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 September 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
--------
ANDREA ELECTRONICS CORPORATION
-----------------------------------------------------
(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: As of November 12, 2001, there
are 16,233,968 common shares outstanding.
ITEM 1. FINANCIAL STATEMENTS
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2001 December 31, 2000
(unaudited) (audited)
----------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,782,414 $ 9,151,835
Accounts receivable, net of allowance for doubtful accounts of
$186,340 and $186,121 1,773,801 3,503,713
Inventories 6,128,324 6,285,038
Prepaid expenses and other current assets 430,321 221,259
----------------- -----------------
Total current assets 13,114,860 19,161,845
PROPERTY AND EQUIPMENT, net 935,333 1,393,760
DEFERRED INCOME TAXES 1,806,615 1,806,615
GOODWILL 12,589,341 13,403,836
OTHER INTANGIBLE ASSETS 8,661,691 9,243,917
OTHER ASSETS 2,491,495 2,262,893
----------------- -----------------
Total assets $ 39,599,335 $ 47,272,866
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 1,737,274 $ 2,107,660
Current portion of long-term debt 189,830 676,046
Other current liabilities 1,867,242 1,343,088
----------------- -----------------
Total current liabilities 3,794,346 4,126,794
LONG-TERM DEBT 100,370 195,867
----------------- -----------------
Total liabilities 3,894,716 4,322,661
----------------- -----------------
SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01 par value;
authorized: 1,000 shares, issued and outstanding: 283 and 500 shares,
respectively; liquidation value: $2,830,000 and $5,000,000, respectively 2,747,442 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 7,356,688 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: 70,000,000 shares; issued
and outstanding: 15,503,886 and 13,897,572 shares, respectively 7,751,943 6,948,786
Additional paid-in capital 55,661,922 46,711,609
Deferred stock compensation (26,490)
Accumulated deficit (37,786,886) (22,872,915)
----------------- -----------------
Total shareholders' equity 25,600,489 30,787,480
----------------- -----------------
Total liabilities and shareholders' equity $ 39,599,335 $ 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 Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
NET SALES $ 2,937,199 $ 5,318,936 $ 8,170,767 $ 11,701,688
COST OF SALES 2,105,848 3,772,311 5,897,960 8,537,839
------------ ------------ ------------ ------------
Gross profit 831,351 1,546,625 2,272,807 3,163,849
RESEARCH AND DEVELOPMENT EXPENSES 774,108 1,249,167 2,654,392 3,488,839
GENERAL, ADMINISTRATIVE
AND SELLING EXPENSES 2,117,360 2,389,736 6,739,458 6,784,391
------------ ------------ ------------ ------------
Loss from operations (2,060,117) (2,092,278) (7,121,043) (7,109,381)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income(expense) (3,365) 21,208 117,505 92,497
Other (5,669) 25,632 20,220 10,812
------------ ------------ ------------ ------------
(9,034) 46,840 137,725 103,309
------------ ------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (2,069,151) (2,045,438) (6,983,318) (7,006,072)
PROVISION FOR INCOME TAXES -- -- -- --
------------ ------------ ------------ ------------
Net loss $ (2,069,151) $ (2,045,438) $ (6,983,318) $ (7,006,072)
============ ============ ============ ============
PREFERRED STOCK DIVIDENDS 140,755 60,577 430,653 212,364
NON-CASH CHARGE ATTRIBUTABLE TO BENEFICIAL
CONVERSION FEATURE 7,500,000 -- 7,500,000 --
------------ ------------ ------------ ------------
Net loss attributable to
common shareholders $ (9,709,906) $ (2,106,015) $(14,913,971) $ (7,218,436)
============ ============ ============ ============
PER SHARE INFORMATION:
Net Loss Per Share:
Basic $ (.64) $ (.15) $ (1.00) $ (.53)
============ ============ ============ ============
Diluted $ (.64) $ (.15) $ (1.00) $ (.53)
============ ============ ============ ============
Shares used in computing net loss per share:
Basic 15,137,578 13,836,893 14,848,707 13,702,946
============ ============ ============ ============
Diluted 15,137,578 13,836,893 14,848,707 13,702,946
============ ============ ============ ============
See Notes to Consolidated Financial Statements
-3-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the Nine Months ended September 30, 2001
(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 1,578,814 789,407 1,415,330 -- -- 2,204,740
Exercise of stock options, net of related
costs 27,500 13,750 2,733 -- -- 16,483
Option grant to Consultant -- -- 32,250 (32,250) -- --
Amortization of Deferred Stock
Compensation -- -- -- 5,760 -- 5,760
Preferred stock dividends -- -- -- -- (430,653) (430,656)
Non-cash charge attributable to
beneficial conversion feature -- -- 7,500,000 -- (7,500,000) --
Net loss -- -- -- -- (6,983,318) (6,983,318)
------------ ----------- ----------- ------------ ------------ ------------
BALANCE, September 30, 2001 15,503,886 $ 7,751,943 $55,661,922 $ (26,490) $(37,786,886) $ 25,600,489
============ =========== =========== ============ ============ ============
See Notes to Consolidated Financial Statements
-4-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
September 30,
--------------------------
2001 2000
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(6,983,318) $(7,006,072)
Adjustments to reconcile net loss to net cash used in operating
activities:
Non-cash interest expense -- 39,964
Non-cash stock compensation expense 5,760 --
Depreciation and amortization 2,707,094 2,633,944
(Increase) Decrease in:
Accounts receivable, net 1,729,912 (1,022,442)
Inventories 156,714 646,065
Prepaid expenses and other current assets (719,418) (420,436)
Other assets (447,375) 769
Increase (Decrease) in:
Trade accounts payable (370,386) 285,013
Other current and long term liabilities 245,143 (98,660)
----------- -----------
Net cash used in operating activities (3,675,874) (4,941,855)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (108,313) (221,688)
----------- -----------
Net cash used in investing activities (108,313) (221,688)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of debt obligations (601,717) (555,038)
Payment of convertible notes -- (1,485,077)
Proceeds from issuance of common stock upon exercise of stock
options, net of related costs 16,483 1,516,833
----------- -----------
Net cash used in financing activities (585,234) (523,282)
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,369,421) (5,686,825)
=========== ===========
CASH AND CASH EQUIVALENTS, beginning of period 9,151,835 9,153,148
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 4,782,414 $ 3,466,323
=========== ===========
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 $ 2,204,740 $ 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 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 Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Numerator:
Net loss $ (2,069,151) $ (2,045,438) $ (6,983,318) $ (7,006,072)
Preferred stock dividends 140,755 60,577 430,653 212,364
Non-cash charge attributable to
beneficial conversion feature 7,500,000 -- 7,500,000 --
------------ ------------ ------------ ------------
Net loss attributable to
common shareholders $ (9,709,906) $ (2,106,015) $(14,913,971) $ (7,218,436)
============ ============ ============ ============
Denominator:
Weighted-average common shares
outstanding - Basic and Diluted* 15,137,578 13,836,893 14,848,707 13,702,946
============ ============ ============ ============
Net loss per share - Basic and
Diluted $ (.64) $ (.15) $ (1.00) $ (.53)
============ ============ ============ ============
* 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
-6-
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 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 nine months ended
September 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, 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 Andrea operates in international markets, it does so
presently without the use of derivative instruments. Accordingly, the
adoption of this statement as of January 1, 2001, did not have an effect.
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, Andrea is
required to adopt FAS 142 effective January 1, 2002. Andrea is currently
evaluating the effect that adoption of the provisions of FAS 142 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 September 30, 2001, sales of Andrea's
products to IBM and certain of IBM's affiliates, distributors, licensees
and integrators accounted for approximately 40% of 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
-7-
value $0.50 per share) at a conversion price equal to the lower of $8.775
(the "Maximum 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.
Any unconverted Series B Preferred Stock that remains outstanding on June
18, 2004 will automatically convert into Andrea's Common Stock. Andrea has
reserved 8,876,355 shares 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.
Andrea engaged an investment banker to assist in obtaining additional
capital and funding which if successful could involve the triggering of the
redemption rights. If such redemption rights are triggered and Andrea has
insufficient funds to satisfy the redemption, Andrea will be required to
obtain a waiver from the holders of the Series B Preferred Stock. If the
Series B Preferred Stock holders do not consent to such a waiver, Andrea's
efforts to obtain additional funding and capital will be materially
adversely affected and its ability to continue its current operations will
be materially adversely affected.
In the nine-month period ending September 30, 2001, the following number of
shares of Series B Preferred Stock, together with related accrued
dividends, were converted:
Number of Series B Number of
Date of Preferred Stock Conversion Common
Conversion Converted Price Shares
----------------- ---------- --------- ---------------
January 11, 2001 100 $ 1.875 566,824
January 18, 2001 52 $ 1.875 294,961
August 16, 2001 65 $ .985 717,029
------ ---------
Total 217 1,578,814
====== =========
As of September 30, 2001, the Series B Preferred Stock is recorded net of
the unaccreted present value of the warrants of $82,558. Due to the
redemption features described above, the Series B Preferred Stock is
presented outside of stockholders' equity in the accompanying consolidated
balance sheets.
-8-
On November 2, 2001, 34 shares of the Series B Preferred Stock, together
with related accrued dividends, were converted into 730,082 shares of
Common Stock at a conversion price of $0.51.
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 $1.44. 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
maturity by Andrea, based upon certain circumstances at that time, and is
redeemable by the holder upon certain events. Andrea has reserved
10,890,411 shares of Common Stock for issuance upon conversion of the
shares of the Series B Preferred Stock. 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.
Andrea engaged an investment banker to assist in obtaining additional
capital and funding which if successful could involve the triggering of the
redemption rights. If such redemption rights are triggered and Andrea has
insufficient funds to satisfy the redemption, Andrea will be required to
obtain a waiver from the holders of the Series C Preferred Stock. If the
Series C Preferred Stock
-9-
holders do not consent to such a waiver, Andrea's efforts to obtain
additional funding and capital will be materially adversely affected and
its ability to continue its current operations will be materially adversely
affected.
As of September 30, 2001, the Series C Preferred Stock is recorded net of
unaccreted costs of $143,312. 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 recorded a one
time non-cash charge of $7,500,000 to accumulated deficit. This
pronouncement values the economic benefit of the contingent beneficial
conversion feature that the holders of the Series C Preferred Stock
received when the conversion price of the Series C Preferred Stock was
reset from $7.0565 to $1.44 in July 2001. This charge represents the
maximum charge under this standard and, accordingly, there will be no
additional charges to equity at later reset dates.
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 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 September 30, 2001:
Net Value at Estimated
September 30, 2001 Useful Life
------------------ -----------
Goodwill $12,589,341 15 years
===========
Other Intangible Assets:
Core Technology $ 8,510,113 15 years
Workforce in Place 151,578 7 years
-----------
Total Other Intangible Assets $ 8,661,691
===========
See Note 5 regarding new accounting pronouncement which relates to the
amortization for Goodwill and Other Intangible Assets and is effective for
financial statement periods beginning January 1, 2002.
10. 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 Andrea's management
approach. The management approach, as defined by
-10-
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 Andrea 's segments for the
three months ended September 30, 2001, and 2000:
Andrea DSP
Aircraft Microphone and
Andrea Anti-Noise Communications Software September 30,
Segment Data Products Products Products 2001
----------------------------- ----------------- ------------------ -------------- ---------------
Net sales $ 1,537,844 $ 1,201,895 $ 197,460 $ 2,937,199
Income (loss) from operations (365,430) 250,098 (1,944,785) (2,060,117)
Depreciation 98,612 27,720 50,756 177,088
Aircraft Andrea DSP
Andrea Anti-Noise Communications Microphone and September 30,
Segment Data Products Products Software Products 2000
----------------------------- ----------------- ------------------ -------------- ---------------
Net sales $ 4,560,017 $ 603,056 $ 155,863 $ 5,318,936
Income (loss) from operations 652,886 (170,911) (2,574,253) (2,092,278)
Depreciation 108,868 32,956 43,389 185,213
International revenues are based on the country in which the end-user is
located. For the three months ended September 30, 2001 and 2000, sales and
accounts receivable by geographic area are as follows:
September 30, September 30,
Geographic Data 2001 2000
-------------------- --------------- ---------------
Sales:
United States $ 2,513,906 $ 3,960,340
Europe 136,783 487,129
Other foreign 286,510 871,467
--------------- ---------------
$ 2,937,199 $ 5,318,936
=============== ===============
Accounts receivable:
United States $ 1,576,703 $ 2,447,034
Europe 102,702 719,147
Other foreign 94,396 626,964
--------------- ---------------
$ 1,773,801 $ 3,793,145
=============== ===============
The assets and liabilities of the Company are managed centrally and are
reported internally in the same manner as the consolidated financial
statements, thus no additional information is produced for the Chief
Executive or included herein.
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
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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 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. On September 27, 2001, Andrea
was granted a motion for summary judgment, thereby dismissing the
plaintiff's complaint in its entirety.
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.
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:
o voice communication over the Internet;
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o speech recognition and dictation to desktop, laptop and hand-held
computers;
o audio/video conferencing;
o computer-based automobile monitoring and control systems for use by
drivers and passengers;
o Military and Commerical Aircraft Communications systems;
o electronic equipment for incorporation into home appliances and
industrial and commercial office equipment that is activated and
controlled by voice; and
o 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 canceling
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.
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 Andrea presented in this report are
not necessarily indicative of the actual sales or results of operations to be
realized for the full year.
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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
September 30, 2001 (the "2001 Third Quarter") compared to the three months ended
September 30, 2000 (the "2000 Third Quarter"), and for the nine months ended
September 30, 2001 (the "2001 First Nine Months") compared to the nine months
ended September 30, 2000 (the "2000 First Nine Months"), 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;
- 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 Third Quarter were approximately
$2.9 million compared to approximately $5.3 million in the 2000 Third Quarter.
Net loss applicable to common shareholders for the 2001 Third Quarter, before
giving effect to a special, one-time, non-cash accumulated deficit charge of
$7.5 million, was approximately $2.2 million, or $0.15 per share on a diluted
basis, compared to a net loss applicable to common shareholders of approximately
$2.1 million, or $0.15 per share on a diluted basis, for the 2000 Third Quarter.
Our revenues for the First Nine Months of 2001 were approximately $8.2 million
compared to approximately $11.7 million in the First Nine Months of 2000. For
the First Nine Months of 2001, we had a net loss
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attributable to common shareholders, before giving effect to the special,
one-time, non-cash equity charge, of approximately $7.4 million compared to a
net loss attributable to common shareholders of $7.2 million in the First Nine
Months of 2000. We have experienced a significant decline in headset unit
shipments during the First Nine Months of 2001 compared to the First Nine Months
of 2000, offset to an extent, by increases in aircraft communication revenues.
In response to our declining revenues, we are examining opportunities for
cost-reduction, production efficiencies and further diversification of our
business. However, 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. Additionally, there
could be a financial statement impact due to a new accounting pronouncement that
is effective January 1, 2002, that could prompt us to write-off some portion of
our goodwill and other intangible assets, change the amortization life or method
of these assets or cessation of the amortization of some or all of our goodwill
and other intangible assets (See Note 5 of the financial statement notes). 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. Andrea engaged an investment banker to assist the 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 Andrea. In the event that 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, Andrea's funding and capital raising efforts could
trigger change in control payments due to certain executive officers of Andrea
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 70,000,000 shares of common stock presently authorized,
16,233,968 were outstanding as of November 12, 2001. This does not include
5,915,625 shares of our common stock reserved 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. In addition, this does not include 19,766,766 shares of common stock
reserved for issuance upon conversion of the Series B and Series C convertible
preferred stock and exercise of related warrants. Furthermore, 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, 920,880 of the 1,800,000 shares have been
registered for sale under the Securities Act of 1933.
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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.
As of November 12, 2001, we had 249 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 249 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 Percentage of Outstanding
Conversion Price Issuable Upon Conversion(1) Common Stock(2)
---------------- --------------------------- ---------------
$0.50 4,980,000 23%
$1.50 1,660,000 9%
$2.50 996,000 6%
$3.50 711,429 4%
$4.50 553,333 3%
$5.50 452,727 3%
$6.50 383,077 2%
$7.50 332,000 2%
(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. The numbers in this column do not
reflect these limitations.
(2) Based on 16,233,968 shares of common stock outstanding as of November 12,
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 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 Percentage of Outstanding
Conversion Price Issuable Upon Conversion(1) Common Stock(2)
---------------- --------------------------- ---------------
$0.40 18,750,000 54%
$0.55 13,636,364 46%
$0.70 10,714,286 40%
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$0.85 8,823,529 35%
$1.00 7,500,000 32%
$1.30 5,769,231 26%
$1.44 5,208,333 24%
(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. The numbers in this column do not
reflect these limitations.
(2) Based on 16,233,968 shares of common stock outstanding as of November 12,
2001.
The following table illustrates the varying amounts of shares of Common
Stock that would be issuable upon conversion of all 249 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 Percentage of Outstanding
Conversion Price Issuable Upon Conversion(1)(2)(3) Common Stock(4)
---------------- --------------------------------- ---------------
$0.50 19,980,000 55%
$1.00 9,990,000 38%
$1.44 6,937,500 30%
$2.50 6,204,333 28%
$3.50 5,919,762 27%
$4.50 5,761,667 26%
$5.50 5,661,061 26%
$6.50 5,591,410 26%
$7.50 5,540,333 25%
(1) The calculation assumes that the conversion price of the Series B and
Series C convertible preferred stock are the same at the assumed conversion
prices of $.50, $1.00 and $1.44. This could only occur if the market price
of Andrea's Common Stock declines, and at a future reset date, the
conversion price of the Series C adjusts to the then prevailing market
price (the current fixed conversion price of the Series C is $1.44, and
such conversion price is fixed unless adjusted downward at a future reset
date).
(2) The calculation assumes that for any conversion of the Series B convertible
preferred stock when the prevailing market price is above $1.44, the Series
C would still be converted at its maximum conversion price of $1.44.
(3) 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, 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.
(4) Based on 16,233,968 shares of common stock outstanding as of November 12,
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 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
-17-
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 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
-18-
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 Aircraft Communications 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 Third Quarter, IBM and certain of IBM's affiliates,
distributors, licensees and integrators accounted for 40% of our net sales. This
represents an approximate 63% decrease from the 2000 Third 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.
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 First Nine Months, the U.S. Government accounted for 20% 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.
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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
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.
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
-20-
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 third quarter of
2001, the court held 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.
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
alleged 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 included, negligence, nuisance and strict liability under
the New York State Navigation Law. On September 27, 2001, Andrea was granted a
motion for summary judgment, thereby dismissing the plaintiff's complaint in its
entirety.
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
Third Quarter, sales to customers outside the United States accounted for
approximately 14% of our net sales. International sales and operations are
subject to a number of risks, including:
o trade restrictions in the form of license requirements;
o restrictions on exports and imports and other government controls;
o changes in tariffs and taxes;
o difficulties in staffing and managing international operations;
o problems in establishing and managing distributor relationships;
o general economic conditions; and
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o 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.
We Face Risk From Operating in Israel
Our principal research and development facility is located in the State
of Israel and, as a result, as of September 30, 2001, certain of our key
research and development employees were located in Israel. Although
substantially all of our sales currently are being made to customers outside
Israel, we are nonetheless directly influenced by the political, economic and
military conditions affecting Israel. Since the establishment of the State of
Israel in 1948, a state of hostility has existed, varying in degree and
intensity, between Israel and Arab countries. Although Israel has entered into
various agreements with certain Arab countries and the Palestinian Authority,
and various declarations have been signed in connection with efforts to resolve
some of the economic and political problems in the Middle East, we cannot
predict whether or in what manner these problems will be resolved.
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 September 30, 2001 Compared to the Quarter Ended September
30, 2000
Sales
-----
Sales for the 2001 Third Quarter were $2,937,199, a decrease of 45% from
sales of $5,318,936 for the 2000 Third Quarter. Sales for the 2001 First Nine
Months were $8,170,767, a decrease of 30% from the 2000 First Nine Months sales
of $11,701,688. The decrease in sales for the 2001 Third Quarter reflects an
approximate 66% decrease in sales of Andrea Anti-Noise Products to $1,537,844,
or 52% of total sales, offset by an approximate 99% increase in sales of our
Aircraft Communications Products, to $1,201,895, or 41% of total sales, and an
approximate 27% increase of Andrea DSP Microphone and Software Products to
$197,460, or 7% of total sales. The decline of Andrea Anti-Noise Products was
due, primarily, to a significant decrease in headset unit shipments to IBM and
certain of its affiliates, distributors, licensees and integrators which is
primarily a result of increased competition in the PC headset market, coupled
with unfavorable economic conditions which continues to negatively impact the
technology sector. The increase in our Aircraft Communication Product revenues
is primarily a result of increased sales and marketing activities. For the 2001
Third Quarter, sales of our computer headsets to IBM and certain of its
affiliates, distributors, licensees and integrators accounted for approximately
40% of our total sales; sales of our Aircraft Communication Products to the U.S.
Government accounted for approximately 14% of our total sales.
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Cost of Sales
-------------
Cost of sales as a percentage of sales for the 2001 Third Quarter increased
to 72% from 71% for the 2000 Third Quarter. Cost of sales as a percentage of
sales for the 2001 First Nine Months decreased to 72% from 73% for the 2000
First Nine Months. These slight changes are primarily due to the product mix of
revenues for each respective period, as described under "Sales" above.
Research and Development
------------------------
Research and development expenses for the 2001 Third Quarter decreased 38%
to $774,108 from $1,249,167 for the 2000 Third Quarter. Research and development
expenses for the 2001 First Nine Months were $2,654,392, a decrease of 24% from
the 2000 First Nine Months research and development expenses of $3,488,839.
These decreases are due primarily to a reduction in expenses associated with
research efforts that were determined not to be integral to Andrea's core
portfolio of digital microphone software and hardware technologies. DSP
Microphone and Software Technology efforts were $610,595, or 79% of total
research and development expenses, Aircraft Communications technology efforts
were $78,937, or 10% of total research and development expenses and Andrea Anti-
Noise Product efforts were $84,576, or 11% 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.
General, Administrative and Selling Expenses
--------------------------------------------
General, administrative and selling expenses for the 2001 Third Quarter
decreased 11% to $2,117,360 from $2,389,736 for the 2000 Third Quarter. General,
administrative and selling expenses for the 2001 First Nine Months were
$6,739,458 a decrease of less than 1% from the 2000 First Nine Months general,
administrative and selling expenses of $6,784,391. These decreases are primarily
due to management's cost reduction plan, which is 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 expense for the 2001 Third Quarter was $9,034 compared to other
income of $46,840 for the 2000 Third Quarter. Other income for the 2001 First
Nine Months was $137,725 compared to other income of $103,309 for the 2000 First
Nine Months. The decline in the 2001 Third Quarter compared to the 2000 Third
Quarter is a result of significant unfavorable market conditions for our
invested cash balances (which were also lower) experienced in the 2001 Third
Quarter. Alternatively, the increase in the 2001
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First Nine Months compared to the 2000 First Nine Months is due to a net
favorable rate increase experienced during the 2001 First Nine Months compared
to the 2000 First Nine Months.
Provision for Income Taxes
--------------------------
The Company did not record income tax expense for the 2001 Third Quarter or
2001 First Nine Months 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 Third Quarter was $2,069,151 compared to a net loss
of $2,045,438 for the 2000 Third Quarter. Net loss for the 2001 First Nine
Months was $6,983,318, compared to net loss of $7,006,072 for the 2000 First
Nine Months. The levels of net loss for the 2001 Third Quarter and 2001 First
Nine Months 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 or potential industry partners. At September 30, 2001, we
had cash and cash equivalents of $4,782,414 compared with $9,151,835 at December
31, 2000. The balance of cash and cash equivalents at September 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,
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 September 30, 2001, was $9,320,514 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 $6,046,985,
and $332,448, respectively. The decrease in total current assets reflects
decreases in cash and cash equivalents of $4,369,421, a decrease in accounts
receivable of $1,729,912, and a decrease in inventory of $156,714 partially
offset by increase in prepaid expenses and other current assets of $209,062. The
decrease in current liabilities reflects a decrease in trade accounts payable of
-24-
$370,386 and a decrease in current portion of long-term debt of $486,216,
offset, in part, by an increase in other current liabilities of $524,154.
The decrease in cash from December 31, 2000 to the period ending September
30, 2001 of $4,369,421 reflects $3,675,874 of net cash used in operating
activities, $108,313 of cash used in investing activities and $585,234 of cash
used in financing activities.
The cash used in operating activities, excluding non-cash charges, is
primarily attributable to the $6,983,318 net loss for the 2001 First Nine
Months, a $1,729,912 decrease in accounts receivable, $156,714 decrease in
inventory, $719,418 increase in prepaid and other current assets , a $444,375
increase in other assets, a $370,386 decrease in accounts payable, a $245,143
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 as well as the decrease 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. Furthermore, in accordance with EITF Issue 00-27, "Application
of EITF Issue No. 98-5 to Certain Convertible Instruments", Andrea recorded a
one time non-cash charge of $7,500,000 to accumulated deficit. This
pronouncement values the economic benefit of the contingent beneficial
conversion feature that the holders of the Series C Preferred Stock received
when the conversion price of the Series C Preferred Stock was reset from $7.0565
to $1.44 in July 2001. This charge represents the maximum charge under this
standard and, accordingly there will be no additional charges to equity at later
reset dates. The Company has incurred significant losses in each of the last
three fiscal years. In the nine month period ended September 30, 2001, the
Company incurred losses from operations of $7.1 million and used $3.7 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 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 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 2001, 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 increase production and marketing resources to
meet such demand on favorable terms, or at all.
-25-
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 11 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
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
The registrant did not file any reports on Form 8-K during the three-month
period ended September 30, 2001.
-26-
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 Chief Executive Officer November 14, 2001
----------------------------- and President
Christopher P. Sauvigne
/s/ Richard A. Maue Executive Vice President, November 14, 2001
----------------------------- Chief Financial Officer,
Richard A. Maue and Secretary
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