** **             | ** **     | ** **                  | ** ** |
| **Common  stock $.01 par value; 25,000,000 shares authorized, 10,102,078 and 9,759,465  issued, respectively** | ** ** | **101,021**            | ** **     | **97,595**                  | ** ** |
| **Additional paid-in capital**                                                                                 | ** ** | **13,586,609**         | ** **     | **12,913,497**              | ** ** |
| **Retained earnings**                                                                                          | ** ** | **4,176,259**          | ** **     | **1,925,135**               | ** ** |
| **Accumulated other comprehensive income**                                                                     | ** ** | **1,102,433**          | ** **     | **975,511**                 | ** ** |
| **Treasury Stock, at cost, 607,267 and 567,067 shares**                                                        | ** ** | **(1,756,902**         | **)**          | **(1,584,313**              | **)**      |
| **Total stockholders’ equity**                                                                            | ** ** | **17,209,420**         | ** **     | **14,327,425**              | ** ** |
| ** **                                                                                                     | ** ** | **$**                  | **33,662,094** | ** **                  | **$**      | **32,070,799** | ** ** |

 

***See accompanying notes to condensed consolidated financial statements***

 

3

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**HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

**(UNAUDITED)**

 
| ** **                                       | ** ** | **Three months ended June 30,** | ** **     |
|--------------------------------------------------|------------|--------------------------------------|----------------|
| ** **                                       | ** ** | **2005**                             | ** **     | **2004** | ** ** |
| ** **                                       | ** ** | ** **                           | ** **     | ** ** | ** ** |
| **Net sales**                                    | ** ** | **$**                                | **19,372,783** | ** ** | **$** | **13,794,292** | ** ** |
| **Cost of sales**                                | ** ** | **14,980,624**                       | ** **     | **10,236,138** | ** ** |
| **Gross profit**                                 | ** ** | **4,392,159**                        | ** **     | **3,558,154** | ** ** |
| ** **                                       | ** ** | ** **                           | ** **     | ** ** | ** ** |
| **Selling, general and administrative expenses** | ** ** | **3,582,726**                        | ** **     | **2,928,064** | ** ** |
| **Research & development expenses**     | ** ** | **655,588**                          | ** **     | **512,606** | ** ** |
| **Litigation proceeding**                        | ** ** | **—**                           | ** **     | **(73,000** | **)** |
| **Income from operations**                       | ** ** | **153,845**                          | ** **     | **190,484** | ** ** |
| ** **                                       | ** ** | ** **                           | ** **     | ** ** | ** ** |
| **Other Income:**                                | ** ** | ** **                           | ** **     | ** ** | ** ** |
| **Interest income**                              | ** ** | **3,366**                            | ** **     | **1,237** | ** ** |
| **Foreign currency**                             | ** ** | **19,917**                           | ** **     | **60** | ** ** |
| **Other income**                                 | ** ** | **23,283**                           | ** **     | **1,297** | ** ** |
| **Income before taxes on income**                | ** ** | **177,128**                          | ** **     | **191,781** | ** ** |
| **Tax provision**                                | ** ** | **17,156**                           | ** **     | **23,144** | ** ** |
| **Net income**                                   | ** ** | **$**                                | **159,972**    | ** ** | **$** | **168,637** | ** ** |
| ** **                                       | ** ** | ** **                           | ** **     | ** ** | ** ** |
| **Net income per share:**                        | ** ** | ** **                           | ** **     | ** ** | ** ** |
| **Basic**                                        | ** ** | **$**                                | **0.02**       | ** ** | **$** | **0.02** | ** ** |
| **Diluted**                                      | ** ** | **$**                                | **0.02**       | ** ** | **$** | **0.02** | ** ** |

 

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

 

4

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**HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**(UNAUDITED)**

 
| ** **                                       | ** ** | **Nine months ended June 30,** | ** **     |
|--------------------------------------------------|------------|-------------------------------------|----------------|
| ** **                                       | ** ** | **2005**                            | ** **     | **2004** | ** ** |
| ** **                                       | ** ** | ** **                          | ** **     | ** ** | ** ** |
| **Net sales**                                    | ** ** | **$**                               | **63,095,519** | ** ** | **$** | **48,828,873** | ** ** |
| **Cost of sales**                                | ** ** | **48,572,102**                      | ** **     | **35,758,126** | ** ** |
| **Gross profit**                                 | ** ** | **14,523,417**                      | ** **     | **13,070,747** | ** ** |
| ** **                                       | ** ** | ** **                          | ** **     | ** ** | ** ** |
| **Selling, general and administrative expenses** | ** ** | **10,336,598**                      | ** **     | **9,272,449** | ** ** |
| **Research & development expenses**     | ** ** | **1,844,555**                       | ** **     | **1,367,270** | ** ** |
| **Arbitration proceeding**                       | ** ** | **—**                          | ** **     | **206,250** | ** ** |
| **Litigation proceeding**                        | ** ** | **—**                          | ** **     | **427,000** | ** ** |
| **Income from operations**                       | ** ** | **2,342,264**                       | ** **     | **1,797,778** | ** ** |
| ** **                                       | ** ** | ** **                          | ** **     | ** ** | ** ** |
| **Other Income :**                               | ** ** | ** **                          | ** **     | ** ** | ** ** |
| **Interest income**                              | ** ** | **8,027**                           | ** **     | **4,373** | ** ** |
| **Foreign currency**                             | ** ** | **18,989**                          | ** **     | **21,959** | ** ** |
| **Other Income**                                 | ** ** | **27,016**                          | ** **     | **26,332** | ** ** |
| **Income before taxes on income**                | ** ** | **2,369,280**                       | ** **     | **1,824,110** | ** ** |
| **Tax provision**                                | ** ** | **118,156**                         | ** **     | **118,223** | ** ** |
| **Net income**                                   | ** ** | **$**                               | **2,251,124**  | ** ** | **$** | **1,705,887** | ** ** |
| ** **                                       | ** ** | ** **                          | ** **     | ** ** | ** ** |
| **Net income per share:**                        | ** ** | ** **                          | ** **     | ** ** | ** ** |
| **Basic**                                        | ** ** | **$**                               | **0.24**       | ** ** | **$** | **0.19** | ** ** |
| **Diluted**                                      | ** ** | **$**                               | **0.23**       | ** ** | **$** | **0.18** | ** ** |

 

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

 

5

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**HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME**

**(UNAUDITED)**

 
| ** **                                       | ** ** | **Three months ended June 30****,** | ** **   |
|--------------------------------------------------|------------|------------------------------------------|--------------|
| ** **                                       | ** ** | **2005**                                 | ** **   | **2004** | ** ** |
| **Net  income**                                  | ** ** | **$**                                    | **159,972**  | ** ** | **$** | **168,637** | ** ** |
| **Forward  exchange contracts marked to market** | ** ** | **182,258**                              | ** **   | **26,138** | ** ** |
| **Foreign  currency translation (loss)**         | ** ** | **(528,645**                             | **)**        | **(241,751** | **)** |
| **Other  comprehensive (loss)**                  | ** ** | **$**                                    | **(186,415** | **)** | **$** | **(46,976** | **)** |

 
| ** **                                       | ** ** | **Nine months ended June 30****,** | ** **    |
|--------------------------------------------------|------------|-----------------------------------------|---------------|
| ** **                                       | ** ** | **2005**                                | ** **    | **2004** | ** ** |
| **Net  income**                                  | ** ** | **$**                                   | **2,251,124** | ** ** | **$** | **1,705,887** | ** ** |
| **Forward  exchange contracts marked to market** | ** ** | **308,767**                             | ** **    | **214,116** | ** ** |
| **Foreign  currency translation gain (loss)**    | ** ** | **(181,845**                            | **)**         | **466,131** | ** ** |
| **Other  comprehensive income**                  | ** ** | **$**                                   | **2,378,046** | ** ** | **$** | **2,386,134** | ** ** |

 

***See accompanying notes to condensed consolidated financial statements***

 

6

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**HAUPPAUGE DIGITAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Nine months ended June 30,** | ** **    |
|------------------------------------------------------------------------------------|------------|-------------------------------------|---------------|
| ** **                                                                         | ** ** | **2005**                            | ** **    | **2004** | ** ** |
| **  Net income**                                                              | ** ** | **$**                               | **2,251,124** | ** ** | **$** | **1,705,887** | ** ** |
| **Adjustments to reconcile net income to net cash used in operating  activities:** | ** ** | ** **                          | ** **    | ** ** | ** ** |
| **Depreciation and amortization**                                                  | ** ** | **163,362**                         | ** **    | **181,441** | ** ** |
| **Other non cash items**                                                           | ** ** | **(2,398**                          | **)**         | **11,541** | ** ** |
| **  Changes in current assets and  liabilities:**                             | ** ** | ** **                          | ** **    | ** ** | ** ** |
| **Accounts receivable**                                                            | ** ** | **975,211**                         | ** **    | **2,815,438** | ** ** |
| **Inventories**                                                                    | ** ** | **(3,106,657**                      | **)**         | **(2,044,649** | **)** |
| **Prepaid expenses and other current assets**                                      | ** ** | **(478,308**                        | **)**         | **(246,501** | **)** |
| **Accounts payable and other current liabilities**                                 | ** ** | **(1,290,700**                      | **)**         | **785,137** | ** ** |
| **Total adjustments**                                                              | ** ** | **(3,739,490**                      | **)**         | **1,502,407** | ** ** |
| **  Net cash (used in) provided  by operating activities**                    | ** ** | **(1,488,366**                      | **)**         | **3,208,294** | ** ** |
| ** **                                                                         | ** ** | ** **                          | ** **    | ** ** | ** ** |
| **Cash Flows From Investing Activities:**                                          | ** ** | ** **                          | ** **    | ** ** | ** ** |
| **Purchases of property, plant and equipment**                                     | ** ** | **(228,557**                        | **)**         | **(77,165** | **)** |
| **Net cash used in investing activities**                                          | ** ** | **(228,557**                        | **)**         | **(77,165** | **)** |
| ** **                                                                         | ** ** | ** **                          | ** **    | ** ** | ** ** |
| **Cash Flows From Financing Activities:**                                          | ** ** | ** **                          | ** **    | ** ** | ** ** |
| **Proceeds from employee stock purchases**                                         | ** ** | **676,538**                         | ** **    | **458,363** | ** ** |
| **Purchase of treasury stock**                                                     | ** ** | **(172,589**                        | **)**         | **—** | ** ** |
| **Net cash provided by financing activities**                                      | ** ** | **503,949**                         | ** **    | **458,363** | ** ** |
| **Net (decrease) increase in cash and cash equivalents**                           | ** ** | **(1,212,974**                      | **)**         | **3,589,492** | ** ** |
| **Cash and cash equivalents, beginning of period**                                 | ** ** | **8,661,589**                       | ** **    | **5,838,160** | ** ** |
| **Cash and cash equivalents, end of period**                                       | ** ** | **$**                               | **7,448,615** | ** ** | **$** | **9,427,652** | ** ** |
| **Supplemental disclosures:**                                                      | ** ** | ** **                          | ** **    | ** ** | ** ** |
| **Income taxes paid**                                                              | ** ** | **$**                               | **171,027**   | ** ** | **$** | **85,213** | ** ** |

 

***Seeaccompanying notes to condensed consolidated financial statements***

 

7

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

###### **NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

 

**Note 1. Basis of Presentation**

 

The accompanyingunaudited condensed consolidated financial statements included herein have beenprepared in accordance with generally accepted accounting principles forinterim period reporting in conjunction with the instructions toForm 10-Q. Accordingly, these statements do not include all of the informationrequired by generally accepted accounting principles for annual financialstatements.  In the opinion ofmanagement, all known adjustments (consisting of normal recurring accruals andreserves) necessary to present fairly the Company’s consolidated financialposition, results of operations and cash flows as of and for the interimperiods have been included.  It issuggested that these interim statements be read in conjunction with thefinancial statements and related notes included in the Company’sSeptember 30, 2004 Form 10-K.

 

The operating results forthe three month and nine month periods ended June 30, 2005 are notnecessarily indicative of the results to be expected for the September 30,2005 year end.

 

**Note 2. Receivables**

 

Accounts and otherreceivables as of June 30, 2005 and September 30, 2004 consisted of :

 
| ** **                                 | ** ** | **June 30,  2005** | ** **     | **September 30,  2004** | ** ** |
|--------------------------------------------|------------|-------------------------|----------------|------------------------------|------------|
| **Trade receivables**                      | ** ** | **$**                   | **9,620,863**  | ** **                   | **$**      | **9,584,650** | ** ** |
| **Receivable from contract manufacturers** | ** ** | **5,627,108**           | ** **     | **6,568,968**                | ** ** |
| **GST and VAT taxes receivables**          | ** ** | **576,415**             | ** **     | **575,750**                  | ** ** |
| **Allowances and reserves**                | ** ** | **(3,207,000**          | **)**          | **(3,254,940**               | **)**      |
| **Other**                                  | ** ** | **128,232**             | ** **     | **119,479**                  | ** ** |
| ** **                                 | ** ** | **$**                   | **12,745,618** | ** **                   | **$**      | **13,593,907** | ** ** |

 

**Note 3. Derivative Financial Instruments**

 

For each of the pastthree fiscal years, over 60 % of the Company’s sales were generated by ourEuropean subsidiary and were:

 

•                  Invoiced in local currency-primarilythe Euro

 

•                  Collected in local currency-primarilythe Euro

 

8

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On the supply side, sincethe Company predominantly deals with North American and Asian suppliers andcontract manufacturers, approximately 75% of the Company’s inventory requiredto support the Company’s European sales are purchased and paid in U.S. Dollars.

 

The combination of salesbilled in Euros supported by inventory purchased in U.S. dollars results in anabsence of a natural local currency hedge. Consequently, the Company’sfinancial results are subject to market risks resulting from the fluctuationsin the Euro to U.S. Dollar exchange rates.

 

The Company attempts toreduce these risks by entering into foreign exchange forward contracts withfinancial institutions. The purpose of these forward contracts is to hedge theforeign currency market exposures underlying the U.S. Dollar denominatedinventory purchases required to support the Company’s European sales.

 

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

 

•                                          volatility ofthe currency markets

 

•                                          availabilityof hedging instruments

 

•                                          accuracy ofour inventory forecasts

 

Additionally, there isthe risk that foreign exchange fluctuations will make our products lesscompetitive in foreign markets, which would substantially reduce our sales.

 

As of June 30, 2005,the Company had foreign currency contracts outstanding of approximately$4,093,000 against the delivery of the Euro. The contracts expire throughNovember 2005.  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 recorded a deferred gain of$182,258 and $308,767 for the three and nine months ended June 30, 2005.  As of June 30, 2005,

 

9

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a deferred gain of$209,368 reflecting the cumulative mark to market loss of the Company’sderivatives, was recorded on the Company’s balance sheet as a component ofaccumulated other comprehensive income in our equity section.

 

The Company uses theaverage monthly forward contract exchange rate to translate our Eurodenominated sales into the Company’s U.S. dollar reporting currency. For thethree month and nine month periods ended June 30, 2005, the use of themonthly average spot rate instead of the average monthly forward contractexchange rate to value Euro denominated sales would have resulted in adecrease in sales of $121,126 for the three months ended June 30,2005 and a sales increase of $857,358 for the nine months ended June 30, 2005. Thesesales increases and decreases are related to contracts that closed duringthese periods and the changes in the fair value of our derivativecontracts.  For the three month and nine month periods ended June 30,2004, the use of the monthly average spot rate instead of the average monthlyforward contract exchange rate to value Euro denominated sales would haveresulted in a sales decrease of $45,403 for the three months endedJune 30, 2004 and a sales increase of $863,965 for the nine months endedJune 30, 2004.

 

**Note 4. Inventories**

 

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

 
| ** **           | ** ** | **June 30,  2005** | ** **     | **September 30,  2004** | ** ** |
|----------------------|------------|-------------------------|----------------|------------------------------|------------|
| **Component  Parts** | ** ** | **$**                   | **4,398,431**  | ** **                   | **$**      | **3,522,974** | ** ** |
| **Finished  Goods**  | ** ** | **7,185,480**           | ** **     | **4,954,280**                | ** ** |
| ** **           | ** ** | **$**                   | **11,583,911** | ** **                   | **$**      | **8,477,254** | ** ** |

 

**Note 5. Net Income Per Share**

 

Basic net income pershare includes no dilution and is computed by dividing net income by theweighted average number of shares of common stock outstanding for the period.Diluted net income per share reflects, in the periods in which they have adilutive effect, the dilution which would occur upon the exercise of stockoptions. A reconciliation of the shares used in calculating basic and diluted netincome per share is as follows:

 
| ** **                                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Weighted  average shares outstanding-basic**                        | ** ** | **9,489,843**                         | ** ** | **9,047,561**                        | ** ** | **9,408,827** | ** ** | **8,943,087** | ** ** |
| **Number  of shares issued on the assumed exercise of stock options** | ** ** | **477,669**                           | ** ** | **972,136**                          | ** ** | **581,228** | ** ** | **749,388** | ** ** |
| **Weighted  average shares outstanding-diluted**                      | ** ** | **9,967,512**                         | ** ** | **10,019,697**                       | ** ** | **9,990,055** | ** ** | **9,692,475** | ** ** |

 

10

----

 

Options to purchase174,122 and 38,906 shares of common stock, at prices ranging $3.88 to $ 10.06and $8.75 and $10.06, were outstanding for the three month periods endedJune 30, 2005 and 2004, respectively, but were not included in thecomputation of diluted earnings per share because they were anti-dilutive.

 

Options to purchase112,026 and 111,304 shares of common stock, at prices ranging $4.62 to $ 10.06and $5.25 to $10.06, respectively, were outstanding for the nine month periodsended June 30, 2005 and 2004, respectively, but were not included in thecomputation of diluted earnings per share because they were anti-dilutive.

 

**Note 6.  Accumulated other comprehensive income**

 

The Euro is thefunctional currency of the Company’s European subsidiary, Hauppauge DigitalEurope Sarl.  Assets and liabilities ofthis subsidiary are translated to U.S. Dollars at the spot exchange rate ineffect at the end of each reporting period, while equity accounts aretranslated to U.S. Dollars at the historical rate in effect at the date of thecontribution.  Operating results aretranslated to U.S. Dollars at the average prevailing exchange rate for theperiod, with the exception of sales, which are translated to U.S. Dollars atthe average monthly forward exchange contract rate. The use of translatingaccounts at the spot, historical and average exchange rates results in foreigncurrency translation gains or losses. These translation gains or losses are recorded on the balance sheetunder accumulated other comprehensive income.

 

The Company uses forwardexchange contracts to reduce its exposure to fluctuations in foreigncurrencies.  Mark to market gains andlosses on these open contracts result from the difference between the USD valueof the open foreign currency forward contracts at the average contract rate asopposed to the same contracts translated at the month end spot rate.  The Company qualifies for cash flow hedgeaccounting as prescribed under FAS 133, which allows the Company to record themark to market gains and losses in the equity section of the Company’sbalance sheet under accumulated other comprehensive income.

 

As of June 30, 2005,appearing in the equity section under “Accumulated other comprehensiveincome” was a deferred gain of $1,102,433, which consisted of a deferredtranslation gain of $893,065 and a deferred gain of $209,368 due to the mark tomarket gains on the difference between the value of the Company’s open forwardexchange contracts at the contract rates versus the same contracts valued atthe period ending forward rate.

 

The Company’s Asiansubsidiary reports its financial position and results of operations in thereporting currency of the Company.

 

11

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**Note 7. Revenue Recognition**

 

The Company sells througha sales channel which consist of retailers, distributors and original equipmentmanufacturers (OEM’s). The Company’s prices are fixed consistently over theentire sales channel. The product is shipped on open account with the majorityof the Company’s customers given 30 day payment terms.  Those customers deemed as large credit riskseither pay in advance or issue us a letter of credit.

 

The Company requires thecustomer to submit a purchase order to the Company.  The price of the product and payment termsare fixed per the terms of the purchase order. Upon shipment of the order to the customer, the title to the goods ispassed to the customer. The customer is legally obligated to pay for the orderwithin the payment terms stated on the customer’s purchase order.  The obligation to insure the products and thecost of any pilferage while in the customer’s possession is the responsibilityof the customer.  The Company’s retailproducts are typically stocked on the shelves of retailers, and is subject tothe normal consumer traffic that retail stores attract. Aside from normal storepromotions such as end-caps and advertisements in the store’s circular, theCompany has no further obligation to assist in the resale of the product.

 

The Company offers itscustomers a right of return, but does not offer stock balancing. The Company’saccounting method complies with SFAS 48 as typically at the end of everyquarter the Company, based on historical data, evaluates its sales reservelevel based on the previous six months sales. Due to seasonal nature of the business coupled with the changingeconomic environment, management exercises some judgment with regard to thehistorical data to arrive at the reserve.

 

**Note 8. Product segment and Geographic Information**

** **

The Company offersseveral 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 products includehardware MPEG encoders, which improve the performance of TV recording and addinstant replay and program pause functions, plus also enable the ‘burning’ ofTV recordings onto DVD or CD media. The Company’s EskapeTM Labs products allowusers of Apple®Macintosh® computers to watch television on their computerscreen.

 

The Company offers threetypes of digital TV receivers. The Company’s WinTV® digital receivers canreceive digital TV transmissions and display the digital TV show in are-sizeable window on a user’s PC screen. The Company’s Digital EntertainmentCenter products (“DEC”) allow users to receive digital TV broadcasts anddisplay the digital TV on either a

 

12

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TV set or a PC screen.Our MediaMVPTM product was designed to allow PC users to play digital media suchas digital music, digital pictures and digital videos on a TV set via a homenetwork. The Company’s products are either sold, or can be sold, by the sameretailers and distributors in the Company’s marketing channel. The Company alsosells product directly to OEM customers. The Company evaluates its productlines under the functional categories of analog and digital products.  Sales by functional category are as follows:

 
| ** **             | ** ** | **Three months ended  June 30,** | ** **     | **Nine months ended June 30,** | ** ** |
|------------------------|------------|---------------------------------------|----------------|-------------------------------------|------------|
| ** **             | ** ** | **2005**                              | ** **     | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Product line sales** | ** ** | ** **                            | ** **     | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Analog sales**       | ** ** | **$**                                 | **15,431,163** | ** **                          | **$**      | **10,946,522** | ** ** | **$** | **50,189,313** | ** ** | **$** | **39,099,757** | ** ** |
| **Digital sales**      | ** ** | **3,941,620**                         | ** **     | **2,847,770**                       | ** ** | **12,906,206** | ** ** | **9,729,116** | ** ** |
| ** **             | ** ** | **$**                                 | **19,372,783** | ** **                          | **$**      | **13,794,292** | ** ** | **$** | **63,095,519** | ** ** | **$** | **48,828,873** | ** ** |

 

The Company sells itsproducts through an international network of distributors and retailers.  Sales percent by geographic region are asfollows: 

 
| ** **                             | ** ** | **Three months ended June 30  ,** | ** ** | **Nine months ended June 30  ,** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                             | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Sales percent by geographic region** | ** ** | ** **                             | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **United States**                      | ** ** | **52**                                 | **%**      | **32**                                | **%**      | **46** | **%** | **29** | **%** |
| **Europe**                             | ** ** | **44**                                 | **%**      | **66**                                | **%**      | **51** | **%** | **69** | **%** |
| **Asia**                               | ** ** | **4**                                  | **%**      | **2**                                 | **%**      | **3** | **%** | **2** | **%** |
| **Total**                              | ** ** | **100**                                | **%**      | **100**                               | **%**      | **100** | **%** | **100** | **%** |

 

**Note 9. Stock-Based Compensation**

 

The Company appliesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB 25”), and related interpretations in accounting for itsemployee stock options.  Under APB 25, nocompensation expense is recorded so long as the quoted market price of thestock at the date of the grant is equal to the exercise price.

 

Pro forma informationregarding net income and earnings per share has been determined as if theCompany had accounted for its employee stock options under the fair valuemethod of Financial Accounting Standards Board Statement No. 123“Accounting for Stock-Based Compensation” (“FAS 123”).  The weighted average fair value of optionsoutstanding during the three and nine months ended June 30, 2005 and June 30,2004 was $1.15 to $1.39 and $0.43, respectively.  The fair value for these options wasestimated at the date of grant using a Black-Scholes option pricing model withthe following weighted average assumptions for the three and nine months endedJune 30, 2005 and June 30, 2004: risk-free interest rates of 4.25%,volatility factor of the expected market price of the Company’s Common Stock of35%, assumed dividend yield of 0%, and a weighted-average expected life of theoption of 5 years.

 

13

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Under the accountingprovisions of FAS 123, the Company’s net income and net income per share wouldhave been adjusted to the pro forma amounts indicated below:

 
| ** **                                                                                                             | ** ** | **Three months  ended** | ** **  | **Nine Months  ended**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|-------------------------|------------|
| ** **                                                                                                             | ** ** | **June 30,  2005** | ** **  | **June 30,  2004** | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| **Net  income as reported**                                                                                            | ** ** | **$**                   | **159,972** | ** **              | **$**      | **168,637** | ** ** | **$** | **2,251,124** | ** ** | **$** | **1,705,887** | ** ** |
| **Deduct:  Total stock-based employee compensation expense determined under fair value  method, net of related taxes** | ** ** | **(8,924**              | **)**       | **(24,788**             | **)**      | **(26,772** | **)** | **(74,364** | **)** |
| **Pro  forma net income**                                                                                              | ** ** | **$**                   | **151,048** | ** **              | **$**      | **143,579** | ** ** | **$** | **2,224,352** | ** ** | **$** | **1,631,523** | ** ** |
| ** **                                                                                                             | ** ** | ** **              | ** **  | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  income per share - as reported:**                                                                               | ** ** | ** **              | ** **  | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic**                                                                                                              | ** ** | **$**                   | **0.02**    | ** **              | **$**      | **0.02** | ** ** | **$** | **0.24** | ** ** | **$** | **0.19** | ** ** |
| **Diluted**                                                                                                            | ** ** | **$**                   | **0.02**    | ** **              | **$**      | **0.02** | ** ** | **$** | **0.23** | ** ** | **$** | **0.18** | ** ** |
| **Net  income per share - pro forma:**                                                                                 | ** ** | ** **              | ** **  | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic**                                                                                                              | ** ** | **$**                   | **0.02**    | ** **              | **$**      | **0.02** | ** ** | **$** | **0.23** | ** ** | **$** | **0.18** | ** ** |
| **Diluted**                                                                                                            | ** ** | **$**                   | **0.02**    | ** **              | **$**      | **0.01** | ** ** | **$** | **0.22** | ** ** | **$** | **0.17** | ** ** |

 

**Note 10.  Arrangements with Off-BalanceSheet Risk - Guarantees**

 

FASBInterpretation No. 45 (FIN 45), Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of the Indebtednessof Others, clarified the requirements of SFAS No. 5, Accounting forContingencies, relating to a guarantor’s accounting for and disclosures ofcertain guarantees issued. FIN 45 requires enhanced disclosures for certainguarantees. It also requires certain guarantees that are issued or modifiedafter December 31, 2002, including certain third-party guarantees, to beinitially recorded on the balance sheet at fair value. For guarantees issued onor before December 31, 2002, liabilities are recorded when and if paymentsbecome probable and estimable. FIN 45 has the general effect of delayingrecognition for a portion of the revenue for product sales that are accompaniedby certain third-party guarantees. The financial statement recognitionprovisions became effective prospectively beginning January 1, 2003. TheCompany has not entered into any new guarantees and the Company has beenreleased from the one guarantee it was subject to prior to February 17,2004.

 

The Company occupies afacility located in Hauppauge New York which is used for its executive officesand for the testing, storage and shipping of the Company’s products.  In February 1990, Hauppauge ComputerWorks, Inc., a wholly-owned subsidiary of the Company (“HCW”), enteredinto a lease (the “1990 Lease”), with Ladokk Realty Co., a real estate

 

14

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partnership which isprincipally owned by Kenneth Plotkin, the Company’s Chairman of the Board,Chief Executive Officer, President, Chief Operating Officer and Vice Presidentof Marketing and the holder of approximately 8.8% of the Company’s Common Stockas of June 30, 2005, Dorothy Plotkin, the wife of Kenneth Plotkin, holderof approximately 5.9% of the Company’s Common Stock as of June 30, 2005and Laura Aupperle, believed by the Company to be the holder of approximately10.5% of the Company’s Common Stock, including Common Stock attributed to the Estateof Kenneth R. Aupperle.  Ladokk RealtyCo., LLC is the successor to Ladokk Realty Co. 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 obligated to pay realestate taxes and operating costs of maintaining the premises subject to the1990 Lease.  Until February 17,2004, the premises subject to such lease were subject to two mortgagesguaranteed by us.

 

On February 17,2004, HCW and Ladokk terminated the 1990 Lease and HCW entered into a new leaseagreement with Ladokk Realty Co., LLC (the “2004 Lease”).  The 2004 Lease term is for five years andterminates on February 16, 2009. The annual rent under the 2004 Lease is $360,000, payable monthly.  The Company was also obligated to pay realestate taxes and operating costs of maintaining the premises subject to suchlease.  Concurrently with the new lease,Ladokk completed a refinancing of its mortgages, and the new lender did notrequire HCW to sign a guarantee. Accordingly, the Company no longer guarantees the landlord’s mortgages.

 

TheCompany’s Audit Committee is in the process of evaluating the 2004 Lease.

 

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###### **Item 2.****          ****Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

###### **Three Month Period ended June 30, 2005Compared to June 30, 2004**

 

Results of operations forthe three months ended June 30, 2005 compared to June 30, 2004 are asfollows:

 
| ** **                                                  | ** ** | **Three  Months  Ended** | ** **     | **Three  Months  Ended** | ** ** | **Variance**   | ** ** | **Percentage of sales** | ** **    |
|-------------------------------------------------------------|------------|--------------------------|----------------|--------------------------|------------|----------------|------------|-------------------------|---------------|
| ** **                                                  | ** ** | **6/30/05**              | ** **     | **6/30/04**              | ** ** | **$**          | ** ** | **2005**                | ** **    | **2004** | ** ** | **Variance** | ** ** |
|                                                        |       |                     |           |                     |       |           |       |                    |          |   |   |   |   |
| **Net  sales**                                              | ** ** | **$**                    | **19,372,783** | ** **               | **$**      | **13,794,292** | ** ** | **$**                   | **5,578,491** | ** ** | **100.0** | **%** | **100.0** | **%** | **—** | ** ** |
| **Cost of  sales**                                          | ** ** | **14,980,624**           | ** **     | **10,236,138**           | ** ** | **4,744,486**  | ** ** | **77.33**               | **%**         | **74.21** | **%** | **3.12** | **%** |
| **Gross  profit**                                           | ** ** | **4,392,159**            | ** **     | **3,558,154**            | ** ** | **834,005**    | ** ** | **22.67**               | **%**         | **25.79** | **%** | **-3.12** | **%** |
| **Gross  profit %**                                         | ** ** | **22.67**                | **%**          | **25.79**                | **%**      | **-3.12**      | **%**      | ** **              | ** **    | ** ** | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | ** **               | ** **     | ** **               | ** ** | ** **     | ** ** | ** **              | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Expenses:**                                               | ** ** | ** **               | ** **     | ** **               | ** ** | ** **     | ** ** | ** **              | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Sales &  marketing**                             | ** ** | **2,606,705**            | ** **     | **1,907,692**            | ** ** | **699,013**    | ** ** | **13.46**               | **%**         | **13.83** | **%** | **-0.37** | **%** |
| **Technical  support**                                      | ** ** | **129,738**              | ** **     | **116,763**              | ** ** | **12,975**     | ** ** | **0.67**                | **%**         | **0.85** | **%** | **-0.18** | **%** |
| **General &  administrative**                      | ** ** | **846,283**              | ** **     | **903,609**              | ** ** | **(57,326**    | **)**      | **4.37**                | **%**         | **6.55** | **%** | **-2.18** | **%** |
| **Total  selling, general and administrative expenses**     | ** ** | **3,582,726**            | ** **     | **2,928,064**            | ** ** | **654,662**    | ** ** | **18.50**               | **%**         | **21.23** | **%** | **-2.73** | **%** |
| **Research &  development**                        | ** ** | **655,588**              | ** **     | **512,606**              | ** ** | **142,982**    | ** ** | **3.38**                | **%**         | **3.72** | **%** | **-0.34** | **%** |
| **Total  operating expenses**                               | ** ** | **4,238,314**            | ** **     | **3,440,670**            | ** ** | **797,644**    | ** ** | **21.88**               | **%**         | **24.95** | **%** | **-3.07** | **%** |
| **Net  operating income before litigation and arbitration** | ** ** | **153,845**              | ** **     | **117,484**              | ** ** | **36,361**     | ** ** | **0.79**                | **%**         | **0.84** | **%** | **-0.05** | **%** |
| **Arbitration and litigation items:**                       | ** ** | ** **               | ** **     | ** **               | ** ** | ** **     | ** ** | ** **              | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Litigation proceeding**                                   | ** ** | **—**               | ** **     | **(73,000**              | **)**      | **(73,000**    | **)**      | **0.00**                | **%**         | **-0.53** | **%** | **0.53** | **%** |
| **Net operating income**                                    | ** ** | **153,845**              | ** **     | **190,484**              | ** ** | **(36,639**    | **)**      | **0.79**                | **%**         | **1.37** | **%** | **-0.58** | **%** |
| **Other  income**                                           | ** ** | ** **               | ** **     | ** **               | ** ** | ** **     | ** ** | ** **              | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Interest  income**                                        | ** ** | **3,366**                | ** **     | **1,237**                | ** ** | **2,129**      | ** ** | **0.02**                | **%**         | **0.01** | **%** | **0.01** | **%** |
| **Foreign  currency**                                       | ** ** | **19,917**               | ** **     | **60**                   | ** ** | **19,857**     | ** ** | **0.10**                | **%**         | **0.00** | **%** | **0.10** | **%** |
| **Total  other income**                                     | ** ** | **23,283**               | ** **     | **1,297**                | ** ** | **21,986**     | ** ** | **0.12**                | **%**         | **0.01** | **%** | **0.11** | **%** |
| **Income  before taxes**                                    | ** ** | **177,128**              | ** **     | **191,781**              | ** ** | **(14,653**    | **)**      | **0.91**                | **%**         | **1.38** | **%** | **-0.47** | **%** |
| **Taxes  on income**                                        | ** ** | **17,156**               | ** **     | **23,144**               | ** ** | **(5,988**     | **)**      | **0.09**                | **%**         | **0.17** | **%** | **-0.08** | **%** |
| **Net  income**                                             | ** ** | **$**                    | **159,972**    | ** **               | **$**      | **168,637**    | ** ** | **$**                   | **(8,665**    | **)** | **0.82** | **%** | **1.21** | **%** | **-0.39** | **%** |

 

16

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Net sales for the threemonths ended June 30, 2005 increased $5,578,491 over the three monthsended June 30, 2004 as shown in the table below.

 
| ** **   | ** ** | ** **            | ** **     | ** **            | ** ** | ** **              | ** ** | **Increase**   | ** **    | **Sales by Geographic** | ** ** |
|--------------|------------|-----------------------|----------------|-----------------------|------------|-------------------------|------------|----------------|---------------|-------------------------|------------|
| ** **   | ** ** | **Three Months**      | ** **     | **Three Months**      | ** ** | **Increase (Decrease)** | ** ** | **(Decrease)** | ** **    | **region**              | ** ** |
| **Location** | ** ** | **E****nded 6/30/05** | ** **     | **E****nded 6/30/04** | ** ** | **Dollar****Variance**  | ** ** | **Variance %** | ** **    | **2005**                | ** ** | **2004** | ** ** |
| **Domestic** | ** ** | **$**                 | **10,109,638** | ** **            | **$**      | **4,410,222**           | ** ** | **$**          | **5,699,416** | ** **              | **129**    | **%** | **52** | **%** | **32** | **%** |
| **Europe**   | ** ** | **8,566,299**         | ** **     | **9,146,161**         | ** ** | **(579,862**            | **)**      | **-6**         | **%**         | **44**                  | **%**      | **66** | **%** |
| **Asia**     | ** ** | **696,846**           | ** **     | **237,909**           | ** ** | **458,937**             | ** ** | **193**        | **%**         | **4**                   | **%**      | **2** | **%** |
| **Total**    | ** ** | **$**                 | **19,372,783** | ** **            | **$**      | **13,794,292**          | ** ** | **$**          | **5,578,491** | ** **              | **40**     | **%** | **100** | **%** | **100** | **%** |

 

The primary factorscontributing to the sales increase were:

 

•                                          Increasedvolume of WinTV-PVR-150 OEM sales

 

•                                          Strongerdemand for retail WinTV-PVR-150/350/500 products

 

•                                          Introductionof hybrid video recorder product

 

•                                          Increase inDigital Video Satellite (DVB) sales due to transition to company producedmodels which resulted in more favorable price points

 

•                                          IncreasedWinTV-PVR-USB2 sales due to price reduction and media center awareness

 

•                                          Increase inthe average Euro to USD contract rate of about 7.70% (1.356 versus 1.2122) forthe three months ended June 30, 2005 compared to the three months endedJune 30, 2004, which yielded higher converted Euro to USD sales

 

The sales increases wereoffset by the following negative trends:

 

•                                          Decrease inWinTV PCI analog product sales due shifting technology trends

 

•                                          Decrease inWinTV-USB 1.1 sales

 

•                                          Decrease inDEC set top digital boxes

 

•                                          Decrease inMediaMVP sales

 

Net sales to domesticcustomers were 52% of net sales for the three months ended June 30, 2005compared to 32% for the three months ended June 30, 2004.  Net sales to European customers were 44% ofnet sales compared to 66% for the same period of last year.  Net sales to Asian customers were 4% for thethree months ended June 30, 2005 compared to 2% for the three months endedJune 30, 2004.

 

Gross profit increased$834,005 for the three months ended June 30, 2005 compared to the prioryear’s third quarter.

 

17

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

 
| ** **                                                | ** ** | **Increase  (decrease)** | ** **    |
|-----------------------------------------------------------|------------|--------------------------|---------------|
| **Due to  increased sales**                               | ** ** | **$**                    | **1,957,524** | ** ** |
| **Gross  profit changes due to product sales mix**        | ** ** | **466,654**              | ** **    |
| **Effect  on gross profit due to lower margin OEM sales** | ** ** | **(1,199,024**           | **)**         |
| **Due to  increases in labor related and other costs**    | ** ** | **(391,149**             | **)**         |
| **Total  increase in gross profit**                       | ** ** | **$**                    | **834,005**   | ** ** |

 

Gross profit percentagefor the three months ended June 30, 2005 was 22.67% compared to 25.79% forthe three months ended June 30, 2004, a decrease of 3.12%.

 

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

 
| ** **                                                | ** ** | **Increase  (decrease)** | ** ** |
|-----------------------------------------------------------|------------|--------------------------|------------|
| **Gross  profit changes due to product sales mix**        | ** ** | **2.41**                 | **%**      |
| **Effect  on gross profit due to lower margin OEM sales** | ** ** | **(6.19**                | **)****%** |
| **Labor  related and other costs**                        | ** ** | **0.66**                 | **%**      |
| **Net  decrease in gross profit %**                       | ** ** | **(3.12**                | **)****%** |

 

The decrease in the grossprofit percent of 3.12 % for the three months ended June 30, 2005 comparedto the three months ended June 30, 2004 was primarily due to:

 

•                                          Sales growthof lower gross profit OEM sales contributed to a 6.19% decrease in grossprofit.  The percentage of OEM salesincreased for the three months ended June 30, 2005 over the three monthsended June 30, 2004.  OEM productsrequire less sales, advertising and product support than retail products, butthe gross profit for OEM products is lower than our retail products.

 

•                                          Favorablesales mix of higher gross profit retail sales contributed to a 2.41% increasein gross profit.

 

•                                          Labor relatedand other costs contributed to a 0.66% increase in gross profit percentcompared to three months ended June 30, 2004.  The increase in net sales of 40% exceeded theincrease in labor related and other costs of 30.50%.

 

18

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

 
| ** **                      | ** ** | **Three months ended June 30,** | ** **    | ** **   | ** ** | **Percentage of Sales** | ** ** |
|---------------------------------|------------|--------------------------------------|---------------|--------------|------------|-------------------------|------------|
| ** **                      | ** ** | **Dollar Costs**                     | ** **    | **Increase** | ** ** | ** **              | ** ** | ** ** | ** ** | **Increase** | ** ** |
| ** **                      | ** ** | **2005**                             | ** **    | **2004**     | ** ** | **(Decrease)**          | ** ** | **2005** | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
| **Sales  and marketing**        | ** ** | **$**                                | **2,606,705** | ** **   | **$**      | **1,907,692**           | ** ** | **$** | **699,013** | ** ** | **13.46** | **%** | **13.83** | **%** | **-0.37** | **%** |
| **Technical  support**          | ** ** | **129,738**                          | ** **    | **116,763**  | ** ** | **12,975**              | ** ** | **0.67** | **%** | **0.85** | **%** | **-0.18** | **%** |
| **General  and administrative** | ** ** | **846,283**                          | ** **    | **903,609**  | ** ** | **(57,326**             | **)**      | **4.37** | **%** | **6.55** | **%** | **-2.18** | **%** |
| **Total**                       | ** ** | **$**                                | **3,582,726** | ** **   | **$**      | **2,928,064**           | ** ** | **$** | **654,662** | ** ** | **18.50** | **%** | **21.23** | **%** | **-2.73** | **%** |

 

Selling, general andadministrative expenses increased $654,662 from the prior year’s thirdquarter.  As a percentage of sales,selling, general and administrative expenses decreased by 2.73% when comparedto the three months ended June 30, 2004.

 

The increase in sales andmarketing expense of $699,013, was mainly due to:

 

•                                          Increasescaused by the strengthening of the Euro to the U.S dollar of $60,707, whichaccounted for about 8.7% of the total increase. The average Euro to USD conversion rate was $1.259 for the three monthsended June 30, 2005 compared to $1.205 for the three months endedJune 30, 2004

 

•                                          Higheradvertising and promotional expenses of $469,612

 

•                                          Increasedcommission expense of $96,998 due to higher sales

 

•                                          Increasedcompensation due to additional outside sales persons of $47,702

 

•                                          IncreasedEuropean sales office costs of $41,098

 

The decrease in generaland administrative expenses of $57,326 was primarily due to:

 

•                                          Lowerexecutive compensation of $ 45,263, mainly due to vacant Officer’s position

 

•                                          Lower legalfees of $55,007 as a result of completion of arbitration and litigation

 

•                                          Higherconsulting fees of $45,239 due to start of 404 Compliance work

 

19

----

 

Research and developmentexpenses increased $142,982.  Theincrease was mainly due to

 

•                                          The newresearch and development facility in Taiwan, which began operations duringMarch 2004, which contributed $17,409 to the increase

 

•                                          Highercompensation costs of $13,396 due to the hiring of additional engineers

 

•                                          Increasedprogram development costs of $99,737 due to higher volume of new product andproduct enhancement programs

 

**Litigation Proceeding**

 

In March 2002,Polywell International, Inc. (“Polywell”), a supplier of cables to us,commenced an action seeking $339,520 in damages plus exemplary damages,attorney’s fees, costs and interest with relation to certain unpaidinvoices.  We paid these invoices to thesales representative, who subsequently failed to forward the payments toPolywell.  We had dealt with this salesrepresentative over a number of years, who also represented himself asPolywell’s payment and collection agent.

 

The case went to trialand was heard before a jury in the United States District Court in the NorthernDistrict of Texas, Dallas Division. Since we had dealt with the said sales representative for several yearswith respect to all purchasing and payment issues, we believed that paying theinvoices to this sales representative was tantamount to paying Polywell.  The jury however ruled in favor of Polywelland the court granted Polywell a judgment against us, awarding an amount of$339,520 to Polywell. Inaddition, we were obligated to pay Polywell’s attorney’s fees and interest. We accrueda charge of $500,000 in the second quarter of fiscal year 2004 to cover theaward. Subsequent negotiation reduced the award to $427,000, which was paid inJune 2004. The reduction in the final award was reflected in the resultsfor the three months ended June 30, 2004.

 

**Other income**

 

Net other income for thethree months ended June 30, 2005 was $23,283 compared to net other incomeof $1,297 for the three months ended June 30, 2004 as detailed below:

 
| ** **                              | ** ** | **Three months ended June 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|
| ** **                              | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **Interest  income**                    | ** ** | **$**                                | **3,366**  | ** ** | **$** | **1,237** | ** ** |
| **Foreign  currency transaction gains** | ** ** | **19,917**                           | ** ** | **60** | ** ** |
| **Total  other income**                 | ** ** | **$**                                | **23,283** | ** ** | **$** | **1,297** | ** ** |

 

20

----

 

 

**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 entity’s functional currency, excluding inter-company accountswhich are long term in nature, need to be re-measured into the entity’sfunctional currency, and any gain or loss from this re-measurement are includedin the determination of net income and are booked as a component of otherincome (loss) under the description “foreign currency”.

 

**Accumulated other comprehensive income (loss)**

 

The Euro is the functional currency of our Europeansubsidiary, Hauppauge Digital Europe Sarl. Assets and liabilities of this subsidiary are translated to U.S. Dollarsat the exchange rate in effect at the end of each reporting period, whileequity accounts are translated to U.S. Dollars at the historical rate in effectat the date of the contribution. Operating results are translated to U.S. Dollars at the averageprevailing exchange rate for the period, with the exception of sales which aretranslated to U.S. Dollars at the average monthly forward exchange contractrate. The use of differing exchange rates results in foreign currency translationgains or losses. Since the Euro denominated accounts on HDE Sarl’s books resultin a net asset position (total Euro assets are in excess of Euro liabilities),an increase in the Euro value results in a deferred gain for the translation ofEuro accounts to U.S. Dollars. We had a translation gain of $1,074,910 recordedon the balance sheet as of September 30, 2004. For the nine months ended June 30,2005, we recorded on the balance sheet deferred translation losses of $181,845resulting in a translation gain of $893,065 recorded as a component ofaccumulated other comprehensive income as of June 30, 2005.

 

We use forward exchange contracts to reduceour exposure to fluctuations in foreign currencies. Mark to market gains andlosses on these open contracts result from the difference between the USD valueof our open foreign currency forward contracts at the average contract rate asopposed to the same contracts translated at the month end forward rate.  We qualify for cash flow hedge accounting asprescribed under SFAS 133, which allows us to record the mark to market gainsand losses in the equity section of our balance sheet under accumulatedother comprehensive income.  We had markto market losses of $99,399 recorded on the balance sheet as of September 30,2004.  For the nine months ended June 30,2005, we recorded, as component of other comprehensive income, a mark to marketgain of $308,767, resulting in a mark to market gain of $209,368 for contractsopen as of June 30, 2005.

 

21

----

 

As stated above, accumulated other comprehensive income (loss) consistsof two components:

 

## •                                          Translationsgains and losses

##  

## •                                          FAS 133 markto market gains and losses on our open foreign exchange contracts

##  

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

 
| **Accumulated other comprehensive income** | ** ** | **Balance as of  Sept. 30, 2004** | ** **    | **October 2004 to June  2005 Gains (losses)** | ** ** | **Balance as of  June, 30, 2005** | ** ** |
|--------------------------------------------|------------|-----------------------------------|---------------|----------------------------------------------------|------------|-----------------------------------|------------|
| **Translation gains**                      | ** ** | **$**                             | **1,074,910** | ** **                                         | **$**      | **(181,845**                      | **)**      | **$** | **893,065** | ** ** |
| **FAS 133 mark to market adjustments**     | ** ** | **(99,399**                       | **)**         | **308,767**                                        | ** ** | **209,368**                       | ** ** |
| ** **                                 | ** ** | **$**                             | **975,511**   | ** **                                         | **$**      | **126,922**                       | ** ** | **$** | **1,102,433** | ** ** |

 

**Tax provision**

 

Our net tax provision for the three months ended June 30, 2005 and2004 is as follows:

 
| ** **                                  | ** ** | **Three months ended June 30,** | ** **  |
|---------------------------------------------|------------|--------------------------------------|-------------|
| ** **                                  | ** ** | **2005**                             | ** **  | **2004** | ** ** |
| **Tax  attributable to U.S operations**     | ** ** | **$**                                | **139,000** | ** ** | **$** | **(50,900** | **)** |
| **Tax  expense European operations**        | ** ** | **12,156**                           | ** **  | **18,144** | ** ** |
| **State  taxes**                            | ** ** | **5,000**                            | ** **  | **5,000** | ** ** |
| **Deferred  tax asset valuation allowance** | ** ** | **—**                           | ** **  | **50,900** | ** ** |
| **Net  operating loss utilization**         | ** ** | **(139,000**                         | **)**       | **—** | ** ** |
| **Net tax  provision**                      | ** ** | **$**                                | **17,156**  | ** ** | **$** | **23,144** | ** ** |

 

For the last five fiscal years, our domestic operation has incurredlosses.  We analyzed the futurerealization of our deferred tax assets as of June 30, 2005, and althoughour domestic operation reported a profit for the three months ended June 30,2005, due to the seasonal nature of the business it is uncertain at this timewhether our domestic operation will have a profit for the full year.  In light of this, we did not make any adjustmentsto our valuation allowance for the quarter ended June 30, 2005.

 

As a result of all of the above items mentioned in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations, werecorded net income of $159,972, for the three months ended June 30, 2005,which resulted in basic and diluted net income per share of $0.02 on weightedaverage basic and diluted shares of 9,489,843 and 9,967,512, respectively,compared to a net income of $168,637 for the three months ended June 30,2004, which resulted in basic and diluted net income per share of $0.02 onweighted average basic and diluted shares of 9,047,561 and 10,019,697,respectively.

 

Options to purchase 174,122 and 38,906 shares of common stock, atprices ranging $3.88 to $ 10.06 and $8.75 and $10.06, were outstanding for thethree month periods ended June 30, 2005 and 2004, respectively, but werenot included in the computation of diluted earnings per share because they wereanti-dilutive.

 

22

----

 

###### **Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

###### **NineMonth Period ended June 30, 2005 Compared to June 30, 2004**

######  

Results of operations for the nine months ended June 30, 2005compared to June 30, 2004 are as follows:

 
| ** **                                                  | ** ** | **Nine**       | ** **     | **Nine**       | ** ** | ** **     | ** ** | ** **              | ** **     | ** ** | ** ** | ** **   | ** ** |
|-------------------------------------------------------------|------------|----------------|----------------|----------------|------------|----------------|------------|-------------------------|----------------|------------|------------|--------------|------------|
| ** **                                                  | ** ** | **Months**     | ** **     | **Months**     | ** ** | ** **     | ** ** | ** **              | ** **     | ** ** | ** ** | ** **   | ** ** |
| ** **                                                  | ** ** | **Ended**      | ** **     | **Ended**      | ** ** | **Variance**   | ** ** | **Percentage of sales** | ** **     |
| ** **                                                  | ** ** | **6/30/05**    | ** **     | **6/30/04**    | ** ** | **$**          | ** ** | **2005**                | ** **     | **2004**   | ** ** | **Variance** | ** ** |
|                                                        |       |           |           |           |       |           |       |                    |           |       |       |         |       |
| **Net  sales**                                              | ** ** | **$**          | **63,095,519** | ** **     | **$**      | **48,828,873** | ** ** | **$**                   | **14,266,646** | ** ** | **100.0**  | **%**        | **100.0**  | **%** | **—** | ** ** |
| **Cost of  sales**                                          | ** ** | **48,572,102** | ** **     | **35,758,126** | ** ** | **12,813,976** | ** ** | **76.98**               | **%**          | **73.23**  | **%**      | **3.75**     | **%**      |
| **Gross  profit**                                           | ** ** | **14,523,417** | ** **     | **13,070,747** | ** ** | **1,452,670**  | ** ** | **23.02**               | **%**          | **26.77**  | **%**      | **-3.75**    | **%**      |
| **Gross  profit %**                                         | ** ** | **23.02**      | **%**          | **26.77**      | **%**      | **-3.75**      | **%**      | ** **              | ** **     | ** ** | ** ** | ** **   | ** ** |
| ** **                                                  | ** ** | ** **     | ** **     | ** **     | ** ** | ** **     | ** ** | ** **              | ** **     | ** ** | ** ** | ** **   | ** ** |
| **Expenses:**                                               | ** ** | ** **     | ** **     | ** **     | ** ** | ** **     | ** ** | ** **              | ** **     | ** ** | ** ** | ** **   | ** ** |
| **Sales &  marketing**                             | ** ** | **7,388,718**  | ** **     | **6,075,015**  | ** ** | **1,313,703**  | ** ** | **11.71**               | **%**          | **12.44**  | **%**      | **-0.73**    | **%**      |
| **Technical  support**                                      | ** ** | **374,480**    | ** **     | **332,707**    | ** ** | **41,773**     | ** ** | **0.59**                | **%**          | **0.68**   | **%**      | **-0.09**    | **%**      |
| **General &  administrative**                      | ** ** | **2,573,400**  | ** **     | **2,864,727**  | ** ** | **(291,327**   | **)**      | **4.08**                | **%**          | **5.87**   | **%**      | **-1.79**    | **%**      |
| **Total  selling, general and administrative expenses**     | ** ** | **10,336,598** | ** **     | **9,272,449**  | ** ** | **1,064,149**  | ** ** | **16.38**               | **%**          | **18.99**  | **%**      | **-2.61**    | **%**      |
| **Research &  development**                        | ** ** | **1,844,555**  | ** **     | **1,367,270**  | ** ** | **477,285**    | ** ** | **2.92**                | **%**          | **2.80**   | **%**      | **0.12**     | **%**      |
| **Total  operating expenses**                               | ** ** | **12,181,153** | ** **     | **10,639,719** | ** ** | **1,541,434**  | ** ** | **19.30**               | **%**          | **21.79**  | **%**      | **-2.49**    | **%**      |
| **Net  operating income before litigation and arbitration** | ** ** | **2,342,264**  | ** **     | **2,431,028**  | ** ** | **(88,764**    | **)**      | **3.72**                | **%**          | **4.98**   | **%**      | **-1.26**    | **%**      |
| **Arbitration and litigation items:**                       | ** ** | ** **     | ** **     | ** **     | ** ** | ** **     | ** ** | ** **              | ** **     | ** ** | ** ** | ** **   | ** ** |
| **Arbitration proceeding**                                  | ** ** | **—**     | ** **     | **206,250**    | ** ** | **(206,250**   | **)**      | **0.00**                | **%**          | **0.42**   | **%**      | **-0.42**    | **%**      |
| **Litigation proceeding**                                   | ** ** | **—**     | ** **     | **427,000**    | ** ** | **(427,000**   | **)**      | **0.00**                | **%**          | **0.87**   | **%**      | **-0.87**    | **%**      |
| **Net operating income**                                    | ** ** | **2,342,264**  | ** **     | **1,797,778**  | ** ** | **544,486**    | ** ** | **3.72**                | **%**          | **3.69**   | **%**      | **0.03**     | **%**      |
| **Other  income (expense)**                                 | ** ** | ** **     | ** **     | ** **     | ** ** | ** **     | ** ** | ** **              | ** **     | ** ** | ** ** | ** **   | ** ** |
| **Interest  income**                                        | ** ** | **8,027**      | ** **     | **4,373**      | ** ** | **3,654**      | ** ** | **0.01**                | **%**          | **0.01**   | **%**      | **0.00**     | **%**      |
| **Foreign  currency**                                       | ** ** | **18,989**     | ** **     | **21,959**     | ** ** | **(2,970**     | **)**      | **0.03**                | **%**          | **0.04**   | **%**      | **-0.01**    | **%**      |
| **Total  other income (expense)**                           | ** ** | **27,016**     | ** **     | **26,332**     | ** ** | **684**        | ** ** | **0.04**                | **%**          | **0.05**   | **%**      | **-0.01**    | **%**      |
| **Income  before taxes**                                    | ** ** | **2,369,280**  | ** **     | **1,824,110**  | ** ** | **545,170**    | ** ** | **3.76**                | **%**          | **3.74**   | **%**      | **0.02**     | **%**      |
| **Taxes on  income**                                        | ** ** | **118,156**    | ** **     | **118,223**    | ** ** | **(67**        | **)**      | **0.19**                | **%**          | **0.24**   | **%**      | **-0.05**    | **%**      |
| **Net  income**                                             | ** ** | **$**          | **2,251,124**  | ** **     | **$**      | **1,705,887**  | ** ** | **$**                   | **545,237**    | ** ** | **3.57**   | **%**        | **3.50**   | **%** | **0.07** | **%** |

 

23

----

 

Net sales for the nine months ended June 30, 2005 increased$14,266,646 compared to the nine months ended June 30, 2004 as shown onthe table below.

 
| ** **   | ** ** | ** **        | ** **     | ** **            | ** ** | ** **              | ** ** | **Increase**   | ** **     | **Sales by**          | ** ** |
|--------------|------------|-------------------|----------------|-----------------------|------------|-------------------------|------------|----------------|----------------|-----------------------|------------|
| ** **   | ** ** | **Nine Months**   | ** **     | **Nine Months**       | ** ** | **Increase (Decrease)** | ** ** | **(Decrease)** | ** **     | **Geographic region** | ** ** |
| **Location** | ** ** | **Ended 6/30/05** | ** **     | **E****nded 6/30/04** | ** ** | **Dollar****Variance**  | ** ** | **Variance %** | ** **     | **2005**              | ** ** | **2004** | ** ** |
| **Domestic** | ** ** | **$**             | **28,994,910** | ** **            | **$**      | **14,366,529**          | ** ** | **$**          | **14,628,381** | ** **            | **102**    | **%** | **46** | **%** | **29** | **%** |
| **Europe**   | ** ** | **32,624,781**    | ** **     | **33,756,324**        | ** ** | **(1,131,543**          | **)**      | **-3**         | **%**          | **51**                | **%**      | **69** | **%** |
| **Asia**     | ** ** | **1,475,828**     | ** **     | **706,020**           | ** ** | **769,808**             | ** ** | **109**        | **%**          | **3**                 | **%**      | **2** | **%** |
| **Total**    | ** ** | **$**             | **63,095,519** | ** **            | **$**      | **48,828,873**          | ** ** | **$**          | **14,266,646** | ** **            | **29**     | **%** | **100** | **%** | **100** | **%** |

 

The primary factors contributing to the sales increase were:

 

## •                                          Increasedvolume of WinTV-PVR-150 OEM sales

##  

## •                                          Strongerdemand for retail WinTV-PVR-150/350/500 products

##  

## •                                          IncreasedWinTV-PVR-USB2 sales due to price reduction and media center awareness

##  

## •                                          Increase inDigital Video Satellite (DVB) sales due to transition to company producedmodels which resulted in more favorable price points

##  

## •                                          Increased DECsales to UK and German customers

##  

## •                                          Introductionof hybrid video recorder boards

##  

## •                                          Introductionof Portable MediaMVP portable media player in Europe

##  

## •                                          Increase inthe average Euro to USD contract rate of about 6.53% (1.260 versus 1.1828) forthe nine months ended June 30, 2005 compared to the nine months ended June 30,2004, which yielded higher converted Euro to USD sales

##  

The sales increases were offset by the following negative trends:

 

## •                                          Decrease inWinTV PCI analog product sales due shifting technology trends

##  

## •                                          Decrease inMediaMVP sales compared with the year ago period which included the initialproduct rollout shipments to retailers and distributors

##  

## •                                          Decrease inUSB 1.1 analog sales

 

Net sales to domestic customers were 46% of net sales for the ninemonths ended June 30, 2005 compared to 29% for the nine months ended June 30,2004.  Net sales to European customerswere 51% of net sales compared to 69% for the same period of last year.  Net sales to Asian customers were 3% and 2%for the nine months ended June 30, 2005 and 2004.

 

24

----

 

Gross profit increased $1,452,670 for the nine months ended June 30,2005 compared to the prior year.  Theincreases and (decreases) in the gross profit are detailed below:

 
| ** **                                                | ** ** | **Increase  (decrease)** | ** **    |
|-----------------------------------------------------------|------------|--------------------------|---------------|
| **Due to  increased sales**                               | ** ** | **$**                    | **4,959,464** | ** ** |
| **Gross  profit changes due to product sales mix**        | ** ** | **(500,422**             | **)**         |
| **Effect  on gross profit due to lower margin OEM sales** | ** ** | **(1,941,573**           | **)**         |
| **Due to  increases in labor related and other costs**    | ** ** | **(1,064,799**           | **)**         |
| **Total  increase in gross profit**                       | ** ** | **$**                    | **1,452,670** | ** ** |

 

Gross profit percentage for the nine months ended June 30, 2005 was23.02% compared to 26.77% for the nine months ended June 30, 2004, adecrease of 3.75%.

 

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

 
| ** **                                                | ** ** | **Increase  (decrease)** | ** ** |
|-----------------------------------------------------------|------------|--------------------------|------------|
| **Gross  profit changes due to retail product sales mix** | ** ** | **(0.79**                | **)****%** |
| **Effect  on gross profit due to lower margin OEM sales** | ** ** | **(3.08**                | **)****%** |
| **Labor  related and other costs**                        | ** ** | **0.12**                 | **%**      |
| **Net  decrease in gross profit %**                       | ** ** | **(3.75**                | **)****%** |

 

The decrease in the gross profit percent of 3.75 % for the nine monthsended June 30, 2005 compared to the nine months ended June 30, 2004was primarily due to:

 

## •                                          Sales growthof lower gross profit OEM sales contributed to a 3.08% decrease in grossprofit.  The percentage of OEM salesincreased for the three months ended June 30, 2005 over the three monthsended June 30, 2004.  OEM productsrequire less sales, advertising and product support than retail products, butthe gross profit for OEM products is lower than our retail products

##  

## •                                          Sales mix ofretail sales with lower gross profit compared to last year.

 

## •                                          Labor relatedand other costs contributed to a 0.12% increase in gross profit percentcompared to the nine months ended June 30, 2004.  The increase in net sales of 29% exceeded theincrease in labor related and other costs of 27%.

 

25

----

 

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

 
| ** **                      | ** ** | **Nine months ended June 30,** | ** **     | ** **    | ** ** | **Percentage of Sales** | ** ** |
|---------------------------------|------------|-------------------------------------|----------------|---------------|------------|-------------------------|------------|
| ** **                      | ** ** | **Dollar Costs**                    | ** **     | **Increase**  | ** ** | ** **              | ** ** | ** ** | ** ** | **Increase** | ** ** |
| ** **                      | ** ** | **2005**                            | ** **     | **2004**      | ** ** | **(Decrease)**          | ** ** | **2005** | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
| **Sales  and marketing**        | ** ** | **$**                               | **7,388,718**  | ** **    | **$**      | **6,075,015**           | ** ** | **$** | **1,313,703** | ** ** | **11.71** | **%** | **12.44** | **%** | **-0.73** | **%** |
| **Technical  support**          | ** ** | **374,480**                         | ** **     | **332,707**   | ** ** | **41,773**              | ** ** | **0.59** | **%** | **0.68** | **%** | **-0.09** | **%** |
| **General  and administrative** | ** ** | **2,573,400**                       | ** **     | **2,864,727** | ** ** | **(291,327**            | **)**      | **4.08** | **%** | **5.87** | **%** | **-1.79** | **%** |
| **Total**                       | ** ** | **$**                               | **10,336,598** | ** **    | **$**      | **9,272,449**           | ** ** | **$** | **1,064,149** | ** ** | **16.38** | **%** | **18.99** | **%** | **-2.61** | **%** |

 

Selling, general and administrative expenses increased $1,064,149 fromthe prior year.  As a percentage ofsales, selling, general and administrative expenses decreased by 2.61% whencompared to the nine months ended June 30, 2004.

 

The increase in sales and marketing expense of $1,313,703, was mainlydue to:

 

## •                                          Increasescaused by the strengthening of the Euro to the U.S dollar of $255,103, whichaccounted for about 19.4% of the total increase.  The average Euro to USD conversion rate was$1.2889 for the nine months ended June 30, 2005 compared to $1.2156 forthe nine months ended June 30, 2004

##  

## •                                          Higheradvertising and promotional expenses of $629,362

##  

## •                                          Increasedcommission expense of $232,618 due to higher sales

##  

## •                                          Increasedcompensation due to additional outside sales person and outside sales reps of$195,204

##  

## •                                          IncreasedEuropean sales office costs of $204,788

##  

The decrease in general and administrative expenses of $291,327 wasprimarily due to:

 

## •                                          Lowerexecutive compensation of $ 113,155, mainly due to vacant Officer’s position

##  

## •                                          Lower legalfees of $348,952 as a result of completion of arbitration and litigation

##  

## •                                          Higherconsulting fees of $66,989 due to Sarbanes Oxley 404 Compliance work andTransfer Price study

##  

## •                                          HigherEuropean tax compliance and accounting items of $36,903

 

Research and development expenses increased $477,285.  The increase was mainly due to:

 

26

----

 

## •                                          Highercompensation $105,069 attributable to the research and development facility inTaiwan, which began operations during March 2004

##  

## •                                          Highercompensation costs of $159,453 due to the hiring of additional engineers

##  

## •                                          Increased programdevelopment costs of $178,306 due to higher volume of new product and productenhancement programs

##  

**Other income (expense)**

 

Net other income for the nine months ended June 30, 2005 was $27,016compared to net other income of $26,332 for the nine months ended June 30,2004 as detailed below:

 
| ** **                                       | ** ** | **Nine months ended June 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                       | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| **Interest  income**                             | ** ** | **$**                               | **8,027**  | ** ** | **$** | **4,373** | ** ** |
| **Foreign  currency transaction gains (losses)** | ** ** | **18,989**                          | ** ** | **21,959** | ** ** |
| **Total  other income**                          | ** ** | **$**                               | **27,016** | ** ** | **$** | **26,332** | ** ** |

 

**Arbitration Proceeding**

 

In November 2002, the estate of Kenneth Aupperle (“Estate”) fileda demand for arbitration against us with the American ArbitrationAssociation.  The Estate claimed certainproperty rights and interest in us, amounts due and owing to the Estate based onvarious corporate agreements with the late Mr. Aupperle and certaininsurance policies. The Estate was seeking to recover a minimum of $2.5 millionin damages, fees and expenses.

 

The arbitration proceeding was heard before a New York arbitrationpanel. On April 19, 2004, the arbitration panel awarded the Estate a totalof $206,250 in relation to certain stock options.  No fees or expenses were awarded. We accrueda charge of $206,250 in the second quarter of fiscal year 2004 to cover theaward.  The $206,250 was paid during May 2004.

 

**Litigation Proceeding**

 

In March 2002, Polywell International, Inc. (“Polywell”), asupplier of cables to us, commenced an action seeking $339,520 in damages plusexemplary damages, attorney’s fees, costs and interest with relation to certainunpaid invoices. We paid these invoices to the sales representative, whosubsequently failed to forward the payments to Polywell.  We had dealt with this sales representativeover a number of years, who also represented himself as Polywell’s payment andcollection agent.

 

27

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Thecase went to trial and was heard before a jury in the United States DistrictCourt in the Northern District of Texas, Dallas Division.  Since the we had dealt with the said salesrepresentative for several years with respect to all purchasing and paymentissues, we believed that paying the invoices to this sales representative wastantamount to paying Polywell.  The juryhowever ruled in favor of Polywell and the court granted Polywell a judgmentagainst us, awarding an amount of $339,520 to Polywell. In addition, we wereobligated to pay Polywell’s attorney’s fees and interest.

 

Weaccrued a charge of $500,000 in the second quarter of fiscal year 2004 to coverthe award. Subsequent negotiation reduced the award to $427,000, which was paidin June 2004. The reduction in the final award was reflected in theresults for the nine months ended June 30, 2004.

 

**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 entity’s functional currency, excluding inter-company accountswhich are long term in nature, need to be re-measured into the entity’sfunctional currency, and any gain or loss from this re-measurement are includedin the determination of net income and are booked as a component of otherincome (loss) under the description “foreign currency”.

 

**Accumulated other comprehensive income (loss)**

 

The Euro is the functional currency of ourEuropean subsidiary, Hauppauge Digital Europe Sarl.  Assets and liabilities of this subsidiary aretranslated to U.S. Dollars at the exchange rate 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 the average prevailing exchange rate for theperiod, with the exception of sales which are translated to U.S. Dollars at theaverage monthly forward exchange contract rate. The use of differing exchangerates results in foreign currency translation gains or losses. Since the Eurodenominated accounts on HDE Sarl’s books result in a net asset position (totalEuro assets are in excess of Euro liabilities), an increase in the Euro valueresults in a deferred gain for the translation of Euro accounts to U.S.Dollars. We had a translation gain of $1,074,910 recorded on the balance sheet asof September 30, 2004. For the nine months ended June 30, 2005, werecorded on the balance sheet deferred translation losses of $181,845 resultingin a translation gain of $893,065 recorded as a component of accumulated othercomprehensive income as of June 30, 2005.

 

We use forward exchange contracts to reduceour exposure to fluctuations in foreign currencies.  Mark to market gains and losses on these opencontracts result from the difference between the USD value of our open foreigncurrency forward contracts at the average contract rate as opposed to the samecontracts translated at the month end forward rate.  We qualify

 

28

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for cash flow hedge accounting as prescribed underSFAS 133, which allows us to record the mark to market gains and losses in theequity section of our balance sheet under accumulated other comprehensiveincome.  We had mark to market losses of$99,399 recorded on the balance sheet as of September 30, 2004. For thenine months ended June 30, 2005, we recorded, as component of othercomprehensive income, a mark to market gain of $308,767, resulting in a mark tomarket gain of $209,368 for contracts open as of June 30, 2005.

 

As stated above, accumulated other comprehensive income (loss) consistsof two components:

 

## •                                          Translationsgains and losses

##  

## •                                          FAS 133 markto market gains and losses on our open foreign exchange contracts

##  

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

 
| **Accumulated other comprehensive income** | ** ** | **Balance as  of Sept. 30, 2004** | ** **    | **October 2004 to June  2005 Gains (losses)** | ** ** | **Balance as of June  30, 2005** | ** ** |
|--------------------------------------------|------------|-----------------------------------|---------------|----------------------------------------------------|------------|----------------------------------|------------|
| **Translation gains**                      | ** ** | **$**                             | **1,074,910** | ** **                                         | **$**      | **(181,845**                     | **)**      | **$** | **893,065** | ** ** |
| **FAS 133 mark to market adjustments**     | ** ** | **(99,399**                       | **)**         | **308,767**                                        | ** ** | **209,368**                      | ** ** |
| ** **                                 | ** ** | **$**                             | **975,511**   | ** **                                         | **$**      | **126,922**                      | ** ** | **$** | **1,102,433** | ** ** |

 

**Tax provision**

 

Our net tax provision for the nine months ended June 30, 2005 and2004 is as follows:

 
| ** **                                  | ** ** | **Nine months ended June 30,** | ** **  |
|---------------------------------------------|------------|-------------------------------------|-------------|
| ** **                                  | ** ** | **2005**                            | ** **  | **2004** | ** ** |
| **Tax  attributable to U.S operations**     | ** ** | **$**                               | **442,000** | ** ** | **$** | **(485,000** | **)** |
| **Tax  expense European operations**        | ** ** | **83,156**                          | ** **  | **103,223** | ** ** |
| **State  taxes**                            | ** ** | **35,000**                          | ** **  | **15,000** | ** ** |
| **Deferred  tax asset valuation allowance** | ** ** | **—**                          | ** **  | **485,000** | ** ** |
| **Net  operating loss utilization**         | ** ** | **(442,000**                        | **)**       | **—** | ** ** |
| **Net tax  provision**                      | ** ** | **$**                               | **118,156** | ** ** | **$** | **118,223** | ** ** |

 

For the last five fiscal years, our domestic operation has incurredlosses.  We analyzed the futurerealization of our deferred tax assets as of June 30, 2005, and althoughour domestic operation reported a profit for the nine months ended June 30,2005, due to the seasonal nature of the business it is uncertain at this timewhether our domestic operation will have a profit for the full year.  In light of this, we did not make anyadjustments to our valuation allowance for the nine months ended June 30,2005.

 

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As a result of all of the above items mentioned in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations, werecorded net income of $2,251,124, for the nine months ended June 30,2005, which resulted in basic net income per share of $0.24 and diluted netincome per share of $0.23 on weighted average basic and diluted shares of9,408,827 and 9,990,055, respectively, compared to a net income of $1,705,887for the nine months ended June 30, 2004, which resulted in basic netincome per share of $0.19 and diluted net income per share of $0.18 on weightedaverage basic and diluted shares of 8,943,087 and 9,692,475, respectively.

 

Options to purchase 112,026 and 111,304 shares of common stock, atprices ranging $4.62 to $ 10.06 and $5.25 to $10.06, respectively, wereoutstanding for the nine month periods ended June 30, 2005 and 2004,respectively, but were not included in the computation of diluted earnings pershare because they were anti-dilutive.

 

**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 toDecember), followed by our fourth fiscal quarter (July to September). Inaddition, our international sales, mostly in the European, market, were 65%,68% and 73 % of sales for the years ended September 30, 2004, 2003 and 2002,respectively. Our fiscal fourth quarter sales (July to September) can bepotentially impacted by the reduction of activity experienced in Europe duringthe 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 of our retail sales.

 

**Liquidity and Capital Resources**

 

Our cash, working capital and stockholders’ equity position as of June 30,2005 and September 30, 2004 is set forth below:

 
| ** **                     | ** ** | **June 30, 2005** | ** **    | **September 30, 2004** | ** ** |
|--------------------------------|------------|------------------------|---------------|-----------------------------|------------|
| **Cash**                       | ** ** | **$**                  | **7,488,615** | ** **                  | **$**      | **8,661,589** | ** ** |
| **Working  Capital**           | ** ** | **16,574,523**         | ** **    | **13,760,121**              | ** ** |
| **Stockholders’  Equity** | ** ** | **17,209,420**         | ** **    | **14,327,425**              | ** ** |
|                                |            |                        |               |                             |            |  |  |

 

We had cash and cash equivalents as of June 30, 2005 of$7,488,615, a decrease of $1,212,974 from September 30, 2004.

 

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The decrease in cash was due to :

 
| **Sources  of cash:**                                      | ** ** | ** **     | ** **     |
|------------------------------------------------------------|------------|----------------|----------------|
| **Net  income adjusted for non cash items**                | ** ** | **$**          | **2,412,088**  | ** ** |
| **Decrease  in accounts receivable**                       | ** ** | **975,211**    | ** **     |
| **Proceeds  from employee stock purchases**                | ** ** | **676,538**    | ** **     |
| **Less  cash used for:**                                   | ** ** | ** **     | ** **     |
| **Increase  in inventories**                               | ** ** | **(3,106,657** | **)**          |
| **Decrease  in accounts payable**                          | ** ** | **(1,290,700** | **)**          |
| **Increase  in prepaid expenses and other current assets** | ** ** | **(478,308**   | **)**          |
| **Capital  equipment purchases**                           | ** ** | **(228,557**   | **)**          |
| **Purchase  of treasury stock**                            | ** ** | **(172,589**   | **)**          |
| **Net cash  decrease**                                     | ** ** | **$**          | **(1,212,974** | **)** |

 

Net cash of $1,488,366 used in operating activities was primarily dueto a increases in inventory and prepaid expenses and other current assets of$3,106,657 and $478,308, respectively, plus decreases in accounts payable of$1,290,700.  These uses of cash was offsetby net income adjusted for non cash items of $2,412,088 and a decrease inaccounts receivable of $975,211.

 

Cash of $228,557 and $172,589 was used to purchase fixed assets andrepurchase treasury stock. Proceeds from the stock purchased by employeesthrough the exercise of options and the employee stock purchase plan providedadditional cash of $676,538.

 

On November 8, 1996, we approved a stock repurchase program.  The program, as amended, authorizes us torepurchase up to 850,000 shares of our own stock. We intend to use therepurchased shares for certain employee benefit programs. On December 17,1997, the stock repurchase program was extended by a resolution of our Board ofDirectors. As of June 30, 2005, we held 607,267 treasury shares purchasedfor $1,756,902 at an average purchase price of approximately $2.89 per share.

 

We believe that our cash and cash equivalents as of June 30, 2005and our internally generated cash flow will provide us with sufficientliquidity to meet our currently foreseeable short-term and long-term capitalneeds.

 

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**Future Contractual Obligations**

 

The following table shows our contractual obligations related to leaseobligations as of June 30, 2005:

 
| ** **                       | ** ** | **Payments due by period** | ** **    |
|----------------------------------|------------|----------------------------|---------------|
| ** **                       | ** ** | **Total**                  | ** **    | **Less than 1 year** | ** ** | **1-3 years** | ** ** | **3 to 5 tears** | ** ** |
| **Operating  lease obligations** | ** ** | **$**                      | **1,398,608** | ** ** | **$** | **506,222** | ** ** | **$** | **757,386** | ** ** | **$** | **135,000** | ** ** |
|                                  |            |                            |               |  |  |  |  |  |  |  |  |  |  |

 

**Critical Accounting Policies and Estimates**

 

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

 

## •                                          RevenueRecognition

##  

## •                                          Management’sestimates

##  

## •                                          Hedgingprogram for European subsidiary inventory purchases denominated in U.S. dollars

##  

## •                                          Translationof assets and liabilities denominated in non functional currencies on ourEuropean financial statements

##  

**Revenue Recognition**

 

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.  Sales to our customers are documented by apurchase order which describes the conditions of sale. Sales are recorded whenproducts are shipped to our customers, the product price is fixed anddeterminable, collection of the resulting receivable is probable and productreturns are reasonably estimable.  Revenuefrom freight charged to customers is recognized when products are shipped.Provisions for customer returns and other adjustments are provided for in theperiod the related sales are recorded based upon historical data.

 

**Management’s Estimates**

 

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 thesefinancial statements requires management to make estimates and judgments thataffect the reported amounts of assets, liabilities and related disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts for revenues and expenses during thereporting period. On an

 

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ongoing basis, management evaluates estimates, including those relatedto sales provisions, as described above, income taxes, bad debts, inventoryreserves 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 judgments approximating thecarrying values of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates

 

**Hedging program for sales denominated in a foreigncurrency**

 

For each of the past three fiscal years, over 60 % of our sales weregenerated by our European subsidiary and were:

 

## •                                          Invoiced inlocal currency-primarily the Euro

##  

## •                                          Collected inlocal 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 European sales.

 

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 we procure are specifically entered into to as a hedge againstforecasted 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 orweakening of the U.S. dollar against the Euro impacts our sales, our grossprofit, operating income and retained earnings. Factors that could impact theeffectiveness of our hedging program are:

 

## •                                          volatility ofthe currency markets

##  

## •                                          availabilityof hedging instruments

##  

## •                                          accuracy ofour inventory forecasts

 

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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 denominatedin non functional currencies on our European financial statements**

 

The functional currency of our European subsidiary is the Euro.  In preparing our consolidated financialstatements, we are required to translate assets and liabilities denominated ina non functional currency, mainly U.S. Dollars, to Euros on the books of ourEuropean subsidiary.  This processresults in exchange gains and losses depending on the changes in the Euro to U.S.Dollar exchange rate.  Under the relevantaccounting guidance, with the exception of gains and losses that areattributable to inter-company accounts which are long term in nature, we areobligated to include these gains and losses on our statement of operations,which we report in other income or expense under the description “foreigncurrency”.

 

The extent of these gains and losses can fluctuate greatly from monthto month depending on the change in the exchange rate, causing results to varywidely.  Due to the past volatility ofthe Euro, it is difficult to forecast the long term trend of these gains andlosses.

 

**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 commonlegal currency among 11 of the 15 member countries of the European Community.On that date, the participating countries established fixed Euro conversionrates (i.e. the conversion exchange rate between their existing currencies andthe Euro).  The Euro now trades oncurrency exchanges and is available for non-cash transactions. A new EuropeanCentral Bank was established to direct monetary policy for the participating countries.

 

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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 invoicingour customers who are located in the eleven member countries in Euros. Wecontinue to bill customers located in the United Kingdom in British Pounds. Thebenefits to billing customers in Euros were twofold:

 

## •                                          Our foreigncurrency hedging program was streamlined to the Euro and the British Pound

##  

## •                                          The pricingfrom country to country was harmonized, eliminating price differences betweencountries due to the fluctuating local currencies

##  

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

 

**Recent Accounting Pronouncements**

 

On December 15, 2004, the Financial Accounting Standards Board (“FASB”)issued a revised SFAS No. 123R “Share Based Payment”  This statement requires us to measure allemployee stock based compensation, such as the options granted under our stockoptions plans, using a fair value method and to recognize such expense in ourconsolidated financial statements. The adoption of SFAS No. 123R willreduce our net income, but will not affect our cash flows.  The statement is effective as of thebeginning of our fiscal year ending September 30, 2006.

 

We are evaluating the effect this statement will have on itsoperations.

 

**Item 3. Quantitative and Qualitative Disclosures about Market Risks**

 

For each of the past three fiscal years, over 60 % of our sales weregenerated by our European subsidiary and were:

 

## •                                          Invoiced inlocal currency-primarily the Euro

##  

## •                                          Collectedin 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.

 

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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 European sales.

 

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 we procure are specifically entered into to as a hedge againstforecasted 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 orweakening of the U.S. dollar against the Euro impacts our sales, our grossprofit, operating income and retained earnings. Factors that could impact theeffectiveness of our hedging program are:

 

## •                                          volatility ofthe currency markets

##  

## •                                          availabilityof hedging instruments

##  

## •                                          accuracy ofour 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 June 30, 2005, the Company had foreign currency contractsoutstanding of approximately $4,093,000 against the delivery of the Euro. Thecontracts expire through November 2005. Our accounting policies for these instruments designate such instrumentsas cash flow hedging transactions. We do not enter into such contracts forspeculative purposes. We record all derivative gains and losses on the balancesheet as a component of stockholders’ equity under the caption “Accumulatedother comprehensive income (loss)”.  TheCompany recorded a deferred gain of $182,258 and $308,767 for the three andnine months ended June 30, 2005.  Asof June 30, 2005, a deferred gain of $209,368 reflecting the cumulativemark to market loss of the Company’s derivatives, was recorded on the Company’sbalance sheet as a component of accumulated other comprehensive income in ourequity section

 

We use the average monthly forward contract exchange rate to translateour Euro denominated sales into our U.S. dollar reporting currency. For thethree month and nine month periods ended June 30, 2005, the use of themonthly average spot rate instead of the average monthly forward contractexchange rate to value Euro denominated sales would have resulted in adecrease in sales of $121,126 for the three months ended June 30,2005 and a sales increase of $857,358 for the nine months ended June 30,2005. These sales increases and decreases are related to contracts thatclosed during these periods and the changes in the fair value of ourderivative contracts.  For the three month and nine month periods ended June 30,2004, the use of the monthly average spot rate instead of the average monthlyforward contract exchange rate to value Euro denominated sales would haveresulted in a sales decrease of $45,403 for the three months ended June 30,2004 and a sales increase of $863,965 for the nine months ended June 30,2005.

 

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**Item 4. Controls and Procedures**

 

Our Chief Executive Officer and Chief Financial Officer conducted anevaluation of the effectiveness of our disclosure controls and procedures.  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of June 30, 2005 in alerting them in a timelymanner to material information required to be included in our SEC reports. Inaddition, no change in our internal control over financial reporting occurredduring the nine months and fiscal quarter ended June 30, 2005 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**Special Note Regarding Forward Looking Statements**

 

This Quarterly Report contains forward-looking statements as that termis defined in the federal securities laws. The events described in forward-looking statements contained in thisQuarterly Report may not occur. Generally these statements relate to business plans or strategies,projected or anticipated benefits or other consequences of our plans orstrategies, projected or anticipated benefits from acquisitions to be made byus, or projections involving anticipated revenues, earnings or other aspects ofour operating results.  The words “may,” “will,”“expect,” “believe,” “anticipate,” “project,” “plan,” “intend,” “estimate,” and“continue,” and their opposites and similar expressions are intended toidentify 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 Form 10-Kfor the year ended September 30, 2004), 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 operationsand whether forward looking statements made by us ultimately prove to beaccurate.  Our actual results,performance and achievements could differ materially from those expressed orimplied in these forward-looking statements. We undertake no obligation to publicly update or revise anyforward-looking statements, whether from new information, future events orotherwise.

 

**PART II.  OTHER INFORMATION**

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

 

On November 8, 1996, we approved a stock repurchase program.  The program authorizes us to repurchase up to850,000 shares of our own stock. The stock repurchase program was extended by aresolution of our Board of Directors on December 17, 1997.

 

37

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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, 2004   |       | 567,067       |       | $            | 2.79       |                      | 567,067    |                  | 282,933    |   |
| October 1  to October 31, 2004   |       | 5,000         |       | 3.49         |       | 5,000                     |       | 277,933               |       |
| February 1  to February 28, 2005 |       | 20,000        |       | 4.57         |       | 20,000                    |       | 257,933               |       |
| March 1  to March 31, 2005       |       | 10,000        |       | 4.08         |       | 10,000                    |       | 247,933               |       |
| April 1  to April 30, 2005       |       | 5,200         |       | 4.39         |       | 5,200                     |       | 242,733               |       |
| Purchases  as of June 30, 2005        |       | 607,267       |       | $            | 2.89       |                      | 607,267    |                  | 242,733    |   |

 

**Item 6.  Exhibits**

 

**(c) Exhibits**

 

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

 

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

 

32       Certificationof Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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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:  | August 12, 2005     |   | By | /s/ Kenneth Plotkin |   |
|   |                     | KENNETH PLOTKIN |
|   |                     | Chief Executive Officer and Director |
|   |                     |
| Date:  | August 12, 2005     |   | By | /s/ Gerald Tucciarone |   |
|   |                     | GERALD TUCCIARONE |
|   |                     | Treasurer and Chief Financial Officer |
|        |                          |  |  |  |  |  |  |

 

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