UNITED STATES 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, 2002
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
----------------------------------------------------------
(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 registrant's classes of
common equity, as of the latest practicable date: As of August 19, 2002, there
are 19,086,098 common shares outstanding.
ITEM 1. FINANCIAL STATEMENTS
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
(unaudited) (audited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,452,829 $ 3,724,130
Accounts receivable, net of allowance for doubtful accounts of $141,348 and
$176,292 2,796,298 2,094,146
Inventories 3,100,163 3,389,729
Prepaid expenses and other current assets 421,109 547,892
------------ ------------
Total current assets 10,770,399 9,755,897
PROPERTY AND EQUIPMENT, net 687,283 811,392
DEFERRED INCOME TAXES 1,806,615 1,806,615
GOODWILL 12,458,872 12,317,843
INTANGIBLE ASSETS 8,567,707 8,969,950
OTHER ASSETS 305,870 357,962
------------ ------------
Total assets $ 34,596,746 $ 34,019,659
============ ============
LIABILITIES, REDEEMABLE SECURITIES,
AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 967,076 $ 1,147,160
Current portion of long-term debt 74,477 158,802
Accrued Restructuring Charges 398,069 499,724
Deferred Revenue 1,666,680 258,221
Other current liabilities 2,552,443 2,061,075
------------ ------------
Total current liabilities 5,658,745 4,124,982
LONG-TERM DEBT 26,816 37,619
DEFERRED REVENUE 3,156,987 741,779
OTHER LIABILITIES 35,831 41,509
------------ ------------
Total liabilities 8,878,379 4,945,889
------------ ------------
COMMITMENTS AND CONTIGENCIES -- --
SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01
par value; authorized: 1,000 shares, issued and outstanding: 120 and 249
shares, respectively; liquidation value: $1,200,000 and $2,490,000,
respectively 1,169,952 2,421,009
------------ ------------
SERIES C REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01
par value; authorized: 1,500 shares, issued and outstanding: 750 shares;
liquidation value: $7,500,000 7,377,345 7,364,011
------------ ------------
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: 19,086,098 and 16,308,968 shares, respectively 9,543,049 8,154,484
Additional paid-in capital 54,639,161 54,642,571
Deferred stock compensation (133,925) (52,334)
Accumulated deficit (46,877,215) (43,455,971)
------------ ------------
Total shareholders' equity 17,171,070 19,288,750
------------ ------------
Total liabilities, redeemable securities, and shareholders' equity $ 34,596,746 $ 34,019,659
============ ============
See Notes to Consolidated Financial Statements
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
--------------------------------- -----------------------------------
2002 2001 2002 2001
-------------- -------------- ------------- -------------
REVENUES
Net product revenues $ 1,602,245 $ 2,617,929 $ 3,393,317 $ 5,233,568
License revenues 168,114 - 176,333 -
------------- ------------ ------------ ------------
Total revenues, net $ 1,770,359 $ 2,617,929 $ 3,569,650 $ 5,233,568
COST OF SALES 1,147,076 1,872,758 2,312,869 3,792,112
------------- ------------ ------------ ------------
Gross profit 623,283 745,171 1,256,781 1,441,456
RESEARCH AND DEVELOPMENT EXPENSES 886,534 881,384 1,792,356 1,880,284
GENERAL, ADMINISTRATIVE AND SELLING EXPENSES 1,423,585 2,308,755 2,922,450 4,622,098
------------- ------------ ------------ ------------
Loss from operations (1,686,836) (2,444,968) (3,458,025) (5,060,926)
------------- ------------ ------------ ------------
OTHER INCOME:
Interest income (expense), net (1,542) 47,150 17,218 120,870
Other 4,626 30,138 19,563 25,889
------------- ------------ ------------ ------------
3,084 77,288 36,781 146,759
------------- ------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (1,683,752) (2,367,680) (3,421,244) (4,914,167)
PROVISION FOR INCOME TAXES - - - -
------------- ------------ ------------ ------------
Net loss $ (1,683,752) $ (2,367,680) $ (3,421,244) $ (4,914,167)
============= ============ ============ ============
PREFERRED STOCK DIVIDENDS 118,424 143,613 242,526 289,898
------------- ------------ ------------ ------------
Net loss attributable to
common shareholders $ (1,802,176) $ (2,511,293) $ (3,663,770) $ (5,204,065)
============= ============ ============ ============
PER SHARE INFORMATION:
Net Loss Per Share:
Basic $ (.10) $ (.17) $ (.20) $ (.35)
============= ============ ============ ============
Diluted $ (.10) $ (.17) $ (.20) $ (.35)
============= ============ ============ ============
Shares used in computing net loss per share:
Basic 18,579,299 14,778,121 17,918,754 14,701,878
============= ============ ============ ============
Diluted 18,579,299 14,778,121 17,918,754 14,701,878
============= ============ ============ ============
See Notes to Consolidated Financial Statements
-2-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the Six Months Ended June 30, 2002
(UNAUDITED)
Additional Total
Shares Common Paid-In Deferred Stock Accumulated Shareholders'
Outstanding Stock Capital Compensation Deficit Equity
----------- ------- ---------- -------------- ------------ -------------
BALANCE, January 1, 2002 16,308,968 $8,154,484 $54,642,571 $ (52,334) $(43,455,971) $19,288,750
Conversions of Series B Redeemable
Convertible Preferred Stock, net
of related costs 2,439,630 1,219,815 178,366 - - 1,398,181
Preferred stock dividends - - (242,526) - - (242,526)
Employee Stock Grant 337,500 168,750 60,750 (229,500) - -
Amortization of deferred stock
compensation - - - 147,909 - 147,909
Net loss - - - - (3,421,244) (3,421,244)
----------- ---------- ----------- --------- ------------ -----------
BALANCE, June 30, 2002 19,086,098 $9,543,049 $54,639,161 $(133,925) $(46,877,215) $17,171,070
=========== ========== =========== ========= ============ ===========
See Notes to Consolidated Financial Statements
-3-
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended
June 30,
-------------------------------------
2002 2001
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,421,244) $ (4,914,167)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Non-cash stock compensation expense 147,909 3,075
Depreciation and amortization 823,637 1,349,303
Change in:
Accounts receivable, net (702,152) 1,116,417
Inventories 289,566 (182,898)
Prepaid expenses and other current assets 4,569 (321,872)
Intangible and other assets (138,173) (241,259)
Trade accounts payable (180,084) (305,267)
Accrued Restructuring Charges (101,655) -
Deferred Revenue 3,823,667 -
Other current and long-term liabilities 403,621 16,693
------------ ------------
Net cash provided by (used in) operating activities 949,661 (3,479,975)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (125,834) (22,869)
------------ ------------
Net cash used in investing activities (125,834) (22,869)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of debt obligations (95,128) (535,751)
Proceeds from issuance of common stock upon exercise of stock options,
net of related costs - 16,483
------------ ------------
Net cash used in financing activities (95,128) (519,268)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 728,699 (4,022,112)
CASH AND CASH EQUIVALENTS, beginning of period 3,724,130 9,151,835
------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 4,452,829 $ 5,129,723
============ ============
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 $ 1,398,181 $ 1,548,153
============ ============
Stock grant to employees $ 229,500 $ 32,250
============ ============
See Notes to Consolidated Financial Statements
-4-
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.
These unaudited consolidated financial statements have been prepared in
accordance with the instructions for Form 10Q and accordingly, they do not
include all of the information and footnotes normally provided in annual
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, 2001.
Reclassifications - Certain prior year amounts have been reclassified to
conform to the current year presentation.
Management Estimates - The preparation of financial statements in
conformity with accounting principles generally accepted in the United
States of America, requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and
expenses reported in those financial statements. Significant estimates
reflected in the financial statements include: allowances for doubtful
accounts, inventory obsolescence reserves, deferred tax asset valuation
reserve, and the fair value of intangible assets. Actual results could
differ from those estimates and assumptions.
Revenue Recognition - Non software-related revenue is recognized upon
shipment. Andrea reports such sales levels on a net sales basis, with net
sales being computed by deducting from gross sales, the amount of actual
sales returns and the amount of reserves established for anticipated
returns. With respect to software revenues, the Company recognizes revenue
in accordance with Statement of Position ("SOP") 97-2, "Software Revenue
Recognition," as amended, and Staff Accounting Bulletin ("SAB") No. 101
"Revenue Recognition in Financial Statements." License revenue is
recognized based on the terms and conditions of individual contracts (see
Note 12). In addition, fee-based services are performed on a
time-and-material basis or on a fixed-fee basis, under separate service
arrangements.
2. Earnings Per Common Share - Basic net loss per common share is computed by
dividing net loss attributable to common shareholders by the
weighted-average number of common shares outstanding. Diluted net loss per
common share is computed by dividing net loss attributable to common
shareholders 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,
------------------------------ ------------------------------
2002 2001 2002 2001
----------- ------------- ------------- ------------
Numerator:
Net loss $(1,683,752) $(2,367,680) $(3,421,244) $(4,914,167)
Preferred stock dividends 118,424 143,613 242,526 289,898
----------- ----------- ----------- -----------
Net loss attributable to
common shareholders $(1,802,176) $(2,511,293) $(3,663,770) $(5,204,065)
=========== =========== =========== ===========
Denominator:
Weighted-average common shares
outstanding - Basic and Diluted* 18,579,299 14,778,121 17,918,754 14,701,878
=========== =========== =========== ===========
-5-
For the Three Months Ended For the Six Months Ended
June 30, June 30,
-------------------------- -------------------------
2002 2001 2002 2001
------ ------- ------ ------
Net loss per share - Basic and
Diluted $(.10) $(.17) $(.20) $(.35)
===== ===== ===== =====
* 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 Statement of
Financial Accounting Standard ("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 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, 2002 and 2001, Andrea's operations did not give rise to items
includible in comprehensive loss, which were not already included in net
loss. Accordingly, Andrea's comprehensive loss is the same as its net loss
for all periods presented.
4. Derivative Instruments -The Financial Accounting Standards Board ("FASB")
issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"). This statement establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. FAS 133 was adopted by Andrea on January 1, 2001, and 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.
5. In July 2001, the FASB issued SFAS 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). Andrea has adopted FAS 142 standard effective
January 1, 2002, and accordingly, those intangible assets that continue to
be classified as goodwill or as other intangibles with indefinite lives are
no longer amortized. Other intangible assets, which do not have indefinite
lives (such as core technology - Note 11), continue to be amortized. Andrea
has made an assessment of its intangible assets to identify goodwill
separately from other identifiable intangibles. No adjustment was deemed
necessary, although the intangible asset "Workforce in Place", which
amounted to $141,029, was reclassified as goodwill on January 1, 2002. In
accordance with FAS 142, intangible assets, including purchased goodwill,
is evaluated annually for impairment, or more often if circumstances
warrant. We performed our initial transitional impairment testing of
goodwill and intangible assets during the first quarter of fiscal 2002.
That effort, and preliminary assessments of our identifiable intangible
assets, indicated that little or no adjustment would be required upon
adoption of this pronouncement. The impairment testing is performed in two
steps: (step one) the determination of impairment, based upon the fair
value of a reporting unit as compared to its carrying value, and (step two)
if there is an impairment, this step measures the amount of impairment loss
by comparing the implied fair value of goodwill with the carrying amount of
that goodwill. FAS 142 requires that an entity complete step one of the
transitional goodwill impairment test within six months of adoption, and
that if there is an indication that the carrying amount of the net assets
of a reporting unit exceeds its fair value, step two must be completed by
the end of the fiscal year. In the second quarter of fiscal 2002, we
determined that the carrying value of this unit might be greater than its
fair value. In order to finalize our determination of fair value, we will
require the assistance of a third-party valuation firm. We anticipate
completing this analysis during the second half of 2002.
-6-
The following table presents adjusted net loss and net loss per share data
restated to include the pro forma retroactive impact of the adoption of FAS 142:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------------------------------------
2002 2001 2002 2001
------------- ------------- -------------- --------------
Reported Net Loss attributable to common $ (1,802,176) $ (2,511,293) $ (3,663,770) $ (5,204,065)
shareholders
Goodwill and Workforce in Place Amortization - 282,047 - 564,093
------------ ------------ ------------ ------------
Adjusted Net Loss $ (1,802,176) $ (2,229,246) $ (3,663,770) $ (4,639,972)
============ ============ ============ ============
Net Loss Per Share - Basic and Diluted $ (.10) $ (.17) $ (.20) $ (.35)
Goodwill and Workforce in Place
Amortization - .02 - .04
------------ ------------ ------------ ------------
Adjusted Net Loss Per Common Share $ (.10) $ (.15) $ (.20) $ (.31)
============ ============ ============ ============
Weighted-average common shares
outstanding - Basic and Diluted 18,579,299 14,778,121 17,918,754 14,701,878
============ ============ ============ ============
The changes in the carrying amount of Goodwill and Intangible assets during the
six months ended June 30, 2002 were as follows:
Core Trademarks Workforce in
Goodwill Technology and Patents Place Total
------------- ---------------- -------------- -------------- -------------
Balance as of December 31, 2001 $ 12,317,843 $ 8,326,587 $ 502,334 $ 141,029 $ 21,287,793
Additions during period -- -- 123,379 -- 123,379
Reclassification 141,029 -- -- (141,029) --
Amortization -- (367,054) (17,539) -- (384,593)
------------ ------------ ---------- ---------- ------------
Balance as of June 30, 2002 12,458,872 7,959,533 608,174 -- 21,026,579
============ ============ ========== ========== ============
Intangible assets as of June 30, 2002 and December 31, 2001 consisted of the
following:
June 30, 2002 December 31, 2001
------------- -----------------
Core Technology 7,959,533 8,326,587
Trademarks and Patents 608,174 502,334
Workforce in Place -- 141,029
---------- ----------
Total Intangible Assets 8,567,707 8,969,950
========== ==========
Amortization of core technology is expected to be $734 thousand a year for the
next 11 years. Trademarks and Patents are amortized using the straight-line
method over 17 years.
-7-
6. Inventories are stated at the lower of cost (on a first in, first out) or
market basis.
Inventories, net, consists of the following: June 30, 2002 December 31, 2001
------------- -----------------
Raw Material $1,986,158 $2,000,375
Work-in-process 205,211 130,167
Finished Goods 1,564,477 1,845,720
Less: reserve for obsolescence (655,683) (586,533)
---------- ----------
$3,100,163 3,389,729
========== ==========
7. New Accounting Pronouncements-In August 2001, the FASB issued SFAS No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets." This
statement supersedes SFAS No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and
Accounting Principles Board Opinion No. 30 "Reporting Results of Operations
- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions."
The Statement retains the fundamental provisions of SFAS No. 121 for
recognition and measurement of impairment, but amends the accounting and
reporting standards for segments of a business to be disposed of. The
provisions of this statement are required to be adopted no later than
fiscal years beginning after December 31, 2001. The impact of adopting this
standard was not material to the financial statements.
On April 30, 2002 the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". SFAS No. 145 eliminates the requirement that gains
and losses from the extinguishment of debt be aggregated and, if material,
classified as an extraordinary item, net of the related income tax effect
and eliminates an inconsistency between the accounting for sale- leaseback
transactions and certain lease modifications that have economic effects
that are similar to sale-leaseback transactions. Generally, SFAS No. 145 is
effective for transactions occurring after May 15, 2002. The adoption of
this standard is expected to have no impact to the Company.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS 146"), provides guidance on the recognition and
measurement of liabilities for cost associated with exit or disposal
activities. The provisions of this Statement are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company
is currently reviewing SFAS 146 to determine the impact upon adoption.
8. Restructuring Accrual - During the fourth quarter of fiscal 2001, Andrea
recorded restructuring charges in connection with exiting a PC headset
channel, or customer-type, within the Anti-Noise Product segment. The
restructuring charge was recorded as accrued restructuring charges or as a
reduction of assets, as applicable. During the first half of fiscal 2002,
we made payments of $101,655, which reduced the restructuring liability
that had been established during the fourth quarter of fiscal 2001.
Currently, Andrea expects to settle all of its remaining obligations
related to the restructuring by the end of fiscal 2002. As of June 30,
2002, there were no material revisions to the plan, exit costs, or the
anticipated timing of our plan's execution.
9. 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 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.
All of the Series B Preferred Stock is currently convertible into Andrea's
Common Stock, and Andrea has reserved 4,486,002 shares of Common Stock for
issuance upon conversion.
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
-8-
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 is actively seeking to obtain 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 six-month period ended June 30, 2002, the following number of
shares of Series B Preferred Stock, together with related accrued
dividends, were converted:
Number of Series Number of
Date of B Preferred Conversion Common
Conversion Stock Converted Price Shares
-------------------- ------------------ ------------- -------------
January 11, 2002 40 $ 0.59 747,657
March 15, 2002 37 $ 0.51 805,075
May 22, 2002 52 $0.655 886,898
Total 129 2,439,630
=== =========
The original value of the warrants upon issuance was $348,457. As of June
30, 2002, the Series B Preferred Stock is recorded net of the unaccreted
present value of the warrants of $30,048. Due to the redemption features
described above, the Series B Preferred Stock is presented outside of
shareholders' equity in the accompanying consolidated balance sheets.
10. 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 is 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 $0.555 as of June 30, 2002.
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. All of the Series C Preferred Stock is currently covertible into
Andrea's Common Stock, and Andrea has reserved 10,890,411 shares of Common
Stock for issuance upon conversion of the shares of the Series C Preferred
Stock.
In accordance with EITF Issue 00-27, "Application of EITF Issue No. 98-5 to
Certain Convertible Instruments", in the third quarter of 2001, Andrea
recorded a 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
-9-
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 original value of the deal costs upon issuance was $175,000. As of June
30, 2002, the Series C Preferred Stock is recorded net of the unaccreted
present value of the deal costs of $122,655. Due to the redemption features
discussed above, the Series C Preferred Stock is presented outside of
shareholders' equity in the accompanying consolidated balance sheet.
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.
On March 15, 2002, Andrea announced that a triggering event had occurred
and that as a result of the trigger, the investor had the right to require
Andrea to redeem all of the Series C Preferred Shares. The investor has
agreed, in a Waiver Agreement, to waive its right to receive the aggregate
Triggering Event Redemption Price (as defined in a Certificate of
Amendment) (together with any interest and related cash payments or
penalties thereon) the investor was otherwise entitled to as a result of
the existing triggering event until April 7, 2007. In addition, the
investor agreed to waive, until April 7, 2007, its right to receive the
aggregate Triggering Event Redemption Price, as defined, (together with any
interest and related cash payments or penalties thereon) with respect to
(1) any future Triggering Event relating to additional registration
failures, provided that the existing registration statements remain
effective and available to the investor for the number of shares covered by
such registration statements as of the date of the waiver (less any future
sales made pursuant to such registration statements), and (2) any future
Triggering Event relating to the delisting of Andrea's common stock,
provided that the Common Stock is thereafter authorized for trading on the
OTC Bulletin Board. In addition, the investor agreed to waive, until April
7, 2007, Andrea's obligation to register any additional shares and Andrea's
obligation to make certain cash payments, if any, for its failure to
register any additional shares. Finally, the investor acknowledged that no
Maturity Date Redemption Price (as defined) is due on October 10, 2002. The
investor's waivers described above shall be null and void immediately,
however, upon the earlier of April 7, 2007, if such Triggering Event
Redemption Price is not paid on April 7, 2007, the first date on which
Andrea fails to comply in any material respect with the terms of the Waiver
Agreement, and related agreements entered into between Andrea and the
investor (the "Agreements"), and the first date on which Andrea is
insolvent.
As consideration for the Waiver Agreement, Andrea agreed to grant the
investor a security interest in all of Andrea's assets; however, the
investor agreed to have its lien on Andrea's assets subordinated to (1) any
lien granted in the future to a non-affiliated third party in connection
with a strategic transaction with a financing component, provided that such
third-party lien relates only to the amount of the financing component of
such transactions, and (2) any lien granted in the future to a bank or
other similar institution pursuant to any asset-based financing
transaction. In addition, the investor agreed to release its lien in
connection with any sale of any assets subject to the investor's lien,
provided the investor receives a lien on the proceeds of the sale. The
investor acknowledged that its lien in any portion of Andrea's intellectual
property is effectively subordinate to the interest of any current or
future licensee of such intellectual property, as any interest the investor
may have in such intellectual property cannot be greater than Andrea's
interest therein.
Given that the waiver granted by the investor does not cover all Triggering
Events set forth in the Certificate of Amendment and that the Waiver
Agreement will be null and void in the event Andrea fails to comply in any
-10-
material respect with the terms of the Agreements, among other things,
there is a risk that the investor could declare a Triggering Event that
would trigger 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 new waiver
from the holders of the Series C Preferred Stock. If the Series C 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.
11. Acquisition Of Business - On May 5, 1998, Andrea acquired all of the
outstanding shares of capital stock of Lamar Signal Processing, Ltd. (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 $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, 2002:
Net Value at Estimated
June 30, 2002 Useful Life
------------- -----------
Goodwill $12,458,872 N/A
===========
Other Intangible Assets -
Core Technology $ 7,959,533 15 years
===========
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.
12. In December 2001 and March 2002, Andrea entered into two agreements
with Analog Devices, Inc. to be their provider of noise canceling
technologies for use with certain of their computer audio product
offerings. These license agreements relate to Andrea's high
performance noise canceling technologies that enable clear voice
communications and high-performance audio in small home-office and regular
office environments. Under our agreements with Analog Devices, they are
obligated to pay us a total of $5 million in license fees during calendar
2002. Through the second quarter of 2002, and in accordance with our
agreements, we have received $3 million of these license fees. The license
agreements, as amended, are recorded as an account receivable and deferred
revenue ($1,666,680 of which is classified as current and $3,156,987
classified as long-term as of June 30, 2002) in the accompanying
consolidated balance sheets. All license revenues will be recognized on a
straight-line basis over their respective three-year periods.
13. COMMITMENTS AND CONTINGENCIES
Leases - Andrea's corporate headquarters is located in Melville, New York,
where Andrea leases space for manufacturing, research and development,
sales and executive offices from an unrelated party. The lease is for
-11-
approximately 40,000 square feet and expires in June 2008. Rent expense
under this operating lease was approximately $562,000, $540,000 and
$507,000 for the years ended December 31, 2001, 2000 and 1999,
respectively. As of June 30, 2002, the minimum future lease commitments,
under this lease and all other noncancellable operating leases, are as
follows:
2002 (second half of 2002) $ 391,197
2003 776,487
2004 744,021
2005 657,530
2006 683,832
Thereafter 1,050,375
------------
Total $ 4,303,442
Legal Proceedings - As previously reported in Andrea's Annual Report on
Form 10-K for the year ended December 31, 2001, Andrea was engaged in a
lawsuit filed in the U.S. District Court for the Eastern District of New
York by NCT Group, Inc. ("NCT") and its subsidiary NCT Hearing Products,
Inc. Andrea filed and served an answer to the NCT complaint, denying the
allegations and asserting affirmative defenses and counterclaims. Effective
July 29, 2002, Andrea executed a non-cash settlement of the lawsuit with
NCT which dismissed both NCT's claims and Andrea's counterclaims.
14. Segment Information - Andrea follows the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131"). Reportable operating segments are determined based on Andrea's
management approach. The management approach, as defined by FAS 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 June 30, 2002,
and 2001:
Andrea DSP
Aircraft Microphone
Andrea Anti- Communications and Software
Segment Data Noise Products Products Products June 30, 2002
---------------------------------- -------------- -------------- ------------ -------------
Net sales $ 663,308 $ 729,643 $ 377,408 $ 1,770,359
Income (loss) from operations (107,358) 86,531 (1,666,009) (1,686,836)
Depreciation 47,153 21,506 18,384 87,043
Andrea DSP
Aircraft Microphone
Andrea Anti- Communications and Software
Segment Data Noise 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
The following represents selected consolidated financial information for
Andrea's segments for the six months ended June 30, 2002, and 2001:
Andrea DSP
Aircraft Microphone and
Andrea Anti- Communications Software
Segment Data Noise Products Products Products June 30, 2002
----------------------------- ---------------- -------------- -------------- -------------
Net Sales 1,252,902 1,824,334 492,414 3,569,650
Income (loss) from operations (375,389) 375,383 (3,458,019) (3,458,025)
Depreciation 90,997 48,926 110,020 249,943
Andrea DSP
Aircraft Microphone and
Andrea Anti- Communications Software
Segment Data Noise Products Products Products June 30, 2001
----------------------------- ---------------- -------------- -------------- -------------
Net Sales 2,492,418 2,340,117 401,033 5,233,568
Income (loss) from operations (1,495,645) 887,221 (4,452,502) (5,060,926)
Depreciation 201,370 72,885 115,079 389,334
-12-
International revenues are based on the country in which the end-user is
located. For the three months ended June 30, 2002 and 2001, sales and
accounts receivable by geographic area are as follows:
Geographic Data June 30, 2002 June 30, 2001
-------------------- --------------- ---------------
Sales:
United States $ 1,552,804 $ 2,030,543
Europe 80,418 249,057
Other foreign 137,137 338,329
--------------- ---------------
$ 1,770,359 $ 2,617,929
=============== ===============
Accounts receivable:
United States $ 2,663,218 $ 1,892,539
Europe 85,248 304,816
Other foreign 47,832 189,941
--------------- ---------------
$ 2,796,298 $ 2,387,296
=============== ===============
For the six months ended June 30, 2002 and 2001, sales by geographic
area are as follows:
Geographic Data June 30, 2002 June 30, 2001
-------------------- --------------- ---------------
Sales:
United States $ 2,985,585 $ 4,035,927
Europe 178,894 369,972
Other Foreign 405,171 827,669
--------------- ---------------
$ 3,569,650 $ 5,233,568
=============== ===============
Approximately $2 million, or 72% of total accounts receivable is due from
Analog Devices, Inc. at June 30, 2002 (Note 12).
The assets and liabilities of Andrea 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.
Concentration of Credit Risk
Andrea is a manufacturer of audio communications equipment for several
industries. Andrea primarily generates sales from its noise canceling and
active noise canceling products as well as through sales to the federal
government. Sales of Andrea Anti-Noise products were significant to one
customer and its affiliates, accounting for approximately 9% and 25% of the
total sales for the 2002 and 2001 second quarter, respectively, and 9% and
23% for the 2002 and 2001 first half, respectively. Sales to the federal
government and related subcontractors were approximately 18% and 27% of the
total sales for the 2002 and 2001 second quarter, respectively, and 22% and
24% for the 2002 and 2001 first half, respectively.
ITEM 2. Management's Discussion and Analysis OR PLAN OF Operation
Overview of Our Products, Technologies and Markets
We design, develop and manufacturer state-of-the-art microphone
technologies and products for enhancing speech-based applications software and
communications that require high quality, clear voice signals. Our technologies
eliminate unwanted background noise to enable the optimum performance of any
speech-based application.
Andrea's products and technologies optimize the performance of
speech-based applications in markets such as:
. voice communication over the Internet;
. speech recognition for use with desktop, laptop and hand-held
computers;
. audio/video conferencing;
. computer-based automobile monitoring and control systems for use by
drivers and passengers;
. military and commercial aircraft communications systems;
. call centers;
. 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.
-13-
Our patented and patent-pending digital technologies enable a speaker to be
several feet from the microphone, and free 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 an array of microphones
in a product into digital signals that are then processed to cancel background
noise from the signal to be transmitted. These two adaptive technologies
represent the core technologies within our portfolio of far-field technologies.
In addition to DSDA and DFTA, Andrea has developed and commercialized several
other digital microphone technologies, including, among others, Andrea EchoStop,
a high-quality acoustic echo canceller, and Andrea PureAudio, a leading
technology for canceling unwanted stationary noises. All of our digital,
far-field technologies can be tailored and embedded into various form factors,
for example, into the monitor of a PC, a rear view mirror, or a personal digital
assistant, and can be used individually or combined depending on particular
customer requirements. We are currently targeting our far-field microphone
technologies primarily at 1) the desktop computing market (primarily through our
relationship with Analog Devices, Inc., 2) the market for personal computers
designed for use in automobiles, trucks and buses to control satellite-based
navigation systems and other devices within vehicles, 3) the market for mobile
devices, such as a personal digital assistants and 4) the military and
commercial aircraft communication systems market. Our digital technologies and
related products comprise our Andrea Digital Signal Processing (DSP) Microphone
and Software line of business, and sales of such technologies and products
during the Second Quarter 2002 and the Second Quarter 2001 approximated 21% and
5%, respectively, of our total net revenues. We dedicate the majority of our
marketing and research and development resources to this business segment, as we
believe that communication products will increasingly require high performance,
untethered (hands-free and headset-free) microphone technology.
In May 1998, we acquired Lamar Signal Processing, Ltd. ("Lamar"), an
Israeli corporation engaged in the development of scalable, digital signal
processing-based directional, noise cancellation microphone technologies. 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.
Our Active Noise Cancellation microphone and patented 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.
During the fourth quarter 2001, we recorded restructuring charges relating
to repositioning our business plan for our Andrea Anti-Noise Product business
segment as part of our overall effort to drive high margin product sales and
become profitable. The restructuring focused on exiting from an increasingly
unprofitable PC OEM/retail headset channel within Andrea's Anti-Noise Headset
product segment. This was primarily a result of the increasing competitive
nature of the PC headset market, coupled with Andrea's ongoing strategic efforts
to focus on being primarily a supplier of high-end, digital-based, far-field
microphone technologies. This PC OEM/retail headset channel primarily purchased
our lower-end, low margin headset products, and required substantial support
which, when combined with decreasing volumes realized during 2001, became
unprofitable. During the Second Quarter 2002 and the Second Quarter 2001 our
Andrea Anti-Noise Product segment approximated 38% and 45%, respectively, of our
total net revenues.
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. During 2000 and 2001, we dedicated development
efforts aimed at increasing the manufacturability of certain intercom products
as well as to accommodate future implementation of our digital audio
technologies. We refer to this line of business as our Aircraft Communications
line of business, and sales of such products during the Second Quarter 2002 and
Second Quarter 2001 approximated 41% and 50%, respectively, of our total net
revenues.
-14-
We are incorporated under the laws of the State of New York and have been
engaged in the electronic communications industry since 1934.
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.
Our Critical Accounting Policies
Our consolidated financial statements and the notes to our consolidated
financial statements contain information that is pertinent to management's
discussion and analysis. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities. We
believe the following critical accounting policies, in addition to estimating
allowances for doubtful accounts and inventory obsolescence as well as the
recording and presentation of our convertible preferred stock, involve
additional management judgment due to the sensitivity of the methods,
assumptions, and estimates necessary in determining the related asset and
liability amounts:
Statement of Financial Accounting Standards, or SFAS, No. 144 "Accounting
for the Impairment or Disposal of Long-Lived Assets" supersedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and Accounting Principles Board Opinion No. 30 "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions". SFAS No. 144 retains the fundamental provisions of SFAS No. 121
for recognition and measurement of impairment, but amends the accounting and
reporting standards for segments of a business to be disposed of. The provisions
of this statement require management judgments regarding the future operating
and disposition plans for marginally performing assets, and estimates of
expected realizable values for assets to be sold. The impact of adopting this
standard was not material to the financial statements.
Revenue Recognition - Non software-related revenue is recognized upon
shipment. Andrea reports such sales levels on a net sales basis, with net sales
being computed by deducting from gross sales, the amount of actual sales returns
and the amount of reserves established for anticipated returns. With respect to
software revenues, the Company recognizes revenue in accordance with Statement
of Position ("SOP") 97-2, "Software Revenue Recognition," as amended, and Staff
Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial
Statements." License revenue is recognized based on the terms and conditions of
individual contracts (see Note 12). In addition, fee-based services are
performed on a time-and-material basis or on a fixed-fee basis, under separate
service arrangements.
Statements of Financial Accounting Standards, or SFAS, No. 141, "Business
Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets" 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). Andrea has adopted
this standard effective January 1, 2002, and, accordingly, those intangible
assets that continue to be classified as goodwill or as other intangibles with
indefinite lives are no longer amortized. The adoption of this pronouncement, to
date, resulted in a $564 thousand decrease in amortization expense for the first
six months of 2002 over the same period in the prior year. Other intangible
assets, which do not have indefinite lives, continue to be amortized. Andrea has
made an assessment of its intangible assets to identify goodwill separately from
other identifiable intangibles. No adjustment was deemed necessary, although the
intangible asset "Workforce in Place" is reclassified as goodwill pursuant to
SFAS No. 142. We performed our initial transitional impairment testing of
goodwill and intangible assets during the first quarter of fiscal 2002. That
effort, and preliminary assessments of our identifiable intangible assets,
indicated that little or no adjustment would be required upon adoption of this
pronouncement. The impairment testing is performed in two steps: (step one) the
determination of impairment, based upon the fair value of a reporting unit as
compared to its carrying value, and (step two) if there is an impairment, this
step measures the amount of impairment loss by comparing the implied fair value
of goodwill with the carrying amount of that goodwill. FAS 142 requires that an
entity complete step one of the transitional goodwill impairment test within
six months of adoption, and that if there is an indication that the carrying
amount of the net assets of a reporting unit exceeds its fair value, step two
must be completed by the end of the fiscal year. In the second quarter of fiscal
2002, we determined that the carrying value of this unit might be greater than
its fair value. In order to finalize our determination of fair value, we will
require the assistance of a third-party valuation firm. We anticipate completing
this analysis during the second half of 2002.
We have recorded a substantial valuation reserve against our deferred tax
assets related to net operating loss carryforwards. The realization of a portion
of our 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. We will be continually
re-assessing our reserves on deferred income tax assets in future periods on a
quarterly basis. Our determination that the deferred tax asset of $1.8 million,
as well as to the realization of additional reserves is, and will be, based on
Andrea's expectations of future income.
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, 2002 (the "2002 Second Quarter") compared to the three months ended
-15-
June 30, 2001 (the "2001 Second Quarter") and for the six months ended June 30,
2002 (the "2002 First Half") compared to the six months ended June 30, 2001 (the
"2001 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 the following:
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;
- the cost of development of our products;
- 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;
- fluctuations in Department of Defense spending/funding; and
- general economic conditions.
We cannot assure that the level of sales and gross profit, if any, that we
achieve in any particular period will not be significantly lower than in other
periods. Our revenues for the 2002 Second Quarter, were approximately $1.8
million compared to approximately $2.6 million in the 2001 Second Quarter. Net
loss applicable to common shareholders for the 2002 Second Quarter was
approximately $1.8 million, or $0.10 per share on a diluted basis, versus net
loss applicable to common shareholders of approximately $2.5 million, or $0.17
per share on a diluted basis, for the Second Quarter 2001. Our revenues for the
2002 First Half were approximately $3.6 million compared to approximately $5.2
million in the 2001 First Half. For the 2002 First Half, we had a net loss
attributable to common shareholders of approximately $3.7 million compared to a
net loss attributable to common shareholders of $5.2 million in the 2001 First
Half. In response to significant declines in our sales of Andrea Anti-Noise
Products as a result of increased competition with respect to a specific
customer channel, as well as our overall shift in strategic direction to deliver
digital, far-field microphone solutions, during the fourth quarter of 2001, we
recorded restructuring charges of approximately $4.5 million. This restructuring
is expected to result in further decreases in sales, on a comparable period
basis, during the remainder of fiscal 2002. We are examining additional
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 continues to fall below our expectations
and, therefore, our net income or loss may
-16-
be disproportionately affected by any further reduction in sales revenue.
Furthermore, our acquisition in 1998 of Lamar resulted in a substantial amount
of goodwill and other intangible assets. The amortization of these intangible
assets has had, and will continue to have, a negative, non-cash impact on our
results of operations (other than goodwill). 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 or maintain access to funds sufficient
to meet our operating needs, 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, and could result in our
delisting from the American Stock Exchange or inability to continue operations.
In recent years, we have sustained significant operating losses. We have
been unable to generate sufficient cash flow from operations to meet our
operating needs and, correspondingly, 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. 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. 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, or redemptions of Andrea's Series B and Series C Redeemable
Convertible Preferred Stock. Given our current financial condition and market
conditions, it may be difficult to attract additional financings on favorable
terms, or at all, as compared to prior periods. We have revised our business
strategies to reduce our expenses and capital expenditures, but we cannot assure
you that we will be successful in obtaining financings or access to additional
sources of funding in amounts necessary to continue our operations. Failure to
maintain sufficient access to funding may also result in our delisting from the
American Stock Exchange.
We face the risk that Andrea could be required to redeem the 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 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.
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 investor's 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.
We face the risk that Andrea could be required to redeem the 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"). 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, including the announcement of a
major transaction, as defined in the Certificate of Amendment, or upon
-17-
certain other triggering events. On March 25, 2002, Andrea announced that a
triggering event had occurred and that Andrea was seeking a waiver from the
Series C Preferred Stock holders. A final agreement regarding the waiver
arrangement was reached on March 28, 2002. The waiver related to the existing
triggering event, as well as certain possible future triggering events, however,
will be null and void upon the earlier of April 7, 2007, the first date on which
Andrea fails to comply in any material respect with the terms of the waiver and
related documents, and the first date on which Andrea is insolvent.
As consideration for the Series C Preferred Stock holder's agreement to
waive its current and, in certain circumstances, any future right to receive the
aggregate Triggering Event Redemption Price for the Series C Preferred Stock,
Andrea agreed to grant a security interest in all of Andrea's assets. However,
the Series C Preferred Stock holder agreed to have its lien on Andrea's assets
subordinated to (1) any lien granted in the future to a non-affiliated third
party in connection with a strategic transaction with a financing component,
provided that such third-party lien relates only to the amount of the financing
component of such transactions, and (2) any lien granted in the future to a bank
or other similar institution pursuant to any asset based financing transaction.
In addition, the Series C Preferred Stock holder agreed to release its lien in
connection with any sale of any assets subject to its lien, provided they
receive a lien on the proceeds of the sale. The Series C Preferred Stock holder
acknowledged that its lien in any portion of Andrea's intellectual property is
effectively subordinate to the interest of any current or future licensee of
such intellectual property, as any interest the investor may have in such
intellectual property cannot be greater than Andrea's interest therein.
Given that the waiver granted by the Series C Preferred Stock holder does
not cover all triggering events that could require the redemption of the Series
C Preferred Stock, and that the waiver will be null and void in the event Andrea
fails to comply in any material respect with the terms of the agreements
relating to the waiver, among other things, there is a risk that the Series C
Preferred Stock holder could declare a triggering event that would trigger 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 new waiver from the holder of the Series C Preferred Stock. If no such waiver
can be obtained, Andrea's ability to continue its current operations will be
materially adversely affected and if Andrea has insufficient funds to redeem the
Series C Preferred Stock, it could result in Andrea's inability to meet its
operating obligations and, consequently, delisting from the American Stock
Exchange.
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,
19,086,098 were outstanding as of August 16, 2002. This does not include
5,732,375 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 15,376,413 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.
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 August 16, 2002, we had 120 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.
-18-
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 120 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 Common
Conversion Price Issuable Upon Conversion/(1)/ Stock/(2)/
--------------------------- ---------------------------------- ----------------------------------
$0.50 2,400,000 11%
$1.50 800,000 4%
$2.50 480,000 2%
$3.50 342,857 2%
$4.50 266,667 1%
$5.50 218,182 1%
$6.50 184,615 1%
(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 19,086,098 shares of common stock outstanding as of August 16,
2002.
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 Common
Conversion Price Issuable Upon Conversion/(1)/ Stock/(2)/
$ 0.25 30,000,000 61%
$ 0.30 25,000,000 57%
$ 0.35 21,428,571 53%
$ 0.40 18,750,000 50%
$ 0.45 16,666,667 47%
$ 0.50 15,000,000 44%
$0.555 13,513,514 41%
(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 19,086,098 shares of common stock outstanding as of August 16,
2002.
The following table illustrates the varying amounts of shares of Common
Stock that would be issuable upon conversion of all 120 outstanding shares of
Series B convertible preferred stock and all 750 outstanding shares of
-19-
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 Common
Conversion Price Issuable Upon Conversion/(1)(2)(3)/ Stock/(4)/
$ .35 24,857,143 57%
$ .45 19,333,333 50%
$ .50 17,400,000 48%
$ .555 15,675,676 45%
$ 1.50 14,313,514 43%
$ 2.50 13,993,514 42%
$ 3.50 13,856,371 42%
$ 4.50 13,780,180 42%
$ 5.50 13,731,695 42%
(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 $ .35, $ .45 and $ .50. 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 $ .555, 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 $ 0.555, the
Series C would still be converted at its maximum conversion price of $
0.555.
(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 19,086,098 shares of common stock outstanding as of August 16,
2002.
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 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.
-20-
If we fail to market and commercialize our Andrea DSP Microphone and Software,
Andrea Anti-Noise, or Andrea Aircraft Communications products, our revenues may
not increase at a high enough rate to improve our results of operations or may
not increase at all.
Our business, results of operations and financial condition depend on
successful commercialization of our Andrea DSP Microphone and Software and
Andrea Anti-Noise products and technologies. Since we began sales of the initial
Andrea Anti-Noise products in 1995, we have developed and introduced new
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 desktop computer market, the market
for computer-based automobile monitoring and control systems for use by drivers
and passengers, and the mobile device market. In addition, we recently developed
and introduced a new aircraft intercom system aimed at increasing overall
manufacturability as well as to enable future implementations of our Andrea DSP
Microphone and Software technologies. 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 Andrea DSP Microphone and
Software 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, Andrea DSP Microphone
and Software 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
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 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. For
example, our Aircraft Communications business segment is subject to the Federal
Aviation Administration (FAA). 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.
-21-
If our marketing collaborators do not effectively market their products with
which our products are included or incorporated, our sales growth could be
adversely affected.
We have entered into collaborative and distribution arrangements with
software publishers and computer hardware manufacturers relating to the
marketing and sale of 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 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 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 Second Quarter 2002, the U.S. Government accounted for 18% 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 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, Aircraft Communications and Andrea DSP Microphone
products, such as microphones, digital signal processing boards and special
switches, 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 the sales of our 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
-22-
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.
Changes in economic and political conditions outside the United States could
adversely affect our business, results of operations and financial condition.
We generate sales to regions outside the United States, particularly in
Europe and areas in the Americas and Asia. For the three months ended June 30,
2002, sales to customers outside the United States accounted for approximately
12% 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 of 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, certain of our key research and development employees
are 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
-23-
business, results of operations and financial condition. Our future success
depends on our continuing ability to attract and retain highly qualified
managers and technical personnel. As of the date of this filing, the Company is
in the process of negotiating contracts with each of Douglas J. Andrea, Chairman
of the Board of Directors, Christopher P. Sauvigne, President and Chief
Executive Officer and Richard A. Maue, Chief Financial Officer. 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, 2002 Compared to the Quarter Ended June 30, 2001 and
Six Months Ended June 30, 2002 Compared to the Six Months Ended June 30, 2001
Sales
Sales for the 2002 Second Quarter were $1,770,359, a decrease of 32% from
sales of $2,617,929 for the 2001 Second Quarter. Sales for the 2002 First Half
were $3,569,650, a decrease of 32% from the 2001 First Half sales of $5,233,568.
The decrease in sales for the 2002 Second Quarter reflects an approximate 43%
decrease in sales of Andrea Anti-Noise Products to $663,308, or 38% of total
sales, an approximate 44% decrease of Aircraft Communications Product to
$729,643, or 41% of total sales, both partially offset by an approximate 183%
increase in sales of our Andrea DSP Microphone and Software Products, to
$377,408, or 21% of total sales. The decrease in sales for the 2002 First Half
reflects an approximate 50% decrease of Andrea Anti-Noise Products to
$1,252,902, or 35% of total sales, an approximate 22% decrease of Aircraft
Communications Product to $1,824,334, or 51% of total sales, both partially
offset by an approximate 23% increase in sales of our Andrea DSP Microphone and
Software Products, to $492,414, or 14% of total sales.
The primary reason for the decreases in sales of Andrea Anti-Noise Product
is due to our decision, during the fourth quarter 2001, to exit from an
unprofitable, PC OEM/retail headset channel within Andrea's Anti-Noise Headset
product segment. This customer channel included IBM, and for the Second Quarter
2002, sales to IBM and certain of IBM's affiliates, such sales representing
contractual obligations which we accepted during 2001, accounted for
approximately 8.5% of our total sales, or $150,503. This reflects an approximate
77% decrease from $648,157 for the Second Quarter 2001.
The decreases in our Aircraft Communication Product revenues is primarily a
result of a decrease in U.S. Department of Defense funding which affected
programs where Andrea's products are used, primarily during 2002 Second Quarter.
For the 2002 Second Quarter, sales of our Aircraft Communications Products to
the U.S. Government accounted for approximately 18% of our total sales.
The increases in sales of Andrea DSP Microphone and Software Products is
primarily due to licensing revenue recognized during the Second Quarter 2002
associated with the Company's agreements with Analog Devices.
Cost of Sales
Cost of sales as a percentage of sales for the 2002 Second Quarter
decreased to 65% from 72% in the 2001 Second Quarter. Cost of Sales as a
percentage of sales for the 2002 First Half decreased to 65% from 72% for the
2001 First Half. These decreases primarily reflect the impact of the significant
changes in the composition of our revenues as described under "Sales" above, in
particular, the increase in high-margin license revenues associated with the
Company's agreements with Analog Devices (primarily attributable to the 2002
Second Quarter), coupled with the decreases in sales of low-margin Andrea
Anti-Noise Products.
Research and Development
Research and development expenses for the 2002 Second Quarter increased 1%
to $886,534 from $881,384 for the 2001 Second Quarter. Research and development
expenses for the First Half were $1,792,356, a decrease of 5% from the 2001
First Half research and development expenses of $1,880,284. The decrease in the
First Half is due primarily to cost reduction efforts realized on a comparable
2002 First Quarter basis, offset, to an extent, by a reallocation of resources
from general and administrative activities to research and development during
the 2002 First
-24-
Half. DSP Microphone and Software Technology efforts were $725,623, or 82% of
total research and development expenses, Aircraft Communications technology
efforts were $107,112, or 12% of total research and development expenses and
Andrea Anti-Noise Product efforts were $53,799, or 6% 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 Andrea's
digital super directional array microphone technology ("DSDA") and certain other
related technologies obtained through the acquisition of Lamar in May 1998. We
believe that the acquisition of Lamar significantly reinforces our position in
digital signal processing by extending our 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 Andrea with a competitive
advantage.
General, Administrative and Selling Expenses
General, administrative and selling expenses for the 2002 Second Quarter
decreased 38% to $1,423,585 from $2,308,755 for the 2001 Second Quarter.
General, administrative and selling expenses for the 2002 First Half were
$2,922,450 a decrease of 37% from the 2001 First Half general, administrative
and selling expenses of $4,622,098. These decreases are primarily due to cost
reduction efforts, as well as our adoption, on January 1, 2002, of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("FAS"). Under FAS No. 142, goodwill and intangible assets with indefinite lives
are no longer amortized but are reviewed for impairment from time to time. The
adoption of this pronouncement resulted in a decrease of $282,047 and $564,093
in amortization expense for the 2002 Second Quarter and 2002 First Half,
respectively, when compared to the same periods in the prior year.
Notwithstanding the beneficial impact of this pronouncement to our 2002 Second
Quarter and 2002 First Half, goodwill and intangible assets which are no longer
subject to periodic amortization will be reviewed for impairment as part of a
transitional assessment and from time to time (at least annually) thereafter,
and such reviews may result in adjustments that would negatively impact future
operating results.
Other Income (Expense)
Other income for the 2002 Second Quarter was $3,084 compared to other
income of $77,288 for the 2001 Second Quarter. Other income for the 2002 First
half was $36,781 compared to other income of $146,759 for the 2001 First Half.
These declines are a result of unfavorable market conditions for our invested
cash balances (which were also substantially lower) experienced in the 2002
First Half.
Provision for Income Taxes
We did not record income tax expense for either the 2002 or 2001 Second
Quarter in light of the net loss recorded for both periods. Furthermore, the
realization of a portion of our 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. We
will be continually re-assessing our 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 we believe that, more likely than not, previously
reserved deferred tax assets will be realized, we will reduce the reserve
accordingly. With respect to our ongoing efforts to raise capital, certain
transactions may occur in the future which could change our determination of the
amount of our valuation allowance.
Net Income (Loss)
-25-
Net loss for the 2002 Second Quarter was $1,683,752 compared to a net loss
of $2,367,680 for the 2001 Second Quarter. Net loss for the 2002 First Half was
$3,421,244, compared to a net loss of $4,914,167 for the 2001 First Half. The
levels of net loss for the 2002 Second Quarter and 2002 First Half principally
reflect the factors described above.
Liquidity And Capital Resources
Andrea'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 and potential industry partners. At June 30, 2002, we had
cash and cash equivalents of $4,452,829 compared with $3,724,130 at December 31,
2001. The balance of cash and cash equivalents at June 30, 2002 is primarily a
result of our recently executed license transactions with Analog Devices, Inc.
Working capital at June 30, 2002, was $5,111,654 compared to $5,630,915 at
December 31, 2001. The decrease in working capital reflects increases in total
current assets and total current liabilities of $1,014,502, and $1,533,763,
respectively. The increase in total current assets reflects an increases in cash
and cash equivalents of $728,699, an increase in accounts receivable of $702,152
(such increase is primarily a result of our license agreements with Analog
Devices, Inc.), a decrease in inventory of $289,566, and a decrease in prepaid
expenses and other current assets of $126,783. The increase in total current
liabilities reflects a decrease in trade accounts payable of $180,084, a
decrease in current portion of long-term debt of $84,325, a decrease of $101,655
in accrued restructuring charges, an increase of $1,408,459 in deferred revenue
and an increase of $491,368 in other current liabilities.
The increase in cash from December 31, 2001 to the period ending June 30,
2002 of $728,699 reflects $949,661 of net cash provided by operating activities,
$125,834 of cash used in investing activities and $95,128 of cash used in
financing activities.
The cash provided by operating activities, excluding non-cash charges, is
attributable to the $3,421,244 net loss for the 2002 Second Quarter, a $702,152
increase in accounts receivable, a $289,566 decrease in inventory, a $4,569
decrease in prepaid and other current assets, a $138,173 increase in intangible
and other assets, a $180,084 decrease in accounts payable, a $101,655 decrease
in accrued restructuring charges, a $3,823,667 increase in deferred revenue and
a $403,621 increase in other current and long-term liabilities. The increase in
accounts receivable and deferred revenue reflects the impact of our license
agreements with Analog Devices, Inc. The decrease in inventory, as well as the
decrease in accounts payable and the increase in other current and long-term
liabilities 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 Andrea'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 our existing computer systems.
We believe that it will be necessary to raise additional working capital to
support operations. In December 1995, April 1996, August 1996 and June 1998,
Andrea raised working capital through the issuance of convertible subordinated
debentures. In June 1999, Andrea raised $7.5 million through the issuance and
sale of Series B Preferred Stock. In October 2000, Andrea raised $7.5 million
through the issuance and sale of Series C Preferred Stock. Andrea has incurred
significant losses in each of the last three fiscal years. In the year ended
December 31, 2001, Andrea incurred losses from operations, excluding the impact
of restructuring charges, of $9.3 million, and used $4.5 million in cash from
its operating activities. Management expects that operating losses and negative
cash flows will continue at least through Fiscal 2002 as Andrea continues to
market its products and technologies. Notwithstanding, in December 2001 and
March 2002, we entered into two agreements with Analog Devices, Inc. whereby
Analog Devices is obligated to pay us a total of $5 million in license fees
during calendar 2002 (which generated positive operating cash flow in the 2002
First Half). As of June 30, 2002, and in accordance with our agreements, we
received $3 million of these license fees. If we fail to develop revenues from
sales of our products to generate adequate funding from operations, or if we
fail to obtain additional financing through a capital transaction or other type
of funding, we will be required to either significantly reduce our current
operating expenses and/or operations or we may have to relinquish our products,
technologies or markets. We have no commitment for additional financing, and we
may
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experience difficulty in obtaining additional financing on favorable terms, if
at all. Any financing we obtain may contain covenants that restrict our freedom
to operate our business or may have rights, preferences or privileges senior to
our common stock and may dilute our current shareholders' ownership interest in
Andrea. We cannot assure that demand will continue for any of our products,
including future products related to our Andrea DSP 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.
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. 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 13 to the unaudited financial statements in this
quarterly report for a discussion of the legal proceedings of Andrea.
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
99.1 Chief Executive Officer Certification
99.2 Chief Financial Officer Certification
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(b) Reports on Form 8-K
On August 12, 2002, the Company filed a Current Report on Form 8-K
reporting that Arthur Andersen LLP was no longer its independent accountant
and that PricewaterhouseCoopers LLP had been engaged as the Company's
independent accountants.
On August 15, 2002, the Company filed a Current Report on Form 8-K
reporting that it had dismissed PricewaterhouseCoopers LLP as its
independent accountants.
On August 15, 2002, the Company filed a Current Report on Form 8-K
reporting that Marcum & Kliegman LLP had been engaged as the Company's
independent accountants.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant 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 and President August 19, 2002
---------------------------------
Christopher P. Sauvigne
/s/ Richard A. Maue Executive Vice President, Chief August 19, 2002
--------------------------------- Financial Officer, and Secretary
Richard A. Maue
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