SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001
OR
(_) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from
____________ to ____________
Commission file number 1-4324
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ANDREA ELECTRONICS CORPORATION
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(Exact name of registrant as specified in its charter)
New York 11-0482020
-------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
45 Melville Park Road, Melville, New York 11747
----------------------------------------------- ---------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 631-719-1800
------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
---
Indicate the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 14,786,857.
ITEM 1. FINANCIAL STATEMENTS
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2001 December 31, 2000
(unaudited) (audited)
-------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,129,723 $ 9,151,835
Accounts receivable, net of allowance for doubtful accounts of $180,543
and $186,121 2,387,296 3,503,713
Inventories 6,467,936 6,285,038
Prepaid expenses and other current assets 373,286 221,259
-------------- ---------------
Total current assets 14,358,241 19,161,845
PROPERTY AND EQUIPMENT, net 1,073,322 1,393,760
DEFERRED INCOME TAXES 1,806,615 1,806,615
GOODWILL 12,860,839 13,403,836
OTHER INTANGIBLE ASSETS 8,855,766 9,243,917
OTHER ASSETS 2,481,003 2,262,893
-------------- ---------------
Total assets $ 41,435,786 $ 47,272,866
============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 1,802,393 $ 2,107,660
Current portion of long-term debt 254,365 676,046
Other current liabilities 1,404,017 1,343,088
-------------- ---------------
Total current liabilities 3,460,775 4,126,794
LONG-TERM DEBT 101,801 195,867
-------------- ---------------
Total liabilities 3,562,576 4,322,661
-------------- ---------------
SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01 par value;
authorized: 1,000 shares, issued and outstanding: 348 and 500 shares,
respectively; liquidation value: $3,480,000 and $5,000,000, respectively 3,373,116 4,830,060
-------------- ---------------
SERIES C REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01 par value;
authorized: 1,500 shares, issued and outstanding: 750 shares; liquidation
value: $7,500,000 7,348,968 7,332,665
-------------- ---------------
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value; authorized: 4,997,500 shares; none issued
and outstanding -- --
Common stock, $.50 par value; authorized: 35,000,000 shares; issued and
outstanding: 14,786,857 and 13,897,572 shares, respectively 7,393,428 6,948,786
Additional paid-in capital 47,863,853 46,711,609
Deferred stock compensation (29,175)
Accumulated deficit (28,076,980) (22,872,915)
--------------- ----------------
Total shareholders' equity 27,151,126 30,787,480
-------------- ---------------
Total liabilities and shareholders' equity $ 41,435,786 $ 47,272,866
============== ===============
See Notes to Consolidated Financial Statements
-2-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
--------------------------------- -----------------------------------
2001 2000 2001 2000
-------------- -------------- ------------- -------------
NET SALES $ 2,617,929 $ 3,181,268 $ 5,233,568 $ 6,382,752
COST OF SALES 1,872,758 2,366,353 3,792,112 4,765,528
-------------- -------------- ------------- -------------
Gross profit 745,171 814,915 1,441,456 1,617,224
RESEARCH AND DEVELOPMENT EXPENSES 881,384 1,089,194 1,880,284 2,239,672
GENERAL, ADMINISTRATIVE AND SELLING EXPENSES
2,308,755 2,253,357 4,622,098 4,394,655
-------------- -------------- ------------- -------------
Loss from operations (2,444,968) (2,527,636) (5,060,926) (5,017,103)
-------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest income 79,212 116,554 167,935 223,392
Interest expense (32,062) (64,931) (47,065) (152,103)
Other 30,138 - 25,889 (14,820)
-------------- -------------- ------------- -------------
77,288 51,623 146,759 56,469
-------------- -------------- ------------- -------------
LOSS BEFORE PROVISION FOR INCOME TAXES (2,367,680) (2,476,013) (4,914,167) (4,960,634)
PROVISION FOR INCOME TAXES - - - -
-------------- -------------- ------------- -------------
Net loss $ (2,367,680) $ (2,476,013) $ (4,914,167) $ (4,960,634)
============== ============== ============= =============
PREFERRED STOCK DIVIDENDS 143,613 60,410 289,898 151,787
-------------- -------------- ------------- -------------
Net loss attributable to
common shareholders $ (2,511,293) $ (2,536,423) $ (5,204,065) $ (5,112,421)
============== ============== ============= =============
PER SHARE INFORMATION:
Net Loss Per Share:
Basic $ (.17) $ (.18) $ (.35) $ (.37)
============== ============== ============= =============
Diluted $ (.17) $ (.18) $ (.35) $ (.37)
============== ============== ============= =============
Shares used in computing net loss per share:
Basic 14,778,121 13,821,885 14,701,878 13,635,237
============== ============== ============= =============
Diluted 14,778,121 13,821,885 14,701,878 13,635,237
============== ============== ============= =============
See Notes to Consolidated Financial Statements
-3-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
Additional Deferred Total
Shares Common Paid-In Stock Accumulated Shareholders'
Outstanding Stock Capital Compensation Deficit Equity
----------- ----------- ------------ ------------ ------------ -------------
BALANCE, December 31, 2000 13,897,572 $ 6,948,786 $ 46,711,609 $(22,872,915) $ 30,787,480
Conversion of Series B Redeemable
Convertible Preferred Stock, net of
related costs 861,785 430,892 1,117,261 - - 1,548,153
Exercise of stock options, net of related
costs 27,500 13,750 2,733 - - 16,483
Option grant to Consultant - - 32,250 (29,175) - 3,075
Preferred stock dividends - - - (289,898) (289,898)
Net loss
- - - - (4,914,167) (4,914,167)
----------- ----------- ------------ ------------ ------------ ------------
BALANCE, June 30, 2001 14,786,857 $ 7,393,428 $ 47,863,853 $ (29,175) $(28,076,980) $ 27,151,126
=========== =========== ============ ============ ============ ============
See Notes to Consolidated Financial Statements
-4-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended June 30,
------------------------------------
2001 2000
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,914,167) $(4,960,634)
Adjustments to reconcile net loss to net cash used in operating
activities:
Non-cash interest expense 39,964
Non-cash stock compensation expense 3,075
Depreciation and amortization 1,349,303 1,815,117
(Increase) Decrease in:
Accounts receivable, net 1,116,417 (109,839)
Inventories (182,898) (179,573)
Prepaid expenses and other current assets (321,872) (284,189)
Other assets (241,259) 766
Decrease in:
Trade accounts payable (305,267) (294,218)
Other current and long term liabilities 16,693 (311,379)
----------- -----------
Net cash used in operating activities (3,479,975) (4,283,985)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (22,869) (174,876)
----------- -----------
Net cash used in investing activities (22,869) (174,876)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of debt obligations (535,751) (517,529)
Payment of convertible notes - (1,485,077)
Proceeds from issuance of common stock upon exercise of stock
options, net of related costs 16,483 1,357,246
----------- -----------
Net cash (used in) provided by financing activities (519,268) (645,360)
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,022,112) (5,104,221)
----------- -----------
CASH AND CASH EQUIVALENTS, beginning of period 9,151,835 9,153,148
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 5,129,723 $ 4,048,927
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Non-cash investing and financing activities:
Conversion of Series B Redeemable Convertible Preferred Stock and related
accrued dividends into common stock
$ 1,548,153 $ 2,417,402
=========== ===========
Option grant to consultant $ 32,250 $ -
=========== ===========
See Notes to Consolidated Financial Statements
-5-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation - The accompanying consolidated financial
statements include the accounts of Andrea Electronics Corporation and
its subsidiaries ("Andrea"). All intercompany balances and transactions
have been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial
reporting. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. The results of
operations for any interim period are not necessarily indicative of the
results to be expected for the fiscal year. For further information,
refer to the consolidated financial statements and accompanying
footnotes included in the Andrea's annual report on Form 10-K for the
year ended December 31, 2000.
2. Earnings Per Common Share - Basic net loss per common share is computed
by dividing net loss by the weighted-average number of common shares
outstanding. Diluted net loss per common share is computed by dividing
net loss by the weighted-average number of common shares and dilutive
common share equivalents and convertible securities then outstanding.
The following chart provides a reconciliation of information used in
calculating the per share amounts:
For the Three Months Ended For the Six Months Ended
June 30, June 30,
------------------------------------ ----------------------------------
2001 2000 2001 2000
------------- ---------------- ------------ --------------
Numerator:
Net loss $(2,367,680) $(2,476,013) $(4,914,167) $(4,960,634)
Preferred stock dividends 143,613 60,410 289,898 151,787
------------ ----------- ----------- -----------
Net loss attributable to
common shareholders $(2,511,293) $(2,536,423) $(5,204,065) $(5,112,421)
=========== =========== =========== ===========
Denominator:
Weighted-average common shares
outstanding - Basic and Diluted* 14,778,121 13,821,885 14,701,878 13,635,237
=========== =========== =========== ===========
Net loss per share - Basic and
Diluted $(.17) $(.18) $(.35) $(.37)
=========== =========== =========== ===========
* The effect of dilutive securities (stock options, Redeemable Convertible
Preferred Stock and warrants) have not been included herein as their
inclusion would be anti-dilutive.
3. Comprehensive Income - Andrea follows the provisions of SFAS No. 130,
"Reporting Comprehensive Income", which requires companies to report
all changes in equity during a period, except those resulting from
investment by owners and distribution to owners, in a financial
statement for the period in which they are recognized. Comprehensive
income is the
-6-
total of net income (loss) and all other non-owner changes in equity
(or other comprehensive income) such as unrealized gains/losses on
securities available-for-sale, foreign currency translation adjustments
and minimum pension liability adjustments. Comprehensive and other
comprehensive income must be reported on the face of the annual
financial statements or, in the case of interim reporting, in the
footnotes to the financial statements. For the six months ended June
30, 2001 and 2000, Andrea's operations did not give rise to items
includible in comprehensive income (loss), which were not already
included in net income (loss). Accordingly, the Andrea's comprehensive
loss is the same as its net loss for all periods presented.
4. Derivative Instruments - In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement establishes
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
and for hedging activities. SFAS No. 133, as by SFAS No. 137, was
effective for Andrea on January 1, 2001. This statement requires the
recognition of all derivative instruments as either assets or
liabilities in the balance sheet measured at fair value. Derivative
instruments will be recognized as gains or losses in the period of
change. If certain conditions are met where the derivative instrument
has been designated as a fair value hedge, the hedge items may also be
marked to market through earnings, thus creating an offset. If the
derivative is designed and qualifies as a cash flow hedge, the changes
in fair value of the derivative instrument may be recorded in
comprehensive income. While the Andrea operates in international
markets, it does so presently without the use of derivative
instruments. Accordingly, the adoption of the statement as of january
1, 2001 did n ot effect the Company's financial statements.
5. In July 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141, "Business
Combinations" ("FAS 141") and No. 142, "Goodwill and Other Intangible
Assets" ("FAS 142"). FAS 141 requires all business combinations
initiated after June 30, 2001 to be accounted for using the purchase
method. Under FAS 142, goodwill and intangible assets with indefinite
lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable
intangible assets that are not deemed to have indefinite lives will
continue to be amortized over their useful lives (but with no maximum
life). The amortization provisions of FAS 142, apply to goodwill and
intangible assets acquired after June 30, 2001. With respect to
goodwill and intangible assets acquired prior to July 1, 2001, the
Company is required to adopt FAS 142 effective January 1, 2002. The
Company is currently evaluating the effect that adoption of the
provisions of FAS 142 which are effective January 1, 2002, will have on
its results of operations and financial position.
6. Procurement Agreement - Andrea has an agreement with International
Business Machines and its subsidiaries ("IBM") to produce and procure
certain products, as defined. The agreement continues in full force and
effect unless terminated earlier for material breach by either party,
as defined. For the three month period ending June 30, 2001, sales of
the Andrea `s products to IBM and certain of IBM's affiliates,
distributors, licensees and integrators accounted for approximately 25%
of the Andrea 's total net sales.
7. Series B Redeemable Convertible Preferred Stock - On June 22, 1999,
Andrea issued and sold in a private placement $7,500,000 of Series B
Redeemable Convertible Preferred Stock (the "Series B Preferred
Stock"), and a warrant covering 75,000 shares of Andrea's Common Stock.
Each of the 750 shares of Series B Preferred Stock (par value $0.01 per
share) has a stated value of $10,000 plus dividends of 4% per annum,
which sum is convertible into Common Stock (par value $0.50 per share)
at a conversion price equal to the lower of $8.775 (the "Maximum
-7-
Conversion Price") and the average of the two lowest closing bid prices
of the Common Stock during the 15 consecutive trading days immediately
preceding a conversion date (the "Market Price"), subject to certain
adjustments, including anti-dilution. The 4% dividends may, at the
option of Andrea, be paid in cash. The warrant has an exercise price of
$8.775 per share and expires on June 18, 2004.
The Series B Preferred Stock becomes convertible into Andrea's Common
Stock according to a vesting schedule, with 12.5% of the shares having
become convertible on October 17, 1999, 12.5% of the shares having
become convertible on November 17, 1999, 12.5% of the shares having
become convertible on December 17, 1999, and an additional 12.5%
becoming convertible at the end of next five succeeding 30-day periods.
The vesting schedule will lapse for conversions occurring at the
Maximum Conversion Price and upon the occurrence of certain
extraordinary events, as defined. Any unconverted Series B Preferred
Stock that remains outstanding on June 18, 2004 will automatically
convert into Andrea's Common Stock. Andrea has reserved 3,653,745 of
Common Stock for issuance upon conversion of the shares of the Series B
Preferred Stock.
Upon the announcement of a major transaction, as defined in Andrea's
Certificate of Incorporation, the investors have the right to require
Andrea to redeem all or a portion of the investors' Preferred Shares at
a redemption price equal to the greater of 120% of the stated value
plus any accrued dividends or the Market Price on the day of
announcement. In addition, upon the occurrence of certain triggering
events, as defined, and depending on Andrea's control over such events,
the investors may have the right to require Andrea to i) redeem all or
a portion of the Preferred Shares at a redemption price equal to the
greater of 120% of the stated value plus any accrued dividends or the
Market Price on the day of announcement, or ii) pay a penalty equal to
1% of the remaining principal amount outstanding for a period not to
exceed 20 days in any 365 day period, and adjust the Maximum Conversion
Price, as defined.
The Company has engaged an investment banker to assist the Company in
obtaining additional capital and funding which if successful could
involve the triggering of the redemption rights. If such redemption
rights are triggered and the Company has insufficient funds to satisfy
the redemption, the Company will be required to obtain a waiver for
this Series B Preferred Stock holders. If the Series B Preferred Stock
holders do not consent to such waiver, the company's efforts to obtain
additional funding and capital will be materially adversely affected
and its and ability to continue its current operations will be
materially adversely affected.
On January 11, 2001 and January 18, 2001, 100 shares and 52 shares of
the Series B Preferred Stock, together with related accrued dividends,
were converted into 566,824 and 294,961 shares, respectively, of Common
Stock at a conversion price of $1.88, respectively. As of June 30,
2001, the Series B Preferred Stock is recorded net of the unaccreted
present value of the warrants of $106,882. Due to the redemption
features described above, the Series B Preferred Stock is presented
outside of stockholders' equity in the accompanying consolidated
balance sheet.
8. Series C Redeemable Convertible Preferred Stock - On October 10, 2000,
Andrea issued and sold in a private placement $7,500,000 of Series C
Redeemable Convertible Preferred Stock (the "Series C Preferred
Stock"). Each of the 750 shares of Series C Preferred Stock (par value
$0.01 per share) has a stated value of $10,000 plus dividends of 5% per
annum, which sum is convertible into Common Stock (par value $0.50 per
share) at a conversion price which was initially equal to $7.0565 or
110% of the average of the two lowest closing bid prices of the Common
Stock during the 5 consecutive trading days immediately preceding the
issuance date for the first nine months. The conversion price will be
reset every six months thereafter to the lesser of the then existing
conversion price or the average of the two lowest closing bid prices of
the Common Stock during the 5 consecutive trading days immediately
preceding the six-month reset dates or, for the period beginning on the
day two years after the initial issuance and ending on the maturity of
the Series C Preferred Stock, the least of: (i) the then existing
conversion price, (ii) the average of the two lowest closing bid prices
of the Common Stock during the 15 consecutive trading days immediately
preceding such two year date or (iii) the closing bid price on the day
of conversion, subject in each case to certain adjustments. The current
conversion price is $1.555. The 5% dividend amount may, at the option
of Andrea, be paid in cash or in shares of Andrea's Common Stock. The
Series C Preferred Stock is convertible or redeemable at
-8-
maturity by Andrea, based upon certain circumstances at that time, and
is redeemable by the holder upon certain events. Andrea has the right
to require the conversion of the Series C Preferred Stock after one
year upon the satisfaction of certain conditions. During the eighteen-
month period beginning on October 10, 2000, the investors may exercise
an option to purchase up to an additional $2.5 million of Andrea's
Series C Preferred Stock, subject to the closing bid price of Andrea's
Common Stock being no less than $7.0565 as of the date of such
exercise. These additional Preferred Shares would be identical in all
material respects to those purchased at Initial Issuance and,
consequently, a contingent beneficial conversion feature exists which
may result in the Investor obtaining a conversion price for such
additional Preferred Shares which, at the time of the exercise of the
option, could be less than the market price of the Common Stock at such
date. In accordance with the provisions of Emerging Issues Task Force
Issue No. 98-5, "Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios",
Andrea may be required to record, at the time of exercise for such
additional Preferred Shares, a charge to accumulated deficit as a
result of this beneficial conversion right.
Upon the announcement of a major transaction or upon certain triggering
events, as defined, the investors have the right to require Andrea to
redeem all or a portion of the investors' Series C Preferred Shares at
a redemption price equal to the greater of (i) 120% of the Liquidation
Value, as defined, or (ii) the product of the applicable conversion
rate in effect on the date of the major transaction or the triggering
event and the closing bid price of the Common Stock of Andrea on the
trading day immediately preceding the major transaction or triggering
event or the closing bid price of Andrea's Common Stock on the date the
holder's delivery to Andrea of notice. In addition, if Andrea is unable
to effect such redemption (i) interest will accumulate on the value of
the Series C Preferred Shares that Andrea is unable to redeem at the
rate of 2% per month and (b) the holders of the Series C Preferred
Stock are entitled to void their redemption notices and receive a reset
of their applicable conversion price.
The Company has engaged an investment banker to assist the Company in
obtaining additional capital and funding which if successful could
involve the triggering of the redemption rights. If such redemption
rights are triggered and the Company has sufficient funds to satisfy
the redemption, the Company will be required to obtain a waiver for
this Series C Preferred Stock holders. If the Series C Preferred Stock
holders do not consent to such a waiver, the Company's efforts to
obtain additional funding and capital will be adversely affected and
its ability to continue its current operations will be materially
adversely affected. The Company is currently negotiating with the
Series C Preferred Stock holders to obtain a waiver from certain
registration rights provisions of the Series C Preferred Stock which
have, in turn, triggered the redemption rights provisions. While the
Company believes it will be successful in obtaining such waiver,
failure to obtain such waiver will materially adversely affect the
Company's efforts to obtain additional funding and capital and its
ability to continue its current operations.
As of June 30, 2001, the Series C Preferred Stock is recorded net of
unaccreted costs of $151,032. Due to the redemption features described
above, the Series C Preferred Stock is presented outside of
stockholders' equity in the accompanying consolidated balance sheet.
Furthermore, in accordance with EITF Issue 00-27, "Application of EITF
Issue No. 98-5 to Certain Convertible Instruments", Andrea may be
required to record a charge to accumulated deficit at the end of the
reset period and each reset period thereafter, as defined, which will
reduce income available to common shareholders and earnings per share
at such times. The magnitude of this charge, which could be material,
will depend, to an extent, on Andrea's stock price at the reset date.
9. Acquisition Of Business -On May 5, 1998, Andrea acquired all of the
outstanding shares of capital stock of Lamar (the "Acquisition"). The
consideration paid by Andrea for the Acquisition was approximately
1,800,000 shares of restricted common stock, $1,000,000 in cash and
$2,000,000 in notes payable. The cash was recorded at stated value.
Both the notes payable and the shares issued were discounted to reflect
the appropriate value of the consideration paid taking into account the
underlying restrictions, arriving at values of $1,615,000 and
$23,129,532, respectively. Of the approximately 1,800,000 shares issued
to the sellers, one-third became freely transferable on the first
anniversary of the closing; an additional one-third became transferable
on the second anniversary; and the last one-third on the third
anniversary. Of the aggregate cash consideration to be paid by Andrea,
$1,500,000, $500,000 and $500,000 was paid during 1998, 1999 and 2000,
respectively, and the remaining $500,000 was paid on the thirty-six
month anniversary of the closing (May 5, 2001). The Acquisition was
accounted for under the purchase method of accounting and, accordingly,
the operating results of Lamar have been included in the
-9-
consolidating operating results since the date of acquisition. The
purchase, for total aggregate consideration of $27.6 million, including
costs associated with the acquisition of Lamar of $1.4 million,
resulted in intangible assets of $27.3 million. The goodwill and other
intangibles, together with their respective useful lives consist of the
following as of June 30, 2001:
Net Value at June 30, Estimated
2001 Useful Life
------------------------ ---------------
Goodwill $12,860,839 15 years
===========
Other Intangible Assets:
Core Technology $ 8,693,640 15 years
Workforce in Place 162,126 7 years
-----------
Total Other Intangible Assets $ 8,855,766
===========
2. Segment Information - Andrea follows the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information."
Reportable operating segments are determined based on the Company's
management approach. The management approach, as defined by SFAS No.
131, is based on the way that the chief operating decision-maker
organizes the segments within an enterprise for making operating
decisions and assessing performance. While Andrea's results of
operations are primarily reviewed on a consolidated basis, the chief
operating decision-maker also manages the enterprise in three segments:
: (i) Andrea Anti-Noise Products, (ii) Aircraft Communications
Products, and (iii) Andrea DSP Microphone and Software Products. The
following represents selected consolidated financial information for
the Andrea 's segments for the three months ended June 30, 2001, and
2000:
Andrea DSP
Aircraft Microphone and
Andrea Anti-Noise Communications Software
Segment Data Products Products Products June 30, 2001
--------------------------------- ------------------ ---------------- --------------- -------------
Net sales $ 1,171,492 $ 1,313,201 $ 133,236 $ 2,617,929
Income (loss) from operations (841,038) 584,904 (2,188,834) (2,444,968)
Depreciation 97,073 48,495 42,279 187,847
Andrea DSP
Aircraft Microphone and
Andrea Anti-Noise Communications Software
Segment Data Products Products Products June 30, 2001
--------------------------------- ------------------ ---------------- --------------- -------------
Net sales $ 2,424,542 $ 638,453 $ 118,273 $ 3,181,268
Income (loss) from operations 107,696 (169,896) (2,465,436) (2,527,636)
Depreciation 98,242 46,983 82,109 227,334
International revenues are based on the country in which the end-user
is located. For the three months ended June 30, 2001 and 2000, sales
and accounts receivable by geographic area are as follows:
Geographic Data June 30, 2001 June 30, 2000
--------------------- --------------- ---------------
Sales:
-10-
Geographic Data June 30, 2001 June 30, 2000
--------------------- --------------- ---------------
United States $ 2,030,543 $ 1,905,804
Europe 249,057 350,817
Other foreign 338,329 924,647
----------- -----------
$ 2,617,929 $ 3,181,268
=========== ===========
Accounts receivable:
United States $ 1,892,539 $ 2,069,383
Europe 304,816 434,375
Other foreign 189,941 376,784
----------- -----------
$ 2,387,296 $ 2,880,542
=========== ===========
11. Legal Proceedings - As previously reported in "Item 3. Legal
Proceedings" in Andrea's Annual Report on Form 10-K for the year ended
December 31, 2000, on November 17, 1998 a complaint was filed against
Andrea in the U.S. District Court for the Eastern District of New York
by NCT Group, Inc. ("NCT"; formerly Noise Cancellation Technologies,
Inc.) and NCT Hearing Products, Inc., one of NCT's subsidiaries. The
complaint involves two of Andrea's patents relating to certain active
noise reduction technology. Andrea does not currently derive
significant sales or licensing revenue from this technology. The
complaint requests a declaration that the two patents are invalid and
unenforceable and that NCT's products do not infringe the patents. The
complaint alleges that Andrea has engaged in unfair competition by
misrepresenting the scope of the two patents, tortuously interfering
with prospective contractual rights between NCT and its existing and
potential customers, making false and disparaging statements about NCT
and its products, and falsely advertising certain of Andrea's
technology. The complaint seeks to enjoin Andrea from engaging in these
alleged activities and seeks compensatory damages of not less than
$5,000,000, punitive damages of not less than $50,000,000 and
plaintiffs' costs and attorneys' fees. Andrea filed and served an
answer to the NCT complaint, denying the allegations and asserting
various affirmative defenses and counterclaims. Andrea's counterclaims
allege that NCT has willfully infringed the two patents, and that NCT
has engaged in trademark infringement, false designation of origin, and
unfair competition with respect to Andrea's mark ANR READY. The
counterclaims seek injunctive relief with respect to the allegations of
patent infringement, trademark infringement, false designation of
origin and unfair competition. Andrea also seeks exemplary and punitive
damages, prejudgment interest on all damages, costs, reasonable
attorneys' fees and expenses. Andrea believes that, based upon the
advice of outside legal counsel, NCT's allegations are without merit,
and we intend to vigorously defend the claims described above.
In March 1999, Andrea was notified about a claim filed by the owners of
property adjoining Andrea's Long Island City facility with respect to
certain environmental matters. In September 1999, a complaint was filed
in the Supreme Court of the State of New York, County of Nassau seeking
$1 million in compensatory damages from Andrea. While no assurance can
be given as to the ultimate outcome of this matter, Andrea believes,
based on the advice of outside legal counsel, that the claim is without
merit and is vigorously defending itself.
In addition to the litigation noted above, Andrea is from time to time
subject to routine litigation incidental to its business. While it is
not feasible to predict or determine the final outcome of the claims
against Andrea, management believes that the results of the above noted
litigation and other pending legal proceedings will not have a material
adverse effect on Andrea's financial condition, results of operations
or liquidity.
-11-
12. Reclassifications - Certain prior year amounts have been reclassified to
conform to the current year presentation.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Andrea Electronics designs, develops and manufacturers state-of-the-art
microphone technologies and equipment for enhancing speech-based applications
software and communications that require high performance and high quality voice
input.
Andrea's products and technologies optimize the performance of speech-based
applications software in markets such as:
. voice communication over the Internet;
. speech recognition and dictation to desktop, laptop and hand-held
computers;
. audio/video conferencing;
. computer-based automobile monitoring and control systems for use by
drivers and passengers;
. electronic equipment for incorporation into home appliances and
industrial and commercial office equipment that is activated and
controlled by voice; and
. interactive games where one or more players participate over the
Internet.
Our patented Active Noise Cancellation microphone and Active Noise
Reduction earphone technologies help to ensure clear speech in personal computer
and telephone headset applications. Active Noise Cancellation microphone
technology uses electronic circuits that distinguish a speaker's voice from
background noise in the speaker's environment and then cancels the noise from
the signal to be transmitted by the microphone. Active Noise Reduction earphone
technology uses electronic circuits that distinguish the signal coming through
an earphone from background noise in the listener's environment and then reduces
the noise heard by the listener. Together with our lower-end noise cancelling
headset products, these technologies and related products comprise our Andrea
Anti-Noise line of business.
Our patented and patent-pending Andrea Digital Super Directional Array and
Andrea Direction Finding and Tracking Array technologies enable the person
speaking to be several feet from the microphone, and frees the speaker from
having to hold the microphone (we refer to this capability as "far-field"
microphone use). Our DSDA and DFTA microphone products convert sound received by
the array of microphones in the product into digital signals that are then
processed to cancel background noise from the signal to be transmitted. These
two technologies represent the core technologies within our portfolio of far-
field technologies. We are initially targeting our far-field microphone
technologies at the market for personal computers designed for use in
automobiles, trucks and buses to control sound systems, mobile telephones,
satellite-based navigation systems, and other devices within vehicles. These
technologies and related products comprise our Andrea Digital Signal Processing
(DSP) Microphone and Software line of business.
-12-
In May 1998, we acquired Lamar Signal Processing, Ltd., an Israeli
corporation engaged in the development of scalable, digital signal processing-
based directional, noise cancellation microphone technologies, which included
primarily DSDA and DFTA. The consideration paid by Andrea for Lamar was
approximately 1,800,000 shares of restricted common stock, $1,000,000 in cash
and $2,000,000 in notes payable. We recorded the cash at stated value. We
discounted the value of the notes payable to $1,615,000 to reflect Andrea's
borrowing rate as well as the time value of the payments on the notes, and we
discounted the value of the shares to $23,129,532 to reflect, among other
things, trading restrictions on the shares. We believe that the acquired
technologies, together with the research staff at Lamar, provide Andrea with
noise filtering capabilities and performance that is superior to other DSP-based
technologies in the marketplace, and unattainable in traditional mechanical-
based microphone solutions.
We are incorporated under the laws of the State of New York and have been
engaged in the electronic communications industry since 1934. For several
decades prior to our entry into the voice-activated computing market in the
1990's, our primary business was selling intercom systems for military and
industrial use. We refer to this line of business as Aircraft Communications. We
are seeking to apply our knowledge of the military and industrial markets to
develop applications of our Andrea DSP Microphone and Software technologies.
The interim results of operations of the Andrea presented in this report
are not necessarily indicative of the actual sales or results of operations to
be realized for the full year.
Cautionary Statement Regarding Forward-Looking Statements
Certain information contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations for the three months ended June
30, 2001 (the "2001 Second Quarter") compared to the three months ended June 30,
2000 (the "2000 Second Quarter"), and for the six months ended June 30, 2001
(the "2001 First Half") compared to the six months ended June 30, 2000 (the
"2000 First Half"), are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The words "anticipates," "believes,"
"estimates," "expects," "intends," "plans," "seeks," variations of such words,
and similar expressions are intended to identify forward-looking statements. We
have based these forward-looking statements on our current expectations,
estimates and projections about our business and industry, our beliefs and
certain assumptions made by our management. Investors are cautioned that matters
subject to forward-looking statements involve risks and uncertainties including
economic, competitive, governmental, technological and other factors that may
affect our business and prospects. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. In order to obtain the benefits of these "safe harbor"
provisions for any such forward-looking statements, we wish to caution investors
and prospective investors about the following significant factors, which, among
others, have in some cases affected our actual results and are in the future
likely to affect our actual results and could cause them to differ materially
from those expressed in any such forward-looking statements. These factors
include:
Because our operating results are subject to significant fluctuation, period-to-
period comparisons of our operating results may not necessarily be meaningful
and you should not rely on them as indications of our future performance.
Our results of operations have historically been and are subject to
continued substantial annual and quarterly fluctuations. The causes of these
fluctuations include, among other things:
- the volume of sales of our products under our collaborative marketing
arrangements;
-13-
- the cost of development of our products under our collaborative
development arrangements;
- the mix of products we sell;
- the mix of distribution channels we use;
- the timing of our new product releases and those of our competitors;
- fluctuations in the computer and communications hardware and software
marketplace; and
- general economic conditions.
We cannot assure that the level of sales and gross profit, if any, that we
achieve in any particular fiscal period will not be significantly lower than in
other fiscal periods. Our revenues for the 2001 Second Quarter were
approximately $2.6 million compared to approximately $3.2 million in the 2000
Second Quarter. For both the 2001 Second Quarter and 2000 Second Quarter, we had
a net loss attributable to common shareholders of approximately $2.5 million.
Our revenues for the 2001 First Half were approximately $5.2 million compared to
approximately $6.4 million in the 2000 First Half. For the 2001 First Half we
had a net loss attributable to common shareholders of approximately $5.2 million
compared to a net loss attributable to common shareholders of $5.1 million in
the 2000 First Half. We have experienced a significant decline in headset unit
shipments, offset to an extent, by an increase in aircraft communication
revenues. In response, we are examining opportunities for cost-reduction,
production efficiencies and further diversification of our business. But to
remain competitive, we intend to continue incurring substantial research and
development, marketing and general and administrative expenses. We may not be
able to easily and quickly reduce these expenses if our sales revenue falls
below our expectations and, therefore, our net income or loss may be
disproportionately affected by any reduction in sales revenue. Furthermore, our
acquisition in 1998 of Lamar Signal Processing, Ltd. resulted in a substantial
amount of goodwill and other intangible assets. The amortization of these
intangible assets has, and will continue to have, a negative, non-cash impact on
our results of operations. As a result of these factors, we expect to continue
to accumulate losses and the market price of our common stock could decline.
If we fail to obtain additional capital, we may be required to significantly
reduce, sell or refocus, our operations and our business, results of operations
and financial condition could be materially and adversely effected.
From time to time during the past several years, we have raised additional
capital from external sources. We expect to continue to have to raise additional
capital from external sources. These sources may include private or public
financings through the issuance of debt, convertible debt or equity, or
collaborative arrangements. The Company has engaged an investment banker to
assist the Company in seeking additional capital and funding. Additional capital
and funding may not be available on favorable terms, if at all. Additionally, we
may only be able to obtain additional capital or funds through arrangements that
require us to relinquish rights to our products, technologies or potential
markets, in whole or in part, or result in the sale of the Company. In the event
we are unsuccessful in raising additional capital or funding, our funding will
be primarily reliant upon existing funding sources and gross cash flows from
operations which are expected to be insufficient to maintain our operations at
current levels. Additionally, the Company's funding and capital raising efforts
could trigger change in control payments due to certain executive officers of
the Company under their employment contracts.
Shares Eligible For Future Sale May Have An Adverse Effect On Market Price; You
May Experience Substantial Dilution
Sales of a substantial number of shares of our common stock in the public
market could have the effect of depressing the prevailing market price of our
common stock. Of the 35,000,000 shares of common stock presently authorized
(subject to increase to 70,000,000 upon the filing of an amendment to our
Restated Certificate of Incorporation approved by our Board and shareholders),
14,786,857 were outstanding as of August 13, 2001. This does not include
5,915,625 shares of our common stock reserved
-14-
for issuance upon exercise of outstanding awards granted under our 1991
Performance Equity Plan and 1998 Stock Plan and shares of our common stock
reserved for further awards under the 1998 Stock Plan and 8,650,662 shares of
common stock reserved for issuance upon conversion of the Series B and Series C
convertible preferred stock and exercise of related warrants. In addition, in
May 1998, we issued 1,800,000 shares of common stock as part of the
consideration for our acquisition of Lamar Signal Processing, Ltd. Trading
restrictions on these 1,800,000 shares have expired and are subject to demand
and piggyback registration rights. To date, 902,880 of the 1,800,000 shares have
been registered for sale under the Securities Act of 1933.
Conversions of our Series B convertible preferred stock and Series C convertible
preferred stock may result in substantial dilution to other holders of our
common stock.
Currently, we have 348 shares of Series B convertible preferred stock and
750 shares of Series C convertible preferred stock outstanding. Both the Series
B convertible preferred stock and the Series C convertible preferred stock are
convertible into shares of common stock, subject to ownership limitations that
prohibit the holders of the preferred stock from owning more than 4.99% of the
outstanding shares of common stock at the time of conversion or 9.99% over the
sixty day period prior to the conversion. These restrictions do not prevent
purchasers from converting and selling some of their holdings and then later
converting the rest of their holdings.
As the price of our common stock decreases, the number of shares of common stock
issuable upon conversion of our Series B convertible preferred stock and Series
C convertible preferred stock increases.
The variable conversion price of the Series B convertible preferred stock
and any reset of the conversion price of the Series C convertible preferred
stock are functions of the market price of our common stock. If the price of our
common stock decreases over time, the number of shares of common stock issuable
upon conversion of each series will increase.
The following table illustrates the varying amounts of shares of common
stock issuable upon conversion of all 348 shares of Series B Convertible
Preferred Stock at the indicated conversion prices (without regard to any
limitations on conversion) and assuming that the 4% additional amount is paid in
cash:
Number of Shares of Common
Stock Issuable Upon Percentage of Outstanding
Conversion Price Conversion/(1)/ Common Stock/(2)/
----------------- -------------------------- -------------------------
$1.00 3,480,000 19%
$2.00 1,740,000 11%
$3.00 1,160,000 7%
$4.00 870,000 6%
$5.00 696,000 4%
$6.00 580,000 4%
$7.00 497,143 3%
$8.00 435,000 3%
(1) The Series B Holder is prohibited from converting its holdings of the Series
B Convertible Preferred Stock if after giving effect to such conversion it
would beneficially own in excess of 4.99% or, over the sixty day period
prior to the conversion, 9.99% of the outstanding shares of our common stock
following such conversion.
(2) Based on 14,786,857 shares of common stock outstanding as of August 13,
2001.
The following table illustrates, as of any reset date and assuming the
conversion price indicated is lower than the then applicable conversion price on
that date, the varying amounts of shares of common stock that would be issuable
upon conversion of all outstanding 750 shares of Series C convertible
-15-
preferred stock at the indicated conversion prices (without regard to any
limitations on conversion) and assuming that the 5% additional amount is paid in
cash:
Number of Shares of Common
Stock Issuable Upon Percentage of Outstanding
Conversion Price Conversion/(1)/ Common Stock/(2)/
----------------- -------------------------- -------------------------
$1.00 7,500,000 34%
$2.00 3,750,000 20%
$3.00 2,500,000 14%
$4.00 1,875,000 11%
$5.00 1,500,000 9%
$6.00 1,250,000 8%
$7.00 1,071,429 7%
(1) The Series C Holder is prohibited from converting its holdings of the Series
C Convertible Preferred Stock if after giving effect to such conversion it
would beneficially own in excess of 4.99% or, over the sixty day period
prior to the conversion, 9.99% of the outstanding shares of our common stock
following such conversion.
(2) Based on 14,786,857 shares of common stock outstanding as of August 13,
2001.
The following table illustrates the varying amounts of shares of common
stock that would be issuable upon conversion of all 348 outstanding shares of
Series B convertible preferred stock and all 750 outstanding shares of Series C
convertible preferred stock at the indicated conversion prices (without regard
to any limitations on conversion) and assuming that all additional amounts are
paid in cash:
Number of Shares of Common
Stock Issuable Upon Percentage of Outstanding
Conversion Price/(1)/ Conversion/(2)/ Common Stock/(3)/
------------------- -------------------------- -------------------------
$1.00 10,980,000 43%
$2.00 5,490,000 27%
$3.00 3,660,000 20%
$4.00 2,745,000 16%
$5.00 2,196,000 13%
$6.00 1,830,000 11%
$7.00 1,568,571 10%
(1) The calculation assumes that the conversion price of the Series B and Series
C convertible preferred stock are equal. This could occur at any reset date
on which the conversion price for the Series C convertible preferred stock
is adjusted down to the Series B convertible preferred stock conversion
price. The conversion price of the Series B convertible preferred stock
would be the prevailing market price.
(2) The Series B and Series C holder is prohibited from converting the Series C
or Series B convertible preferred stock, or from exercising the warrants
issued in connection with the Series B convertible preferred stock, in some
circumstances.
(3) Based on 14,786,857 shares of common stock outstanding as of August 13,
2001.
Sales of an increased number of shares of common stock issued upon conversion of
the Series B convertible preferred stock and the Series C convertible preferred
stock resulting from a declining market price for our common stock can cause the
market price of our common stock to decline further.
Disregarding the manner in which the shares of common stock issued upon
conversion of the Series B convertible preferred stock and the Series C
convertible preferred stock are sold as well as any
-16-
other factors such as reactions to our operating results and general market
conditions which may be operative in the market at such time, an increase in the
number of shares of common stock eligible for sale can cause a decrease in the
market price of our common stock. This decrease could reduce the conversion
prices of the Series B convertible preferred stock and the Series C convertible
preferred stock, leading to a further increase in the number of shares of common
stock issuable upon future conversions and a further decline in our stock price.
Short sales of our common stock may be attracted by or accompany conversions of
Series B convertible preferred stock and Series C convertible preferred stock,
which sales may cause downward pressure upon the price of our common stock
Short sales of our common stock may be attracted by or accompany the sale
of converted common stock, which in the aggregate could cause downward pressure
upon the price of the common stock, regardless of our operating results, thereby
attracting additional short sales of the common stock. The result of conversions
of the Series B and Series C convertible preferred stock at declining conversion
prices would be increasing and substantial dilution of the interests of the
other holders of common stock.
If we fail to market and commercialize our Andrea Anti-Noise and Andrea Digital
Signal Processing Microphone and Software products, our revenues may not
increase at a high enough rate to improve our results of operations or at all.
Our business, results of operations and financial condition depend on
successful commercialization of our Andrea Anti-Noise and Andrea DSP Microphone
and Software products and technologies. Since we began sales of the initial
Andrea Anti-Noise products in 1995, we have been expanding the number of
products in this line. We introduced our first Andrea Digital Super Directional
Array products in 1998 and we are initially targeting these and our other Andrea
DSP Microphone and Software products at the market for computer-based automobile
monitoring and control systems for use by drivers and passengers. This market is
commonly referred to as the automobile telematics market. The success of these
products is subject to the risks frequently encountered by companies in an early
stage of product commercialization, particularly companies in the computing and
communications industries.
If we are unable to obtain market acceptance of our voice interface and Internet
communications products and technologies or if market acceptance of these
products and technologies occurs at a slow rate, then our business, results of
operations and financial condition will be materially and adversely affected.
We and our competitors are focused on developing and commercializing
products and technologies that enhance the use of voice, particularly in noisy
environments, for a broad range of computer and communications applications.
These products and technologies have been rapidly evolving and the number of our
competitors has grown, but the markets for these products and technologies are
subject to a high level of uncertainty and have been developing slowly. We,
alone or together with our industry, may be unsuccessful in obtaining market
acceptance of these products and technologies.
If we fail to develop and successfully introduce new products and technologies
in response to competition and evolving technology, we may not be able to
attract new customers or retain current customers.
The markets in which we sell our Andrea Anti-Noise and Andrea DSP
Microphone and Software products and our Aircraft Communication products are
highly competitive. We may not compete successfully with any of our competitors.
Most of our current and potential competitors have significantly greater
financial, technology development, marketing, technical support and other
resources than we do. Consequently, these competitors may be able to respond
more quickly to new or emerging
-17-
technologies and changes in customer requirements, or devote greater resources
to the development, marketing, and sale of their products than we can. One or
more of these competitors may independently develop technologies that are
substantially equivalent or superior to our technology. The introduction of
products incorporating new technologies could render our products obsolete and
unmarketable and could exert price pressures on existing products.
We are currently engaged in the development of digital signal processing
products and technologies for the voice, speech and natural language interface
markets. We may not succeed in developing these new digital signal processing
products and technologies, and any of these new digital signal processing
products or technologies may not gain market acceptance.
In the markets for our traditional products, we often compete with major
defense electronics corporations as well as smaller manufacturing firms which
specialize in supplying products and technologies for specific military
initiatives.
Further, the markets for our products and technologies are characterized by
evolving industry standards and specifications that may require us to devote
substantial time and expense to adapt our products and technologies. We may not
successfully anticipate and adapt our products and technologies in a cost
effective and timely manner to changes in technology and industry standards or
to introductions of new products and technologies by others that render our then
existing products and technologies obsolete.
If our marketing collaborators do not effectively market those of their products
with which our products are included or incorporated, our sales growth could be
adversely affected.
We have entered into several collaborative and distribution arrangements
with software publishers and computer hardware manufacturers relating to the
marketing and sale of Andrea Anti-Noise products and Andrea DSP Microphone and
Software products through inclusion or incorporation with the products of our
collaborators. Our success will therefore be dependent to a substantial degree
on the efforts of these collaborators to market those of their products with
which our products are included or incorporated. Our collaborators may not
successfully market these products. In addition, our collaborators generally are
not contractually obligated to any minimum level of sales of our products or
technologies, and we have no control over their marketing efforts. Furthermore,
our collaborators may develop their own microphone, earphone or headset products
that may replace our products or technologies or to which they may give higher
priority.
If we fail to maintain sales of Andrea Anti-Noise products and Andrea DSP
Microphone and Software products to IBM, we would experience a material adverse
effect on our business, results of operations and financial condition.
We are substantially dependent on our product procurement relationship with
IBM. During the 2001 Second Quarter, IBM and certain of IBM's affiliates,
distributors, licensees and integrators accounted for 25% of our net sales. This
represents an approximate 49% decrease from the 2000 Second Quarter. While we
are a party to a procurement agreement with IBM covering the purchase by IBM of
certain of our Andrea Anti-Noise microphone and earphone products for inclusion
with certain of IBM's personal computer products, IBM is not obligated to
purchase these products and is free to purchase microphone and earphone products
and technologies from our competitors. Our failure to maintain sales of Andrea
Anti-Noise Products and Andrea DSP Microphone and Software Products to IBM would
have a material adverse effect on our business, results of operations and
financial condition.
-18-
If we fail to maintain sales of Aircraft Communication Products to the U.S.
Government, we would experience a material adverse effect on our business,
results of operations and financial condition.
We are substantially dependent on product sales to the U.S. Government.
During the 2001 Second Quarter, the U.S. Government accounted for 27% of our net
sales. The U.S. Government is not obligated to continue to purchase these
products and is free to purchase similar products from our competitors. Our
failure to maintain sales of Aircraft Communication Products to the U.S.
Government would have a material adverse effect on our business, results of
operations and financial condition.
Shortages of, or interruptions in, the supply of more specialized components for
our Andrea Anti-Noise products and Andrea DSP Microphone products could have a
material adverse effect on our sales of these products.
We conduct assembly operations at our facilities in New York and Israel
and through subcontractors using purchased components. Some specialized
components for the Andrea Anti-Noise and Andrea DSP Microphone products, such as
microphones and digital signal processing boards, are available from a limited
number of suppliers and subject to long lead times. We may not be able to
continue to obtain sufficient supplies of these more specialized components,
particularly if our sales of Andrea Anti-Noise and Andrea DSP microphone
products increase substantially or market demand for these components otherwise
increases.
If our subcontractor fails to meet our production and shipment schedules, our
business, results of operations and financial condition would be materially and
adversely affected.
We conduct assembly operations at our facilities in New York and Israel
and through subcontracting. During initial production runs of Andrea Anti-Noise
and Andrea DSP Microphone products, we perform assembly operations at our New
York facility from purchased components. As sales of any particular product
increase, assembly operations are primarily transferred to a subcontractor in
Asia.
Our ability to compete may be limited by our failure to adequately protect our
intellectual property or by patents granted to third parties.
We rely on a combination of patents, patent applications, trade
secrets, copyrights, trademarks, nondisclosure agreements with our employees,
licensees and potential licensees, limited access to and dissemination of our
proprietary information, and other measures to protect our intellectual property
and proprietary rights. However, the steps that we have taken to protect our
intellectual property may not prevent its misappropriation or circumvention. In
addition, numerous patents have been granted to other parties in the fields of
noise cancellation, noise reduction, computer voice recognition, digital signal
processing and related subject matter. We expect that products in these fields
will increasingly be subject to claims under these patents as the numbers of
products and competitors in these fields grow and the functionality of products
overlap. Claims of this type could have an adverse effect on our ability to
manufacture and market our products or to develop new products and technologies,
because the parties holding these patents may refuse to grant licenses or only
grant licenses with onerous royalty requirements. Moreover, the laws of other
countries do not protect our proprietary rights to our technologies to the same
extent as the laws of the United States.
An unfavorable ruling in any current litigation proceeding or future proceeding
may adversely affect our business, results of operations and financial
condition.
From time to time we are subject to litigation incidental to our
business. For example, we are subject to the risk of adverse claims,
interference proceedings before the U.S. Patent and Trademark Office,
oppositions to patent applications outside the United States, and litigation
alleging infringement of
-19-
the proprietary rights of others. Litigation to establish the validity of
patents, to assert infringement claims against others, and to defend against
patent infringement claims can be expensive and time-consuming, even if the
outcome is in our favor.
As more fully described in "Item 3. Legal Proceedings" of this annual
report, on November 17, 1998 a complaint was filed against us in the U.S.
District Court for the Eastern District of New York by NCT Group, Inc. and NCT
Hearing Products, Inc., one of NCT's subsidiaries, requesting a declaration that
two of our patents, which relate to active noise reduction technology applicable
to aircraft passenger headphones, are invalid and unenforceable and that these
patents are not being infringed by NCT's products. The complaint also seeks to
enjoin us from engaging in certain alleged activities and seeks compensatory
damages of not less than $5 million, punitive damages of not less than $50
million and plaintiffs' costs and attorneys' fees.
On December 30, 1998, we filed and served an answer to the NCT
complaint, denying the allegations and asserting affirmative defenses and
counterclaims. The counterclaims seek injunctive relief for patent infringement,
trademark infringement, false designation of origin and unfair competition. We
are also seeking exemplary and punitive damages, prejudgment interest on all
damages, costs, reasonable attorneys' fees and expenses. During the second half
of 1999, both NCT and Andrea submitted briefs to the court on whether to have an
early hearing on the meaning of the claims in the two Andrea patents. This type
of hearing is called a "Markman Hearing." We are unable to anticipate when the
court will issue a decision on this question. We and NCT are proceeding with
discovery, including document production and depositions. If this suit is
ultimately resolved in favor of NCT, we could be materially adversely effected.
We believe, however, that NCT's allegations are without merit and we intend to
vigorously defend ourselves and to assert against NCT the claims described
above.
As more fully described in "Item 3. Legal Proceedings" of this annual
report, on March 11, 1999, we were notified about a claim filed with the New
York State Environmental Protection and Spill Compensation Fund by the owners
(Mark J. Mergler and Ann Mergler) of property adjoining our former Long Island
City facility. This claim alleges property damages arising from petroleum
migrating from our former facility and was purportedly detected in the basement
of the claimants' property. In their claim to the fund, the claimants alleged
that their property has been damaged and that they have incurred remedial costs.
In the event the fund honors this claim in whole or in part, we may be liable to
reimburse the fund. The New York State Department of Environmental Conservation
has asserted a demand that we investigate and remediate the discharge of
petroleum from a fuel oil storage tank at our former Long Island City facility,
and determine whether the petroleum discharge has migrated to the claimants'
adjoining property.
We engaged environmental consultants to investigate the discharge from
the fuel oil storage tank and we are currently funding remediation work. We
denied, however, the allegations that any petroleum discharge has migrated to
the claimant's property and objected to the claim made by the claimant to the
fund. On September 2, 1999, a civil action related to this matter was commenced
in the Nassau County Supreme Court by Mark J. Mergler and Ann Mergler. The
plaintiffs allege that the fuel oil released from the heating system of our
former facility has migrated beneath and onto the neighboring property causing
in excess of $1,000,000 in direct and consequential damages. The plaintiffs'
allegations against us include, negligence, nuisance and strict liability under
the New York State Navigation Law. We have submitted an answer denying the
allegations and all liability relating to the alleged property damage. This
lawsuit is at an early stage and we are unable to evaluate the likelihood of an
unfavorable outcome or estimate the amount or range of potential loss, if any.
-20-
Changes in economic and political conditions outside the United States could
adversely affect our business, results of operations and financial condition.
We have been seeking to increase our sales to regions outside the
United States, particularly in Europe and areas in the Americas and Asia. For
the 2001 Second Quarter, sales to customers outside the United States accounted
for approximately 22% of our net sales. International sales and operations are
subject to a number of risks, including:
. trade restrictions in the form of license requirements;
. restrictions on exports and imports and other government controls;
. changes in tariffs and taxes;
. difficulties in staffing and managing international operations;
. problems in establishing and managing distributor relationships;
. general economic conditions; and
. political and economic instability or conflict.
To date, we have invoiced our international sales in U.S. dollars, and
have not engaged in any foreign exchange or hedging transactions. We may not
continue to be able to invoice all our sales in U.S. dollars and to avoid
engaging in foreign exchange or hedging transactions. If we are required to
invoice any material amount of international sales in non-U.S. currencies,
fluctuations in the value of non-U.S. currencies relative to the U.S. dollar may
adversely affect our business, results of operations and financial condition or
require us to incur hedging costs to counter such fluctuations.
If we are unable to attract and retain the necessary managerial, technical and
other personnel necessary for our business, then our business, results of
operations and financial condition will be harmed.
Our performance is substantially dependent on the performance of our
executive officers and key employees. The loss of the services of any of these
executive officers or key employees could have a material adverse effect on our
business, results of operations and financial condition. Our future success
depends on our continuing ability to attract and retain additional highly
qualified managers and technical personnel. Competition for qualified personnel
is intense and we may not be able to attract, assimilate or retain qualified
personnel in the future.
Results Of Operations
Quarter Ended June 30, 2001 Compared to the Quarter Ended June 30, 2000
Sales
-----
Sales for the 2001 Second Quarter were $2,617,929, a decrease of 18%
from sales of $3,181,268 for the 2000 Second Quarter. Sales for the 2001 First
Half were $5,233,568, a decrease of 18% from the 2000 First Half sales of
$6,382,752. The decrease in sales for the 2001 Second Quarter reflects an
approximate 52% decrease in sales of Andrea Anti-Noise Products to $1,171,492 or
45% of total sales, offset by an approximate 106% increase in sales of our
Aircraft Communications Products, to $1,313,201, or 50% of total sales, and an
approximate 13% increase of Andrea DSP Microphone and Software
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Products to $133,236, or 5% of total sales. The decline of Andrea Anti-Noise
Products was due to a significant decrease in headset unit shipments to IBM and
certain of its affiliates, distributors, licensees and integrators. This decline
is primarily a result of increased competition in the PC headset market, coupled
with unfavorable economic conditions which continues to negatively impact the
technology and manufacturing sectors. The increase in our Aircraft Communication
product revenues is primarily a result of increased sales and marketing
activities. For the 2001 Second Quarter, sales of our computer headsets to IBM
and certain of its affiliates, distributors, licensees and integrators accounted
for approximately 25% of our total sales; sales of our aircraft communication
products to the U.S. Government accounted for approximately 27% of our total
sales.
Cost of Sales
-------------
Cost of sales as a percentage of sales for the 2001 Second Quarter
decreased to 72% from 74% for the 2000 Second Quarter. Cost of sales as a
percentage of sales for the 2001 First Half decreased to 73% from 75% for the
2000 First Half. These decreases are primarily due to the product mix of
revenues for each respective period, specifically, the increase in high margin
aircraft communication revenues, coupled with the elimination of certain fixed
overhead costs as a result of our cost reduction efforts during the 2001 First
Half.
Research and Development
------------------------
Research and development expenses for the 2001 Second Quarter decreased
19% to $881,384 from $1,089,194 for the 2000 Second Quarter. Research and
development expenses for the 2001 First Half were $1,880,284, a decrease of 16%
from the 2000 First Half research and development expenses of $2,239,672. These
decreases are due primarily to a reduction in expenses associated with research
efforts that are not integral to Andrea's core portfolio of digital microphone
software and hardware technologies. Specifically, DSP Microphone and Software
Technology efforts were $723,592, or 82% of total research and development
expenses, Aircraft Communications technology efforts were $133,939, or 15% of
total research and development expenses and Andrea Anti-Noise Product efforts
were $23,853, or 3% of total research and development expenses. With respect to
DSP Microphone and Software Technologies, research efforts are primarily focused
on the pursuit of commercializing a natural language-driven human/machine
interface by developing optimal far-field microphone solutions for various
voice-driven interfaces, incorporating the Company's digital super directional
array microphone technology ("DSDA") and certain other related technologies
obtained through the acquisition of Lamar in May 1998. The Company believes that
the acquisition of Lamar significantly reinforces its position in digital signal
processing by extending the Company's marketing programs to other high-growth
industries, including automotive telematics, mobile device markets, the business
videoconferencing market and Internet telephony, among others. Specifically, the
core technology acquired produces noise filtering capabilities that management
believes is preferred to other known DSP-based technologies in the market, and
is unattainable in products using traditional mechanical solutions. In addition,
the nature of a DSP-based solution, together with the people acquired supporting
our technology, offers a solution that is highly scalable and embeddable, and
therefore enables the technology to be integrated into many different
applications and form factors. We believe that continued research and
development spending will provide the Company with a competitive advantage.
During the remainder of 2001, management expects total research and development
spending to continue at levels consistent with that of the 2001 First Half.
General, Administrative and Selling Expenses
--------------------------------------------
General, administrative and selling expenses for the 2001 Second
Quarter decreased 3% to $2,308,755 from $2,253,357 for the 2000 Second Quarter.
General, administrative and selling expenses for the 2001 First Half were
$4,622,098, an increase of 5% from the 2000 First Half general, administrative
and selling expenses of $4,394,655. This increase is due primarily to the
continuing high levels of sales and marketing costs associated with Andrea's
efforts in developing alliances in the
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automotive telematics market space, coupled with the increase in sales and
marketing salaries associated with the reengineering of Andrea's sales and
marketing team during the 2000 Fourth Quarter.
The Company implemented a cost reduction plan aimed at cutting costs
that are not integral to the execution of the Company's overall strategy, and to
ensure conservative spending during the current period of economic uncertainty.
Included in the Company's cost reduction initiatives was a reduction in
workforce which was implemented during February of 2001, representing a
reduction of approximately 25% of the Company's then total workforce.
Other Income (Expense)
----------------------
Other income for the 2001 Second Quarter was $77,288 compared to other
income of $51,623 for the 2000 Second Quarter. Other income for the 2001 First
Half was $146,759 compared to other income of $56,469 for the 2000 First Half.
This change was due to interest earned on higher cash balances, coupled with
lower levels of interest-bearing debt in the 2001 First Half.
Provision for Income Taxes
--------------------------
The Company did not record income tax expense for the 2001 Second
Quarter or 2001 First Half in light of the net loss recorded for the periods.
Furthermore, the realization of a portion of the Company's reserved deferred tax
assets, if and when realized, will not result in a tax benefit in the
consolidated statement of operations, but will result in an increase in
additional paid in capital as they are related to tax benefits associated with
the exercise of stock options. The Company will be continually re-assessing its
reserves on deferred income tax assets in future periods on a quarterly basis.
The determination as to the realization of additional reserves is, and will be,
based on Andrea's expectations of future earnings. To the extent Andrea's
management believes that, more likely than not, previously reserved deferred tax
assets will be realized, Andrea will reduce the reserve accordingly.
Net Income (Loss)
-----------------
Net loss for the 2001 Second Quarter was $2,367,680 compared to a net
loss of $2,476,013 for the 2000 Second Quarter. Net loss for the 2001 First Half
was $4,914,167, compared to net loss of $4,960,634 for the 2000 First Half. The
levels of net loss for the 2001 Second Quarter and 2001 First Half principally
reflect the factors described above.
Liquidity And Capital Resources
The Company's principal sources of funds have historically been, and
are expected to continue to be, gross cash flows from operations and proceeds
from the sale of convertible notes, preferred stock or other securities to
certain financial institutions. At June 30, 2001, we had cash and cash
equivalents of $5,129,723 compared with $9,151,835 at December 31, 2000. The
balance of cash and cash equivalents at June 30, 2001 is primarily a result of
the Company's issuance and sale in a private placement of $7,500,000 of its
Series C Redeemable Convertible Preferred Stock (the "Series C Preferred
Stock"). The Company is using the net proceeds from the issuance of the Series C
Preferred Stock primarily for costs associated with :
1) research and development,
2) creating and maintaining strategic alliances, which includes,
among other things, sales and marketing salaries, substantial
travel costs to market our products and technologies, product
fulfillment costs and technical assistance, and other general
support costs for existing and potential partners,
3) payment of certain debt obligations,
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4) professional fees, and
5) general working capital requirements.
In connection with the acquisition of Lamar, of the aggregate cash
consideration to be paid by the Company, $1,000,000 was paid on May 5, 1998, the
closing date, and $500,000 was paid on each of the six, twelve, twenty-four and
thirty-six month anniversaries of the closing date. The final payment was paid
on May 5, 2001.
Working capital at June 30, 2001, was $10,897,466 compared to
$15,035,051 at December 31, 2000. The decrease in working capital reflects
decreases in total current assets and total current liabilities of $4,803,604,
and $666,019, respectively. The decrease in total current assets reflects
decreases in cash and cash equivalents of $4,022,112 and a decrease in accounts
receivable of $1,116,417, partially offset by increases in inventory and prepaid
expenses and other current assets of $182,898, and $152,027, respectively. The
decrease in current liabilities reflects a decrease in trade accounts payable of
$305,267 and a decrease in current portion of long-term debt of $421,681,
offset, in part, by an increase in other current liabilities of $60,929.
The decrease in cash from December 31, 2000 to the period ending June
30, 2001 of $4,022,112 reflects $3,479,975 of net cash used in operating
activities, $22,869 of cash used in investing activities and $519,268 of cash
used in financing activities.
The cash used in operating activities, excluding non-cash charges, is
primarily attributable to the $4,914,167 net loss for the 2001 First Half, a
$1,116,417 decrease in accounts receivable, $182,898 increase in inventory,
$321,872 increase in prepaid and other current assets, a $241,259 increase in
other assets, a $305,267 decrease in accounts payable, a $16,693 increase in
other current and long term liabilities. The increase in prepaid expenses and
other current assets primarily includes the recognition of increased premiums
for prepaid property taxes and insurance, as well as increases in other service
costs related to the remainder of 2001. The decrease in accounts payable and
other current and long term liabilities as well as the increase in inventory
primarily reflect differences in the timing related to both the payments for and
the acquisition of raw materials as well as for other services in connection
with ongoing efforts related to the Company's various product lines.
The cash used in investing activities is attributable to capital
expenditures consisting of manufacturing dies and molds and, to a lesser extent,
upgrades in the Company's existing computer systems.
The cash used in financing activities reflects the payment of the
thirty-six month anniversary installment payment to the former shareholders of
Lamar, partially offset by exercises of employee stock options.
The Company believes that it is necessary to raise additional working
capital to support operations. In December 1995, April 1996, August 1996 and
June 1998, the Company raised working capital through the issuance of
convertible subordinated debentures. In June 1999, the Company raised $7.5
million through the issuance and sale of Series B Preferred Stock. In October
2000, the Company raised $7.5 million through the issuance and sale of Series C
Preferred Stock. The Company has incurred significant losses in each of the last
three fiscal years. In the six month period ended June 30, 2001, the Company
incurred losses from operations of $5.0 million and used $3.5 million in its
operating activities. Management expects that operating losses and negative cash
flows will continue at least through Fiscal 2001 as the Company continues to
market its Andrea Anti-Noise products, Aircraft Communication products and
Andrea Digital Signal Processing Microphone and Software Technologies.
Management anticipates that existing sources of liquidity and anticipated
revenue will satisfy projected working capital and other cash
-24-
requirements through the first quarter of Fiscal 2002 and the Company is seeking
additional capital and funding with the assistance of an investment banker. If
the Company fails to develop revenues from sales of its products to generate
adequate funding from operations or fails to obtain additional financing through
capital or funding, it will be required to either further reduce its operating
expenses and/or operations or may result in it relinquishing its products,
technologies or markets. Such financing may not be available on acceptable
terms, or at all. Notwithstanding the significance of sales of Andrea Anti-Noise
Products as a percentage of our total sales during 2000, we cannot assure that
demand will continue for these products or any of our other products, including
future products related to our Andrea Digital Signal Processing Microphone and
Software Technologies, or, that if such demand does exist, that we will be able
to obtain the necessary working capital to maintain production and marketing
resources to meet such demand on favorable terms, or at all.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our principal source of financing activities is the issuance of convertible
debt with financial institutions. We are affected by market risk exposure
primarily through any amounts payable in stock, or cash by us under convertible
securities. A significant rise in interest rates could materially adversely
affect our financial condition and results of operations. We do not utilize
derivative financial instruments to hedge against changes in interest rates or
for any other purpose. In addition, substantially all transactions by us are
denominated in U.S. dollars. As such, we have shifted foreign currency exposure
onto our foreign customers. As a result, if exchange rates move against foreign
customers, we could experience difficulty collecting unsecured accounts
receivable, the cancellation of existing orders or the loss of future orders.
The foregoing could materially adversely affect our business, financial
condition and results of operations.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations--Cautionary Statement Regarding Forward-Looking
Statements--An unfavorable ruling in any current litigation proceeding or future
proceeding may adversely affect our business, results of operations and
financial condition" and Note 10 to the unaudited financial statements in this
quarterly report for a discussion of the legal proceedings of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
On August 7, 2001, at the Annual Meeting of Shareholders of the Company,
the shareholders elected as directors of the Company for terms of one year, the
following individuals: John N. Andrea (11,894,680 shares for, 743,385 shares
withheld); Douglas J. Andrea (11,898,330 shares for, 739,735 shares withheld);
Christopher P. Sauvigne (11,987,490 shares for, 650,575 shares withheld); Gary
Jones (11,991,720 shares for, 646,345 shares withheld); Scott Koondel
(11,989,920 shares for, 648,145 shares withheld); Jack Lahav (12,022,220 shares
for, 615,845 shares withheld); John R. Larkin (11,991,920 shares for, 646,145
shares withheld); Paul Morris (11,988,620 shares for, 649,445 shares withheld).
The shareholders voted to amend the Certificate of Incorporation of the Company,
which authorized an increased in the number of authorized shares of Common Stock
to 70,000,000 shares from 35,000,000 (11,606,996 shares for, 968,768 shares
against, 62,301 shares abstained). In addition, the shareholders
-25-
authorized an amendment to the 1998 Stock Plan of the Company to increase the
number of shares of common stock issuable thereunder to 4,375,000 shares from
3,675,000 shares (11,066,066 shares for, 1,507,383 shares against, 64,616 shares
abstained). The shareholders voted for the issuance of shares of Common Stock
upon the conversion of the Company's Series B convertible preferred stock and
upon exercise of the related warrant to the extent such issuance would require
stockholder approval under standards of the American Stock Exchange (3,173,073
shares for, 789,615 shares against, 63,521 shares abstained, 8,611,856 shares
not voted). In addition, the shareholders voted for the issuance of shares of
Common Stock upon the conversion of the Company's Series C convertible preferred
stock to the extent such issuance would require stockholder approval under the
standards of the American Stock Exchange (3,177,457 shares for, 780,731 shares
against, 68,021 shares abstained, 8,611,856 shares not voted); and the
shareholders also ratified the selection of Arthur Andersen LLP as the Company's
independent accountants for the year ending December 31, 2001 (12,261,407 shares
for, 283,403 shares against, and 93,255 shares abstained).
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
On June 6, 2001, the Company filed a Current Report on Form 8-K
reporting that the date of the 2001 annual meeting of stockholders
had changed from June 28, 2001 to August 7, 2001.
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Exchange Act, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ANDREA ELECTRONICS CORPORATION
/s/ Christopher P. Sauvigne President and Chief August 14, 2001
----------------------------
Christopher P. Sauvigne Operating Officer
/s/ Richard A. Maue Senior Vice President, Chief August 14, 2001
----------------------------
Richard A. Maue Financial Officer, and Secretary
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