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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from
____________ to ____________
Commission file number 1-4324
ANDREA ELECTRONICS CORPORATION
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(Exact name of registrant as specified in its charter)
New York 11-0482020
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(State or other jurisdiction of incorporation or organization) (I.R.S. employer identification no.)
45 Melville Park Road, Melville, New York 11747
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 631-719-1800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, par value $.50 per share American Stock Exchange
Securities registered under Section 12(g) of the Exchange Act: None
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 by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ( )
As of March 27, 2002, the aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately $22,148,508 (based on
the closing sale price on the American Stock Exchange).
The number of shares outstanding of the registrant's Common Stock as of
March 27, 2002, was 17,861,700.
DOCUMENTS INCORPORATED BY REFERENCE
The information required in Part III by Items 10, 11, 12, and 13 is
incorporated by reference to the registrant's proxy statement in connection with
the annual meeting of shareholders to be held on or about June 20, 2002, which
will be filed by the registrant within 120 days after the close of its fiscal
year.
EXHIBIT INDEX APPEARS IN ITEM 14
TABLE OF CONTENTS
TITLE PAGE
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PART I
ITEM 1. BUSINESS ................................................................... 1
ITEM 2. PROPERTIES ................................................................. 10
ITEM 3. LEGAL PROCEEDINGS .......................................................... 10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ........................ 11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ...... 11
ITEM 6. SELECTED FINANCIAL DATA .................................................... 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS ............................................................. 13
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ................. 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ................................ 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE ................................................................ 28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ......................... 28
ITEM 11. EXECUTIVE COMPENSATION ..................................................... 28
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ............. 28
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ............................. 28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ........... 28
PART I
ITEM 1. BUSINESS
Overview
Andrea Electronics designs, develops and manufacturers state-of-the-art
microphone technologies and products for enhancing speech-based applications
software and communications that require high quality, clear voice signals.
Andrea's 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:
o voice communication over the Internet;
o speech recognition for use with desktop, laptop and hand-held
computers;
o audio/video conferencing;
o computer-based automobile monitoring and control systems for use
by drivers and passengers;
o military and commercial aircraft communications systems,
o call centers,
o electronic equipment for incorporation into home appliances and
industrial and commercial office equipment that is activated and
controlled by voice; and
o interactive games where one or more players participate over the
Internet.
Our patented 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 at the desktop computing market, the market for personal
computers designed for use in automobiles, trucks and buses to control
satellite-based navigation systems and other devices within vehicles, and mobile
devices such as a personal digital assistants, among others. 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 2001, 2000 and 1999 approximated 7%, 4% and 0%,
respectively, of our total net revenues.
In May 1998, we acquired Lamar Signal Processing, Ltd., an Israeli
corporation engaged in the development of scalable, digital signal
processing-based directional, noise cancellation microphone technologies, which
included primarily DSDA and DFTA. The consideration paid by Andrea for Lamar was
approximately 1,800,000 shares of restricted common stock, $1,000,000 in cash
and $2,000,000 in notes payable. We recorded the cash at stated value. We
discounted the value of the notes payable to $1,615,000 to reflect Andrea's
borrowing rate as well as the time value of the payments on the notes, and we
discounted the value of the shares to $23,129,532 to reflect, among other
things, trading restrictions on the shares. We believe that the acquired
technologies, together with the research staff
1
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, and sales of such products during 2001, excluding
the impact of restructuring charges, 2000 and 1999 approximated 45%, 77% and
78%, respectively, of our total net revenues. During the fourth quarter of 2001,
Andrea adopted a restructuring plan to exit activities related to a specific
customer channel purchasing our lower-end noise canceling headsets within the
Andrea Anti-Noise line of business. (see "Our Strategy" for further details)
For several decades prior to our entry into the voice-activated
computing market in the 1990's, our primary business was selling intercom
systems for military and industrial use. We refer to this line of business as
our Aircraft Communications line of business, and sales of such products during
2001, 2000 and 1999 approximated 48%, 19% and 22%, respectively, of our total
net revenues.
We are incorporated under the laws of the State of New York and have
been engaged in the electronic communications industry since 1934.
Industry Background
Our primary mission is to provide the emerging "voice interface"
markets with state-of-the-art microphone and communication products. The idea
underlying these markets is that natural language spoken by the human voice will
become an important means by which to control many types of computing devices
and other appliances and equipment that contain microprocessors. We are
designing and marketing our products and technologies to be used for these
"natural language, human/machine" interfaces with:
o desktop, laptop and hand-held computers and mobile personal
computing devices;
o automotive communication systems.
o cellular and other wireless communication devices; and
o military and commercial aircraft systems;
We believe that end users of these applications and interfaces will
require high quality microphone and earphone products that enhance voice
transmission, particularly in noisy office and mobile environments. We also
believe that these applications will increasingly require microphones that are
located several feet from the person speaking, or far-field microphone
technology. Applications in this area range include:
o continuous speech dictation to personal computer and personal
data assistants;
o multiparty video teleconferencing and software that allows
participants to see and jointly edit documents, spreadsheets and
other information;
o natural language-driven interfaces for automobiles, home and
office automation.
We believe that an increasing number of these devices will be
introduced during the next several years.
2
Our Strategy
Our strategy is to
o maintain and extend our market position with our Andrea DSP
Microphone and Software technologies and products, and our higher
margin Andrea Anti-Noise products,
o develop relationships with companies that have significant
distribution capabilities for our Andrea DSP Microphone and
Software technologies and products and Andrea Anti-Noise
products,
o broaden our Andrea DSP Microphone and Software product lines and
Andrea Anti-Noise product lines through internal research and
development,
o design our products to satisfy specific end-user requirements
identified by our collaborative partners; and
o outsource manufacturing of some of our products in order to
achieve economies of scale.
An important element of our strategy for expanding the channels of
distribution and broadening the base of users for our products is our
collaborative arrangements with manufacturers of computing and communications
equipment and software publishers that are actively engaged in the various
markets in which our products have application. In addition, we have been
increasing our own direct marketing efforts.
The success of our strategy will depend on our ability to, among other
things,
o increase sales of Andrea DSP Microphone and Software products and
our line of existing Andrea Anti-Noise products,
o contain costs,
o manage growth,
o introduce additional Andrea DSP Microphone and Software products
and Andrea Anti-Noise products,
o maintain the competitiveness of our technologies through
successful research and development, and
o achieve widespread adoption of our products and technologies.
We cannot assure that we will be able to accomplish these strategies or
objectives, or that we will be able to maintain all of our product lines or
technologies in the event we determine that the sale of such product lines or
technologies is necessary to maintain our operations due to cash flow
constraints. During 1999 and 1998, our computer manufacturing customer base
shifted their purchases to lower-priced Andrea Anti Noise products in order to
remain cost competitive in the personal computer marketplace. This shift forced
us to reduce the selling prices of our less expensive products in order to
remain competitive in the personal computer microphone marketplace. During 2000,
in addition to the aforementioned price pressure, unit sales of Andrea
Anti-Noise products to our computer-manufacturing customers declined
significantly. This trend continued through 2001, primarily as a result of a
continued decrease in orders received from our largest customer, IBM, among
other similar customers. Specifically in response to the increasing competitive
nature of the PC headset market which contributed significantly to this decline
during 2001, coupled with Andrea's ongoing strategic efforts to focus on being
primarily a leading supplier of high-end, digital-based, far-field microphone
technologies, we embarked upon a restructuring effort dedicated to focus on
non-commoditized, highly profitable communication products and technologies.
Consequently, during the fourth quarter 2001, we formulated a plan to exit from
an increasingly unprofitable PC headset channel within Andrea's Anti-Noise
Headset product segment. As a result of exiting this customer channel, we
recorded charges approximating $4.5 million in the fourth quarter of 2001. This
channel included our largest customer, IBM. During the years ended December 31,
2001, 2000 and 1999, IBM and certain of IBM's affiliates, distributors,
licensees and integrators excluding the impact of restructuring charges
accounted for 25%, 44% and 49%, respectively, of our net sales, before sales
returns related to the aforementioned restructuring charges.
3
Our Technologies
We design our Andrea DSP Microphone and Software products and Andrea
Anti-Noise products to transmit voice signals with the high level of quality,
intelligibility, and reliability required by the broad range of emerging
voice-based applications in computing and telecommunications. We achieve this
through the use of several audio technologies. Several of these technologies
employ software processes that we believe are proprietary to us. Software
processes of this type are commonly referred to as algorithms.
Andrea DSP Microphone and Software Technology
This set of technologies is generally based on the use of an array of
microphones from which the analog signals are converted to digital form and then
processed using digital electronic circuitry to eliminate unwanted noise in the
speaker's environment. Our Andrea DSP Microphone and Software Products provide
clear acoustic and audio input performance where the desired audio signal is at
a distance from the microphone. An example of this is a person driving an
automobile who wants to control various systems in the car or communicate
through a wireless telephone. Another example is a person using a PDA that wants
to control applications through voice commands rather than using a stylus. We
have also engineered our Andrea DSP Microphone and Software Products to be
compatible with Universal Serial Bus, or USB, computer architecture. USB is a
relatively new industry standard for connecting peripherals, such as
microphones, earphones, headsets, keyboards, mice, joysticks, scanners and
printers, to personal computers. We believe that our Andrea DSP Microphone and
Software technology achieve far-field microphone performance previously
unattainable through microphones based on mechanical acoustic designs and
microphones based on analog signal processing. Our Andrea DSP Microphone and
Software Products include the use of the following technologies, among other
technologies and techniques:
Digital Super Directional Array (DSDA(TM)) Microphone Technology. Our
patented DSDA microphone technology enables high quality far-field
communications by centering microphone sensitivity on a user's voice and
canceling noise outside of that signal. DSDA continuously samples the
continually changing acoustic properties within an environment and adaptively
identifies interfering noises that are extraneous to the voice signal, resulting
in increased intelligibility of communications.
Direction Finding and Tracking (DFTA(TM)). Our patent-pending DFTA
technology utilizes an array of microphones, unique software algorithms and
digital signal processing to detect the presence of a user's voice, determine
the direction of the voice and track the speaker when he or she moves.
PureAudio(TM). Our patented PureAudio is a noise canceling algorithm
that enhances applications that are controlled by speech by sampling the ambient
noise in an environment and attenuating the noise from sources near or around
the desired speech signals, thus delivering a clear audio signal. Designed
specifically to improve the signal-to-noise ratio, PureAudio is effective in
canceling stationary noises such as tires, computer fans, and engines.
SuperBeam(TM) . Our patent-pending SuperBeam is a highly accurate
digital algorithm that forms an acoustic beam that extends from the microphone
to the speech source in an environment. We believe SuperBeam provides a fixed
noise reduction microphone solution for the typical acoustic environment found
in room environments in which speech is used, such as in offices and homes. The
microphone beam is generated by processing multiple microphone samples through
pre-established digital filters and adding the outputs. The result is an optimum
speech enhancement and noise reduction solution to a predefined setting. Because
the beam is able to adapt to changes in the acoustic environment, this
technology is sometimes called adaptive beamforming.
EchoStop(TM). Patent-pending EchoStop is an advanced acoustic echo
canceller developed for use with conferencing systems such as group audio and
videoconferencing systems and cellular car phone kits. EchoStop allows true
two-way communication (often referred to as full duplex) over a conferencing
system, even when the system is used in large spatial environments that may be
vulnerable to extensive reverberation. EchoStop incorporates noise reduction
algorithms to reduce the background noise of both the microphone input and the
loudspeaker output, thus preventing the accumulation of interfering noise over
conferencing systems that allow communication among multiple sites.
4
ExactVoice. ExactVoice is an adaptive, digital audio software process
that extracts a voice signal from unwanted background noise. Utilizing two or
more microphone elements, ExactVoice separates the audio microphone signals into
two or more original sound sources. In a noisy environment, where the
microphones accept both the user's voice signal and background noise, ExactVoice
extracts the voice signal and eliminates the noise. As a result, speech
applications receive only the desired audio signal. This algorithm was optimized
to avoid side affects typical of adaptive processes, such as signal distortion
or artifacts in the sounds.
Andrea Anti-Noise Technologies
Noise Cancellation ("NC") Microphone Technology. This technology is
based on the use of pressure gradient microphones to reduce the transmission of
noise from the speaker's location. Instead of using electronic circuitry to
reduce noise, pressure gradient microphones rely on their mechanical and
acoustic design to do so. Our NC microphones are a less costly alternative to
our ANC microphones and are well-suited for applications in which there is less
background noise in the speaker's environment.
Active Noise Cancellation ("ANC") Microphone Technology. This
technology is based on analog signal processing circuits that electronically
cancel the transmission of noise from the speaker's location. ANC is
particularly well-suited for those environments in which the speaker is
surrounded by high levels of ambient background noise. Our ANC and NC
microphones are most effectively used in "near-field" applications where the
microphone is next to the speaker's mouth, for example, as by wearing a headset.
Active Noise Reduction ("ANR") Earphone Technology. This technology is
based on analog signal processing circuits that electronically reduce the amount
of noise in the listener's environment that the listener would otherwise hear in
the earphone. Our ANR earphones improve the quality of speech and audio heard by
a listener in extremely noisy environments, particularly those characterized by
low frequency sounds, such as those in aircraft, automobiles, trucks and other
ground transportation equipment, machine rooms and factories.
Our Products and Their Markets and Applications
Our Andrea DSP Microphone and Software Products and Andrea Anti-Noise
Products have been designed for applications that are controlled by or depend on
speech across a broad range of hardware and software platforms. These products
incorporate our DSP, NC, ANC and ANR microphone technologies, and are designed
to cancel background noise in a range of increasingly noisy environments, such
as homes, offices, automobiles and factories. We also manufacture a line of
accessories for these products. For the consumer and commercial markets, we have
designed our Andrea DSP Microphone and Software Products and Andrea Anti-Noise
Products for the following applications:
- Speech recognition for word processing, database, and similar
applications
- Distance Learning (education through the use of Internet-base
lessons and training information)
- Telematics (the use of computer-controlled systems in automobiles
and trucks)
- Hand-held and other personal assistant devices
- Hands-free car phone kits
- Speech enabled global positioning systems (GPS)
- Internet telephony and Voice Chat
- Audio/videoconferencing
- Professional audio systems
5
- Voice-activated interactive games
- Cellular and other wireless telecommunications
- Home networking automation systems
We market and sell our products directly to end users, through computer
product distributors, through value-added resellers, to original equipment
manufacturers and to software publishers. We began commercial sales of our
Andrea Anti-Noise Products in 1995. Since that time, a substantial amount of our
revenue from Andrea Anti-Noise Products has been from the sale of our NC
microphone products, particularly under collaborative arrangements with other
companies who bundle our products with theirs. For more information about these
collaborative arrangements, please refer to the information under the caption
"Collaborative Arrangements".
Andrea DSP Microphone and Software Products
We develop our Andrea DSP Microphone and Software Products primarily
through customer-specific integration efforts, and we either license our related
algorithms, sell a product incorporating our related algorithms, or both. For
example, we have developed technologies that can be, or are, embedded into a PC,
PC monitors, high-end videoconferencing units, automotive interiors, intercom
systems, IP telephony applications and hand-held devices, among others. In
addition, we have developed stand-alone products for specific customers who then
sell such product to end users such as, for example, a USB array microphone for
use with laptop computers. As a result, such products are not available from us
directly. However, as part of our strategy to increase sales to prospective
customers desiring high-quality microphone performance for certain
customer-specific environments, we have developed the following products that
may be purchased directly from Andrea:
Andrea AutoArray(TM) Microphone ("AutoArray"). The AutoArray is a
digital, high performance microphone system designed for computing applications
in vehicles such as automobiles and trucks. It is the first super-directional
audio input device designed specifically for Auto PCs, global positioning
systems (GPS) and cellular car phone kits. The AutoArray incorporates DSDA
technology.
Andrea DesktopArray(TM) Microphone ("DesktopArray"). Similar to the
AutoArray, the DesktopArray incorporates DSDA technology. The DesktopArray is
designed for natural, far-field desktop speech recognition and
audio/videoconferencing computing. This is our most advanced desktop microphone,
allowing for clear speech in untethered, hands-free applications.
Andrea USB Microphone Array. Andrea's USB Microphone Array consists of
advanced software algorithms that enable enhanced, noise-free speech using
adaptive beamforming. It utilizes an array of microphones and unique system
design to adaptively control multiple acoustic signals. The system, which plugs
directly into a USB port, utilizes Andrea's proprietary digital audio driver
technology that benefits users running applications in Microsoft Windows 98.
These combined properties allow the user to achieve new levels of microphone
performance for hands-free, untethered, superior quality voice input for speech
applications. Relevant applications include command and control for office and
home automation systems, Internet telephony, Voice over Internet Protocol and
audio/videoconferencing systems.
Andrea Sound Card Array(TM). With the Andrea Sound Card Array, multiple
streams of audio are captured by an array of microphones located in a small
desktop device, providing four channels or paired and summed into two channels
and passed to the sound card line input and converted for the host processor to
enable DSDA processing. The Sound Card Array is currently available for
applications controlled by speech running Microsoft Windows 98/98 Second Edition
or Microsoft Windows 2000 and supported by Andrea Electronics' partner products.
Andrea AudioCommander(TM). Offering an audio interface for controlling
PC multimedia applications, AudioCommander includes controls to operate noise
cancellation features, thereby enhancing microphone performance. The software
also includes an audio wizard that sets microphone levels to optimize PC audio
for speech-enabled applications including speech recognition, Internet telephony
and command and speech control functions. AudioCommander is offered free through
Andrea Electronics' e-commerce website.
6
Andrea Anti-Noise Products
Our Andrea Anti-Noise Products include a line of headsets, handsets and
related accessories that incorporate our NC, ANC and ANR technologies. Our
headsets are mostly differentiated by the various designs of their headband,
microphone boom and earphone components, and are available in both single
earphone monaural and dual earphone stereo models.
NC Products. Our NC products are sold through our contact center, as
well as to original equipment manufacturers for incorporation into, or for use
with, their products. One of our NC headsets has a dual function microphone:
when the headset is worn, the microphone is used in the near field mode; when
the headset is placed on the desktop mount, the microphone is used in the far
field mode. In some models, customers have the unique ability to mix and match
microphone boom and headband components to meet their specific application and
user comfort preferences. The speaker-housing unit in these models can be used
for digital, CD-quality sound. By removing the speaker-housing unit, we can
offer this headset for simple speech applications at a lower price.
ANC Products. All of our ANC products are sold through our contact
center. Two of our ANC products are handsets consisting of a high fidelity
earphone and ANC microphone system that closely resembles the traditional
telephone handset. This product also offers features such as near field and far
field use and an "on/mute" function. Several of our higher end ANC headsets
incorporate a newly developed speaker housing design that optimizes the acoustic
performance of the earphone's digital sound capabilities with tenor and base
attributes that are set, or pre-equalized, at the time of manufacture. We also
offer a higher end stereo headset model that incorporate both our ANC and ANR
technologies and that is equipped with a small audio amplifier.
Call Center Products. During the first quarter of 2002, we introduced
two new headsets specifically designed for the call center market-space. Our
CS-900 monaural and CS-950 binaural headsets are the result of a year long
marketing effort which included collaboration with several call centers, call
center peripheral providers and call center consultants. The CS-900 and CS-950
have, what we believe to be, the most requested headset product features and are
offered for sale at cost effective price points. Both new product offerings will
be available for sale through the Company's website by the end of March.
We have developed and manufacture a line of accessories for our Andrea
Anti-Noise Products.
Andrea ConnectSolutions(TM) - Personal Computer Telephone Interface
("PCTI"). The PCTI is a comprehensive desktop device that integrates computer
applications controlled by speech and traditional telephony applications by
connecting headset users to the telephone, to the computer, or to both
simultaneously. Users can alternately or simultaneously conduct telephone
conversations and use speech recognition to enter data or dictate into the PC,
without having to pause or toggle between connectivity devices.
Andrea APS-100 Auxiliary Power Supply. The APS-100 is used when the
computer microphone input on a user's computer has either no power or
insufficient power for correct microphone operation.
Andrea MC 100 Multimedia Audio Controller. The Andrea MC-100 Multimedia
Audio Controller connects a PC headset or handset with a PC multimedia speaker
system thereby allowing a user to conveniently switch between the
headset/handset and the speaker system.
Our Aircraft Communication Products
For the industrial and military markets, our intercom systems and
related components are designed primarily for avionics applications. The related
components include intercoms, headsets, amplifiers, electronic control boxes and
panels, and wiring harnesses. Unfilled orders under government prime contracts
and subcontracts for these products may be terminated at the convenience of the
government under the provisions of statutes or regulations applicable to defense
procurement contracts. In the event of such termination, we are entitled to
reimbursement for costs incurred plus a percentage of profit. Sales under
defense procurement contracts are also subject, in certain instances, to price
redetermination proceedings. We believe that such proceedings, if any, would not
have a material effect upon our earnings.
7
Our Collaborative Arrangements
An important element of our strategy is to promote widespread adoption
of our products and technologies by collaborating with large enterprises and
market and technology leaders in telecommunications, computer manufacturing, and
software publishing. For example, we have entered into such arrangements and/or
relationships with Analog Devices, Inc., International Business Machines
Corporation ("IBM") and Microsoft Corporation ("Microsoft"). We are currently
discussing additional arrangements with other companies, but we cannot assure
that any of these discussions will result in any definitive agreements.
IBM Procurement Agreement. In 1997, we signed a procurement agreement
with IBM to supply several models of Andrea Anti-Noise Products to IBM for
packaging with a full line of IBM's speech recognition software programs. During
2001, 2000 and 1999, sales of our computer headsets to IBM and certain of its
affiliates, distributors, licensees, and integrators accounted for 22%, 44% and
49%, respectively, of our total sales. During the latter half of 2001, we
formulated a plan to exit from an increasingly unprofitable PC Headset channel
within Andrea's Anti-Noise Headset product segment. This channel included
business with IBM related to this agreement.
Microsoft Procurement Agreement. In January 1999, we entered a
procurement agreement with Microsoft covering the sale by us to Microsoft of our
NC-8 headset for inclusion in Microsoft Encarta Interactive English Learning
software programs for various markets in various languages. This agreement also
covered the inclusion of Andrea product brochures in the packaging for these and
related Microsoft products. During 2001, 2000 and 1999, sales of our computer
headsets to Microsoft approximated $40,000, $500,000 and $300,000, respectively.
During the latter half of 2001, we committed to a formal plan to exit from an
increasingly unprofitable PC Headset channel within Andrea's Anti-Noise Headset
product segment. This channel included business with Microsoft related to this
agreement.
Clever Devices Procurement Agreement. In March 2001, we entered a
procurement agreement with Clever Devices to be the microphone supplier for its
SpeakEasy II(TM) mass transit bus communication system. The integrated
communication system utilizes Andrea Electronics' high performance digital
microphone system to enable the clear voice communications in high noise, mass
transit environments. Andrea Electronics' digital microphone array,
incorporating its DSDA 2.0 algorithm and PureAudio 2.0(TM) noise reduction
algorithm, reduces mass transit noises such as tire, engine and wind noise, as
well as interfering passenger voices. As part of the agreement, Andrea is also
providing Clever Devices with a proprietary digital signal processor reference
design and a patented microacoustic mechanical design to be integrated with the
SpeakEasy(TM) II communication system. Under our procurement agreement with
Clever Devices, Clever Devices is not obligated to procure any minimum quantity
of product from us. During 2001, non-recurring engineering efforts were
substantially completed for the SpeakEasy II, and to date in 2002, we received
orders approximating $70,000.
Analog Devices, Inc. License Agreements. In December 2001 and March
2002, we entered into two license 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
Electronics' 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 date of this Form 10K, and in accordance with our agreements, we
have received $1 million of these license fees in 2002.
Patents, Trademarks, and Other Intellectual Property Rights
We rely on a combination of patents, patent applications, trade
secrets, copyrights, trademarks, nondisclosure agreements, and contractual
restrictions to protect our intellectual property and proprietary rights. We
cannot assure, however, that these measures will protect our intellectual
property or prevent misappropriation or circumvention of our intellectual
property.
Andrea maintains a number of patents in the United States covering
claims to certain of its products and technology, which expire at various dates
ranging from 2010 to 2018. Counterparts to some of those patents have been
granted in other jurisdictions that we have determined to be strategic. We also
have other patent applications currently pending; however, we cannot assure that
patents will be issued with respect to these currently pending or
8
future applications which we may file, nor can we assure that the strength or
scope of our existing patents, or any new patents, will be of sufficient scope
or strength or provide meaningful protection or commercial advantage to us.
Research and Development
We consider our technology to be of substantial importance to our
competitiveness. To maintain this competitiveness, we have organized our
research and development efforts using a "market and applications" approach for
meeting the requirements of new and existing customers. Consistent with this
approach, our engineering staff interacts closely with our sales and marketing
personnel and, frequently, directly with customers. The engineering staff is
responsible for the research and development of new products and the improvement
of existing products. Since 2000, substantially all of our research and
development has been in support of developing Andrea DSP Microphone and Software
Products and Technologies. Research and development expenses for 2001 decreased
26% to $3,462,340 from $4,694,116 for 2000. We expect research and development
expenses to remain at high levels as Andrea seeks to broaden its line of Andrea
Microphone Array Products and Technologies. No assurance can be given that our
research and development efforts will succeed. See "Part II - Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Sales and Marketing
We employ a sales staff as well as outside sales representative
organizations to market our Andrea Anti-Noise Products, our Andrea DSP
Microphone and Software Products and our Aircraft Communications Products.
Andrea Anti-Noise Products and Andrea DSP Microphone and Software Products are
marketed to computer OEMs, distributors of personal computers and
telecommunications equipment, software publishers, and end-users in both
business and household environments. These products are sold to end-users
through distributors and value-added resellers, software publishers, Internet
Service Providers and Internet Content Developers. Under our existing
collaborative agreements, our collaborators have various marketing and sales
rights to our Andrea Anti-Noise and Andrea DSP Microphone and Software Products.
We are seeking to enter additional collaborative arrangements for marketing and
selling our Andrea Anti-Noise Products and Andrea DSP Microphone and Software
Products, but we cannot assure that we will be successful in these efforts.
Market acceptance of the Andrea Anti-Noise Products and Andrea DSP Microphone
and Software Products is critical to our success.
We market our Aircraft Communications Products to OEMs, military
organizations, and industrial customers.
Production Operations
We conduct assembly operations at our New York facility and through
subcontractors. During initial production runs of Andrea Anti-Noise Products, we
assemble the products at our New York facility from purchased components. As
sales of any particular Andrea Anti-Noise Product increase, assembly operations
are transferred to a subcontractor in Asia. Most of the components for the
Andrea Anti-Noise Products and Andrea DSP Microphone and Software Products are
available from several sources and are not characteristically in short supply.
However, certain specialized components, such as microphones and DSP boards, are
available from a limited number of suppliers and subject to long lead times. To
date we have been able to obtain sufficient supplies of these more specialized
components, but we cannot assure that we will continue to be able to do so.
Shortages of, or interruptions in, the supply of these more specialized
components could have a material adverse effect on our sales of Andrea
Anti-Noise Products and Andrea DSP Microphone and Software Products.
We assemble our Aircraft Communications Products at our New York
facility from purchased components. Certain highly specialized components for
our Aircraft Communications Products sold for military and industrial use have
limited sources of supply, the availability of which can affect particular
products. We do not believe, however, that our earnings have been, or will be,
materially affected due to unavailability of these components.
Competition
The markets for our Andrea Anti-Noise Products, Andrea DSP Microphone
and Software Products and Aircraft Communications Products are highly
competitive. Competition in these markets is based on varying
9
combinations of product features, quality and reliability of performance, price,
sales, marketing and technical support, ease of use, compatibility with evolving
industry standards and other systems and equipment, name recognition, and
development of new products and enhancements. Most of our current and potential
competitors in these markets have significantly greater financial, marketing,
technical, and other resources than us. Consequently, these competitors may be
able to respond more quickly to new or emerging technologies and changes in
customer requirements, or to devote greater resources to the development,
marketing, and sale of their products than we can. We cannot assure that one or
more of these competitors will not independently develop technologies that are
substantially equivalent or superior to our technology. We have incurred
significant price pressure, as well as, more recently, a significant decline in
unit sales of Andrea Anti-Noise Products to our OEM customer base shipping
continuous speech dictation products. We attribute this decline to increasing
competition as well as our ongoing strategic efforts to focus on being primarily
a leading supplier of high-end, digital-based, far-field microphone
technologies. In response to these factors, we formulated a plan to exit from an
increasingly unprofitable PC headset channel within Andrea's Anti-Noise Headset
product segment. As a result of exiting this customer channel, we recorded
charges approximating $4.5 million during the fourth quarter of 2001.
In the markets for our Aircraft Communications Products, we often
compete with major defense electronics corporations as well as smaller
manufacturing firms which specialize in supplying to specific military
initiatives. Our performance in these markets is further subject to several
factors, including dependence on government appropriations, the time required
for design and development, the complexity of product design, the rapidity with
which product designs and technology become obsolete, the intense competition
for available business, and the acceptability of manufacturing contracts by
government inspectors.
We believe that our ability to compete successfully will depend upon
our capability to develop and maintain advanced technology, develop proprietary
products, attract and retain qualified personnel, obtain patent or other
proprietary protection for our products and technologies, and manufacture,
assemble and market products, either alone or through third parties, in a
profitable manner.
Employees
At December 31, 2001, we had 88 employees, of whom 36 were engaged in
production and related operations, 29 were engaged in research and development,
and 23 were engaged in management, administration, sales and customer support
duties. None of our employees are unionized or covered by a collective
bargaining agreement. We believe that we generally enjoy good relations with our
employees. During the first quarter of 2001, we undertook steps to reduce the
number of our employees. For more information about this reduction, please see
ITEM 7., "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
ITEM 2. PROPERTIES
Andrea's corporate headquarters is located in Melville, New York. Our
corporate headquarters is located in approximately 40,000 square feet of leased
space which houses our production operations, research and development
activities, sales, administration and executive offices. We also lease
facilities in Utah and Israel dedicated for research and development, and in
Hong Kong for production management and limited research and development
activities. We believe that we maintain our machinery, equipment and tooling in
good operating condition and that these assets are adequate for our current
business and adequately insured. See Notes 7 and 15 to our Consolidated
Financial Statements for further information concerning our property, plant and
equipment and leased facilities.
ITEM 3. LEGAL PROCEEDINGS
We are presently 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. NCT alleges that we: engaged in unfair
competition by misrepresenting the scope our patents, specifically, U.S. Pat.
Nos. 5,732,143, 5,825,897 and 6,061,456 thereby tortuously interfering with
prospective contractual rights between NCT and its existing and potential
customers; made false and disparaging statements about NCT and its products; and
falsely advertised Andrea's ANR products. The complaint requests a declaration
that these patents are invalid and unenforceable and that NCT's products do not
infringe upon these patents and seeks to enjoin Andrea from engaging in these
alleged
10
activities and seeks compensatory damages of not less than $5 million, punitive
damages of not less than $50 million and plaintiffs' costs and attorneys' fees.
We have filed and served an answer to the NCT complaint, denying the
allegations and asserting affirmative defenses and counterclaims. Our
counterclaims, as amended, allege that NCT has willfully infringed the above
mentioned patents, and that NCT has engaged in trademark infringement, false
designation of origin, and unfair competition. The counterclaims seek injunctive
relief with respect to the allegations of patent infringement, trademark
infringement, false designation of origin and unfair competition. We are also
seeking exemplary and punitive damages, prejudgment interest on all damages,
costs, reasonable attorneys' fees and expenses.
During the third quarter of 2001, the court held a "Markman Hearing" to
determine the meaning of the claims in the three Andrea patents. We are unable
to anticipate when the Court will issue a decision on this question. If this
suit is ultimately resolved in favor of NCT, we could be materially adversely
effected. We believe, however, that NCT's allegations are without merit and we
intend to vigorously defend Andrea and to assert against NCT the claims
described above.
In addition to the litigation described above, we are from time to time
subject to routine litigation incidental to our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders of Andrea was held on August 7,
2001. The results of this meeting were reported in our Form 10-Q for the
six-month period ended June 30, 2001.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Andrea's common stock is listed on the American Stock Exchange under
the symbol "AND". The table below sets forth the high and low sales prices for
Andrea's Common Stock as reported by the American Stock Exchange. On March 27,
2002, there were approximately 534 holders of record of Andrea's Common Stock.
Quarter Ended High Low
------------- ---- ---
March 31, 2000 17.75 7.00
June 30, 2000 11.63 5.75
September 30, 2000 9.25 5.31
December 31, 2000 7.65 1.80
March 31, 2001 3.90 1.52
June 30, 2001 2.29 1.36
September 30, 2001 1.70 .46
December 31, 2001 .95 .50
No common stock dividends were paid in 2001 or 2000.
11
- -
ITEM 6. SELECTED FINANCIAL DATA
DECEMBER 31,
------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
INCOME STATEMENT DATA
Net Sales-Operating $ 10,258,875 $15,567,664 $17,112,487 $21,304,570 $26,429,804
Sales Reserve-Restructuring (1) (337,499) -- -- -- --
Net Sales 9,921,376 15,567,664 17,112,487 21,304,570 26,429,804
Cost of Sales
Cost of Sales-Operating 7,401,605 11,279,649 11,908,751 14,178,871 16,077,801
Cost of Sales-Restructuring (1) 2,573,339 -- -- -- --
Total Cost of Sales 9,974,944 11,279,649 11,908,751 14,178,871 16,077,801
Gross Profit (53,568) 4,288,015 5,203,736 7,125,699 10,352,003
Research and Development 3,462,340 4,694,116 3,399,666 2,016,684 1,106,880
Restructuring Charges (1) 1,552,892 -- -- -- --
General, Administrative and Selling
Expenses 8,724,784 9,373,025 8,954,805 13,002,959 5,753,130
Income (Loss) from Operations (13,793,584) (9,779,126) (7,150,735) (7,893,944) 3,491,993
Other Income (Expense) 163,475 204,774 (26,258) 1,447,989 76,864
Income (Loss) Before Provision
(Benefit) for Income Taxes (13,630,109) (9,574,352) (7,176,993) (6,445,955) 3,568,857
Provision (Benefit) for Income Taxes -- -- -- -- 154,461
Net Income (Loss) (13,630,109) (9,574,352) (7,176,993) (6,445,955) 3,414,396
Preferred Stock Dividends 564,604 351,209 195,843 -- --
Non-Cash Charge Attributable to
Beneficial Conversion Feature (2) 7,500,000 -- -- -- --
Net Income (Loss) attributable to
common shareholders $(21,694,713) $(9,925,561) $(7,372,836) $(6,445,955) $ 3,414,396
Earnings (Loss) Per Share
Basic $ (1.43) $ (.72) $ (.56) $ (.61) $ .42
Diluted $ (1.43) $ (.72) $ (.56) $ (.61) $ .39
BALANCE SHEET DATA
Current Assets $ 9,755,897 $19,161,845 $19,315,415 $18,818,190 $14,430,645
Total Assets $ 34,019,659 $47,272,866 $49,853,402 $50,681,940 $17,789,184
Current Liabilities $ 4,124,982 $ 4,126,794 $ 5,293,930 $4,481,074 $ 2,643,986
Total Liabilities $ 4,945,889 $ 4,322,661 $ 6,001,769 $7,103,040 $ 2,682,486
Redeemable Securities $ 9,785,020 $12,162,725 $ 7,187,077 $ -- $ --
Total Equity $ 19,288,750 $30,787,480 $36,664,556 $43,578,900 $15,106,698
(1) Restructuring Charges - The net loss applicable to Common Shareholders
---------------------
reflects the impact of restructuring charges associated with exiting a
specific PC headset customer type, or channel, within the Anti-Noise
Product business segment as follows:
Sales returns $ 337
Cost of sales $2,573
Restructuring charges $1,553
------
Total $4,463
======
(2) Non-cash charge attributable to beneficial conversion feature - The net
-----------------------------------------------------------------------
loss applicable to Common Shareholders reflects the intrinsic value of the
-------------------------------------------------------------------
realization, during the third quarter of 2001, of a contingent beneficial
conversion feature related to the Company's Series C Redeemable Convertible
Preferred Stock.
12
Quarterly Results and Seasonality
The following table sets forth unaudited financial data for each of
Andrea's last eight fiscal quarters.
Year Ended December 31, 2001 Year Ended December 31, 2000
------------------------------------------------- ------------------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------------------------------------------------- ------------------------------------------------
Income Statement Data:
Sales - Operating $2,615,639 $2,617,929 $2,937,199 $2,088,108 $3,201,484 $3,181,268 $5,318,936 $3,865,976
Sales
Reserve-Restructuring - - - (337,499) - - - -
(1)
Net Sales 2,615,639 2,617,929 2,937,199 1,750,609 3,201,484 3,181,268 5,318,936 3,865,976
Cost of
Sales-Operating 1,919,354 1,872,758 2,105,848 1,503,645 2,399,175 2,366,353 3,772,311 2,741,810
Cost of
Sales-Restructuring - - - 2,573,339 - - - -
(1)
Total Cost of Sales 1,919,354 1,872,758 2,105,848 4,076,984 2,399,175 2,366,353 3,772,311 2,741,810
Gross Profit 696,285 745,171 831,351 (2,326,375) 802,309 814,915 1,546,625 1,124,166
Restructuring
Charges, not - - - 1,552,892 - - - -
included above (1)
Loss from Operations (2,615,958) (2,444,968) (2,060,117) (6,672,541) (2,489,467) (2,527,636) (2,092,278) (2,669,745)
Net Loss (2,546,487) (2,367,680) (2,069,151) (6,646,791) (2,484,621) (2,476,013) (2,045,438) (2,568,280)
Preferred Stock
Dividends 146,285 143,613 140,755 133,951 91,377 60,410 60,577 138,845
Non-Cash Charge
Attributable to
Beneficial
Conversion Feature - - 7,500,000 - - - - -
(2)
Net Loss
Attributable to
Common Shareholders (2,692,772) (2,511,293) (9,709,906) (6,780,742) (2,575,998) (2,536,423) (2,106,015) (2,707,125)
Basic and Diluted
Loss per Share (0.18) (0.17) (0.64) (0.42) (0.19) (0.18) (0.15) (0.19)
(1) Restructuring Charges - The net loss applicable to Common Shareholders
reflects the impact of restructuring charges associated with exiting a
specific PC headset customer type, or channel, within the Anti-Noise
Product business segment as follows:
Sales returns $ 337
Cost of sales $2,573
Restructuring charges $1,553
------
Total $4,463
======
(2) Non-cash charge attributable to beneficial conversion feature - The net
loss applicable to Common Shareholders reflects the intrinsic value of the
realization, during the third quarter of 2001, of a contingent beneficial
conversion feature related to the Company's Series C Redeemable Convertible
Preferred Stock.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Our mission is to provide the emerging "voice interface" markets with
state-of-the-art communications products that facilitate natural language,
human/machine interfaces.
Examples of the applications and interfaces for which Andrea DSP
Microphone and Software Products and Andrea Anti-Noise(R) Products provide
benefit include: Internet and other computer-based speech; telephony
communications; multi-point conferencing; speech recognition; multimedia;
multi-player Internet and CD ROM interactive games; military and commercial
aircraft communications; and other applications and interfaces that incorporate
natural language processing. We believe that end users of these applications and
interfaces will require
13
high quality microphone and earphone products that enhance voice transmission,
particularly in noisy environments, for use with personal computers, mobile
personal computing devises, military and commercial aircraft systems, cellular
and other wireless communication devices and automotive communication systems.
Our Andrea DSP Microphone and Software Products use "far-field" digital signal
processing technology to provide high quality transmission of voice where the
user is at a distance from the microphone. High quality audio communication
technologies will be required for emerging far-field voice applications, ranging
from continuous speech dictation, to Internet telephony and multiparty video
teleconferencing and collaboration, to natural language-driven interfaces for
automobiles, home and office automation and other machines and devices into
which voice-controlled microprocessors are expected to be introduced during the
next several years.
In order to complement our internal efforts to develop digital signal
processing technology, in May 1998, we acquired Lamar Signal Processing, Ltd.,
an Israeli corporation engaged in the development of DSP noise cancellation
microphone solutions for voice-driven interfaces covering a wide range of audio
and acoustic applications. This acquisition resulted in a substantial amount of
goodwill and other intangible assets. The amortization of the goodwill and other
intangible assets has a significant, negative, non-cash impact on our results of
operations. See Note 3 to our Consolidated Financial Statements.
We outsource the assembly of most of our Andrea Anti-Noise(R) Products
from purchased components, and we are currently assembling our Andrea DSP
Microphone and Software Products from purchased components at our New York and
Israeli facilities. We manufacture our Aircraft Communications Products at our
New York facility.
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 year ended
December 31, 2001 and other items set forth in this Report on Form 10-K are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. The words "anticipates," "believes," "estimates," "expects,"
"intends," "plans," "seeks," variations of such words, and similar expressions
are intended to identify forward-looking statements. We have based these
forward-looking statements on our current expectations, estimates and
projections about our business and industry, our beliefs and certain assumptions
made by our management. Investors are cautioned that matters subject to
forward-looking statements involve risks and uncertainties including economic,
competitive, governmental, technological and other factors that may affect our
business and prospects. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. In order to obtain the benefits of these "safe harbor"
provisions for any such forward-looking statements, we wish to caution investors
and prospective investors about the following significant factors, which, among
others, have in some cases affected our actual results and are in the future
likely to affect our actual results and could cause them to differ materially
from those expressed in any such forward-looking statements. These factors
include:
Because our operating results are subject to significant fluctuation, period-to-
period comparisons of our operating results may not necessarily be meaningful
and you should not rely on them as indications of our future performance.
Our results of operations have historically been and are subject to
continued substantial annual and quarterly fluctuations. The causes of these
fluctuations include, among other things:
- the volume of sales of our products under our collaborative
marketing arrangements;
- the cost of development of our products under our collaborative
development arrangements;
- the mix of products we sell;
- the mix of distribution channels we use;
- the timing of our new product releases and those of our
competitors;
14
- fluctuations in the computer and communications hardware and
software marketplace; and
- general economic conditions.
We cannot assure that the level of sales and gross profit, if any, that
we achieve in any particular fiscal period will not be significantly lower than
in other fiscal periods. Our revenues for the year ended December 31, 2001, were
approximately $9.9 million versus $15.6 million in the prior year. Net loss
applicable to common shareholders for the year ended December 31, 2001 was
approximately $21.7 million, or $1.43 per share on a diluted basis, versus net
loss applicable to common shareholders of approximately $9.9 million, or $0.72
per share on a diluted basis, for the year ended December 31, 2000. We continued
to experience a significant decline in our sales of Andrea Anti-Noise Products
as a result of increased competition with respect to a specific customer
channel. In response to this decline, as well as our overall shift in strategic
direction to deliver digital, far-field microphone solutions, during the fourth
quarter of 2001, we incurred restructuring charges of approximately $4.5
million. This restructuring is expected to result in a further decrease in sales
during 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
falls below our expectations and, therefore, our net income or loss may be
disproportionately affected by any reduction in sales revenue. Furthermore, our
acquisition in 1998 of Lamar Signal Processing, Ltd. resulted in a substantial
amount of goodwill and other intangible assets. The amortization of these
intangible assets has 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 on 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 the Company'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 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 the Company, 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 n the Certificate of Amendment, or upon 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, the waiver will
be null and void upon the earlier
15
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 requested 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,
17,861,700 were outstanding as of March 27, 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 20,496,848 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 March 27, 2002, we had 172 shares of Series B convertible
preferred stock and 750 shares of Series C convertible preferred stock
outstanding. Both the Series B convertible preferred stock and the Series C
convertible preferred stock are convertible into shares of common stock, subject
to ownership limitations that prohibit the holders of the preferred stock from
owning more than 4.99% of the outstanding shares of common stock at the time of
conversion or 9.99% over the sixty day period prior to the conversion. These
restrictions do not prevent purchasers from converting and selling some of their
holdings and then later converting the rest of their holdings.
As the price of our common stock decreases, the number of shares of common stock
issuable upon conversion of our Series B convertible preferred stock and Series
C convertible preferred stock increases.
The variable conversion price of the Series B convertible preferred
stock and any reset of the conversion price of the Series C convertible
preferred stock are functions of the market price of our common stock. If the
price
16
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 172 shares of Series B Convertible
Preferred Stock at the indicated conversion prices (without regard to any
limitations on conversion) and assuming that the 4% additional amount is paid in
cash:
Number of Shares of Common Stock Percentage of Outstanding
Conversion Price Issuable Upon Conversion(1) Common Stock(2)
---------------- -------------------------------- -------------------------
$0.50 3,440,000 16%
$1.50 1.146,667 6%
$2.50 688,000 4%
$3.50 491,429 3%
$4.50 382,222 2%
$5.50 312,727 2%
$6.50 264,615 1%
$7.50 229,333 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 17,861,700 shares of common stock outstanding as of March 27,
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
Conversion Price Issuable Upon Conversion(1) Common Stock(2)
---------------- -------------------------------- -------------------------
$0.40 18,750,000 51%
$0.50 15,000,000 46%
$0.60 12,500,000 41%
$0.65 11,538,462 39%
$0.70 10,714,286 37%
$0.75 10,000,000 36%
$0.765 9,803,922 35%
(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 17,861,700 shares of common stock outstanding as of March 27,
2002.
The following table illustrates the varying amounts of shares of Common
Stock that would be issuable upon conversion of all 172 outstanding shares of
Series B convertible preferred stock and all 750 outstanding shares of Series C
convertible preferred stock at the indicated conversion prices (without regard
to any limitations on conversion) and assuming that all additional amounts are
paid in cash:
17
Number of Shares of Common Stock Percentage of Outstanding Common
Conversion Price Issuable Upon Conversion(1)(2)(3) Stock(4)
---------------- --------------------------------- --------
$0.50 18,440,000 51%
$0.65 14,184,615 44%
$0.765 12,052,288 40%
$1.50 10,950,588 38%
$2.50 10,491,922 37%
$3.50 10,295,350 37%
$4.50 10,186,144 36%
$5.50 10,116,649 36%
$6.50 10,068,537 36%
(1) The calculation assumes that the conversion price of the Series B and
Series C convertible preferred stock are the same at the assumed conversion
prices of $ .50, $ .65 and $ .765. 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 $ .765, 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 $ .765, the
Series C would still be converted at its maximum conversion price of $
.765.
(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 17,861,700 shares of common stock outstanding as of March 27,
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.
If we fail to market and commercialize our Andrea DSP Microphone and Software
and Andrea Anti-Noise products, our revenues may not increase at a high enough
rate to improve our results of operations or at all.
Our business, results of operations and financial condition depend on
successful commercialization of our Andrea 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 been expanding the number of
products in this line. We introduced our first Andrea Digital Super Directional
Array products in 1998 and we are initially targeting these and our other Andrea
DSP Microphone and Software products at the desktop computer market, the market
for computer-based automobile monitoring and control systems for use by drivers
and passengers, and the mobile device market. The success of these products is
subject to the risks frequently encountered by companies in an early stage of
product commercialization, particularly companies in the computing and
communications industries.
18
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. We may not successfully anticipate and adapt our products and
technologies in a cost effective and timely manner to changes in technology and
industry standards or to introductions of new products and technologies by
others that render our then existing products and technologies obsolete.
If our marketing collaborators do not effectively market those of their products
with which our products are included or incorporated, our sales growth could be
adversely affected.
We have entered into several collaborative and distribution
arrangements with software publishers and computer hardware manufacturers
relating to the marketing and sale of Andrea Anti-Noise products and Andrea DSP
Microphone and Software products through inclusion or incorporation with the
products of our collaborators. Our success will therefore be dependent to a
substantial degree on the efforts of these collaborators to market those of
their products with which our products are included or incorporated. Our
collaborators may not successfully market these products. In addition, our
collaborators generally are not contractually obligated to any minimum level of
sales of our products or technologies, and we have no control over their
marketing efforts. Furthermore, our collaborators may develop their own
microphone, earphone or headset products that may replace our products or
technologies or to which they may give higher priority.
19
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 years ended December 31, 2001, 2000 and 1999, the U.S. Government
accounted for 17%, 18% and 23%, respectively, of our net sales before sales
returns - restructuring. The U.S. Government is not obligated to continue to
purchase these products and is free to purchase similar products from our
competitors. Our failure to maintain sales of Aircraft Communication Products to
the U.S. Government would have a material adverse effect on our business,
results of operations and financial condition.
Shortages of, or interruptions in, the supply of more specialized components for
our Andrea Anti-Noise products and Andrea DSP Microphone products could have a
material adverse effect on our sales of these products.
We conduct assembly operations at our facilities in New York and Israel
and through subcontractors using purchased components. Some specialized
components for the Andrea Anti-Noise and Andrea DSP Microphone products, such as
microphones and digital signal processing boards, are available from a limited
number of suppliers and subject to long lead times. We may not be able to
continue to obtain sufficient supplies of these more specialized components,
particularly if our sales of Andrea Anti-Noise and Andrea DSP microphone
products increase substantially or market demand for these components otherwise
increases.
If our subcontractor fails to meet our production and shipment schedules, our
business, results of operations and financial condition would be materially and
adversely affected.
We conduct assembly operations at our facilities in New York and Israel
and through subcontracting. During initial production runs of Andrea Anti-Noise
and Andrea DSP Microphone products, we perform assembly operations at our New
York facility from purchased components. As sales of any particular product
increase, assembly operations are primarily transferred to a subcontractor in
Asia.
Our ability to compete may be limited by our failure to adequately protect our
intellectual property or by patents granted to third parties.
We rely on a combination of patents, patent applications, trade
secrets, copyrights, trademarks, nondisclosure agreements with our employees,
licensees and potential licensees, limited access to and dissemination of our
proprietary information, and other measures to protect our intellectual property
and proprietary rights. However, the steps that we have taken to protect our
intellectual property may not prevent its misappropriation or circumvention. In
addition, numerous patents have been granted to other parties in the fields of
noise cancellation, noise reduction, computer voice recognition, digital signal
processing and related subject matter. We expect that products in these fields
will increasingly be subject to claims under these patents as the numbers of
products and competitors in these fields grow and the functionality of products
overlap. Claims of this type could have an adverse effect on our ability to
manufacture and market our products or to develop new products and technologies,
because the parties holding these patents may refuse to grant licenses or only
grant licenses with onerous royalty requirements. Moreover, the laws of other
countries do not protect our proprietary rights to our technologies to the same
extent as the laws of the United States.
An unfavorable ruling in any current litigation proceeding or future proceeding
may adversely affect our business, results of operations and financial
condition.
From time to time we are subject to litigation incidental to our
business. For example, we are subject to the risk of adverse claims,
interference proceedings before the U.S. Patent and Trademark Office,
oppositions to patent applications outside the United States, and litigation
alleging infringement of 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.
We are presently 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. NCT alleges that we: engaged in unfair
20
competition by misrepresenting the scope our patents, specifically, U.S. Pat.
Nos. 5,732,143, 5,825,897 and 6,061,456 thereby tortuously interfering with
prospective contractual rights between NCT and its existing and potential
customers; made false and disparaging statements about NCT and its products; and
falsely advertised Andrea's ANR products. The complaint requests a declaration
that these patents are invalid and unenforceable and that NCT's products do not
infringe upon these patents and seeks to enjoin Andrea from engaging in these
alleged activities and seeks compensatory damages of not less than $5 million,
punitive damages of not less than $50 million and plaintiffs' costs and
attorneys' fees.
We have filed and served an answer to the NCT complaint, denying the
allegations and asserting affirmative defenses and counterclaims. Our
counterclaims, as amended, allege that NCT has willfully infringed the above
mentioned patents, and that NCT has engaged in trademark infringement, false
designation of origin, and unfair competition. The counterclaims seek injunctive
relief with respect to the allegations of patent infringement, trademark
infringement, false designation of origin and unfair competition. We are also
seeking exemplary and punitive damages, prejudgment interest on all damages,
costs, reasonable attorneys' fees and expenses.
During the third quarter of 2001, the court held a "Markman Hearing" to
determine the meaning of the claims in the three Andrea patents. We are unable
to anticipate when the Court will issue a decision on this question. If this
suit is ultimately resolved in favor of NCT, we could be materially adversely
effected. We believe, however, that NCT's allegations are without merit and we
intend to vigorously defend Andrea and to assert against NCT the claims
described above.
Changes in economic and political conditions outside the United States could
adversely affect our business, results of operations and financial condition.
We have been seeking to increase our sales to regions outside the
United States, particularly in Europe and areas in the Americas and Asia. For
the year ended December 31, 2001, sales to customers outside the United States
accounted for approximately 17% of our net sales. International sales and
operations are subject to a number of risks, including:
o trade restrictions in the form of license requirements;
o restrictions on exports and imports and other government
controls;
o changes in tariffs and taxes;
o difficulties in staffing and managing international operations;
o problems in establishing and managing distributor relationships;
o general economic conditions; and
o political and economic instability or conflict.
To date, we have invoiced our international sales in U.S. dollars, and
have not engaged in any foreign exchange or hedging transactions. We may not
continue to be able to invoice all our sales in U.S. dollars and to avoid
engaging in foreign exchange or hedging transactions. If we are required to
invoice any material amount of international sales in non-U.S. currencies,
fluctuations in the value of non-U.S. currencies relative to the U.S. dollar may
adversely affect our business, results of operations and financial condition or
require us to incur hedging costs to counter such fluctuations.
We Face Risk From Operating in Israel
Our principal research and development facility is located in the State
of Israel and, as a result, as of December 31, 2001, certain of our key research
and development employees were located in Israel. Although substantially all of
our sales currently are being made to customers outside Israel, we are
nonetheless directly influenced by the political, economic and military
conditions affecting Israel. Since the establishment of the State of Israel in
1948, a state of hostility has existed, varying in degree and intensity, between
Israel and Arab countries. Although Israel has entered into various agreements
with certain Arab countries and the Palestinian Authority, and
21
various declarations have been signed in connection with efforts to resolve some
of the economic and political problems in the Middle East, we cannot predict
whether or in what manner these problems will be resolved.
If we are unable to attract and retain the necessary managerial, technical and
other personnel necessary for our business, then our business, results of
operations and financial condition will be harmed.
Our performance is substantially dependent on the performance of our
executive officers and key employees. The loss of the services of any of these
executive officers or key employees could have a material adverse effect on our
business, results of operations and financial condition. Our future success
depends on our continuing ability to attract and retain additional highly
qualified managers and technical personnel. Competition for qualified personnel
is intense and we may not be able to attract, assimilate or retain qualified
personnel in the future.
Results Of Operations
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Sales
Excluding the impact of restructuring charges, sales for the year ended
December 31, 2001, were $10,258,875, a decrease of 34% from sales of $15,567,664
for the year ended December 31, 2000. This decrease in sales reflects an
approximate 61% decrease in sales of Andrea Anti-Noise Products to $4,656,078,
or 45% of total sales , offset by an approximate 68% increase in sales of our
Aircraft Communications Products, to $4,916,616, or 48% of total sales, and an
approximate 2% increase in sales of Andrea DSP Microphone and Software Products,
to $686,181, or 7% of total sales .
The primary reason for the decrease of Andrea Anti-Noise Product sales
during 2001 was a significant decline in headset unit shipments to IBM which was
primarily a result of increased competition in the PC headset market, coupled
with unfavorable economic conditions which continues to negatively impact the
technology sector. In response, during the fourth quarter 2001, we formulated a
plan to exit from an increasingly unprofitable PC headset channel within
Andrea's Anti-Noise Headset product segment. This customer channel included IBM.
For the year ended December 31, 2001, excluding the impact of restructuring
charges, sales to IBM and certain of IBM's affiliates accounted for
approximately 25% of our total sales, or $2,515,819. This reflects an
approximate 63% decrease from $6,809,575 for the year ended December 31, 2000.
The increase in our Aircraft Communication Product revenues is
primarily a result of increased sales and marketing activities.
Sales of Andrea DSP Microphone and Software Products were primarily
comprised of shipments of Andrea's far-field microphone products for use with
business videoconferencing systems, in-vehicle communications systems, and
desktop speech dictation applications. During the fourth quarter of 2001, we
recorded deferred revenues of $1 million related to a license agreement for
certain of our Andrea DSP Microphone and Software technologies. The deferred
revenue will be recognized over a period of three years beginning March 22,
2002.
Cost of Sales
Excluding the impact of restructuring charges, cost of sales as a
percentage of sales for the year ended December 31, 2001 remained consistent
from the year ended December 31, 2000.
Research and Development
Research and development expenses for the year ended December 31, 2001
decreased 26% to $3,462,340 from $4,694,116 for the year ending December 31,
2000. This decrease is due primarily to a reduction in expenses associated with
research efforts that were determined not to be integral to Andrea's core
portfolio of digital microphone software and hardware technologies. DSP
Microphone and Software Technology efforts were $2,770,491, or 80% of total
research and development expenses, Aircraft Communications technology efforts
were $388,757, or 11% of total research and development expenses and Andrea
Anti-Noise Product efforts were $303,092,
22
or 9% 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 our 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 its 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 us with a competitive advantage. For 2002, we expect total research and
development spending to approach levels similar to that of 2001.
General, Administrative and Selling Expenses
Excluding the impact of restructuring charges, general, administrative
and selling expenses decreased approximately 7% to $8,724,784 for the year ended
December 31, 2001 from $9,373,025 for the year ended December 31, 2000. This
decrease is primarily due to our cost reduction efforts which are aimed at
cutting costs that are not integral to the execution of Andrea's overall
strategy, and to ensure conservative spending during the current period of
economic uncertainty. Included in our cost reduction initiatives was a reduction
in workforce which was implemented during February of 2001, representing a
reduction of approximately 25% of Andrea's then total workforce.
Restructuring Charges
During the fourth quarter 2001, we committed to a defined plan of
action and recorded restructuring charges relating to repositioning our business
plan for our 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 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 leading supplier of
high-end, digital-based, far-field microphone technologies. This 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. The plan resulted in an aggregate restructuring
charge of approximately $4.5 million, and included the following:
1. Sales returns - restructuring reserve - This charge,
approximating $340 thousand, reflects estimated sales returns
activity related to exiting this customer channel.
2. Cost of sales - This charge, approximating $2.6 million, relates
to inventory obsolescence for products that we do not expect to
sell as a result of exiting this activity.
3. Other charges - These charges, approximating $1.6 million, relate
to costs associated with exiting certain agreements, as well as
impairment charges associated with abandoning related assets.
Other Income (Expense)
Other income for the year ended December 31, 2001 was $163,475 compared
to $204,774 for the year ended December 31, 2000. This decrease is due to lower
cash balances coupled with unfavorable market conditions for those invested cash
balances during 2001.
Provision for Income Taxes
We did not record income tax expense for the year ending December 31,
2001 in light of the net loss recorded for the period. Furthermore, the
realization of a portion of our reserved deferred tax assets, if and when
23
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 its reserves on deferred income tax assets in
future periods on a quarterly basis. The determination as to the realization of
additional reserves is, and will be, based on Andrea's expectations of future
earnings. To the extent we believe that, more likely than not, previously
reserved deferred tax assets will be realized, we will reduce the reserve
accordingly. See Note 12 to our Consolidated Financial Statements.
Net Loss
Net loss for the year ended December 31, 2001 was $13,630,109 compared
to a net loss of $9,574,352 for the year ended December 31, 2000. The net loss
for the year ended December 31, 2001 principally reflects the factors described
above.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Sales
Sales for the year ended December 31, 2000 were $15,567,664, a decrease
of 9% from sales of $17,112,487 for the year ended December 31, 1999. The
decrease in sales for the year ended December 31, 2000 reflects an approximate
10% decrease in sales of Andrea Anti-Noise Products to $11,974,410, or 77% of
total sales and an approximate 23% decrease in sales of our Aircraft
Communications Products, to $2,923,031, or 19% of total sales, both offset by
initial sales of Andrea DSP Microphone and Software Products of $670,223, or 4%
of total sales. The primary reasons for the decrease of Andrea Anti Noise
Product sales during 2000 were a significant decline in headset unit shipments
to IBM and, to a lesser extent, continued price pressures from IBM. In addition,
the decrease from 1999 reflects a decline in Aircraft Communication Product
sales as a result of a product transformation required to meet future demand for
printed circuit and digital-based intercom systems. Initial sales of Andrea DSP
Microphone and Software Products were primarily comprised of shipments of
Andrea's far-field microphone products for use with business videoconferencing
systems, professional audio microphones and desktop speech dictation
applications. For the year ended December 31, 2000, sales of our computer
headsets to one customer and certain of that customer's affiliates,
distributors, licensees and integrators accounted for approximately 44% of our
total sales.
Cost of Sales
Cost of sales as a percentage of sales for the year ended December 31,
2000 increased to 72% from 70% for the year ended December 31, 1999. This
increase in cost of sales percentage is primarily a result of lower than
expected Andrea Anti-Noise and Aircraft Communications production and sales
(described above under "Sales") over which to spread our pool of fixed overhead
costs.
Research and Development
Research and development expenses for the year ended December 31, 2000
increased 38% to $4,694,116 from $3,399,666 for the year ending December 31,
1999. This increase is due to our continuing efforts to develop its digital
signal processing microphone and software technologies, coupled with, to a
lesser extent, efforts in Aircraft Communication technologies. Research and
development in DSP-based technology at Andrea is 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 array microphone technologies obtained through the
acquisition of Lamar Signal Processing, Ltd. ("Lamar") in May 1998.
Correspondingly, the activities of Lamar accounted for approximately 28% of the
total research and development expenses during 2000. We believe that the
acquisition of Lamar significantly reinforces its 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 superior to other known DSP-based technologies in the marketplace,
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
24
form factors. We believe that continued research and development spending will
provide us with a significant competitive advantage. For 2001, we expect total
research and development spending to approach levels similar to that of 2000.
General, Administrative and Selling Expenses
General, administrative and selling expenses increased approximately 5%
to $9,373,025 for the year ended December 31, 2000 from $8,954,805 for the year
ended December 31, 1999. The slight increase was due to an increase in sales and
marketing expenses during the second half of the year associated with sales
efforts in the automotive telematics market, as well as increases in overall
sales and marketing salaries. We implemented a cost reduction plan aimed at
cutting costs that are not integral to the execution of Andrea's overall
strategy, and to ensure conservative spending during the current period of
economic uncertainty. Included in our cost reduction initiatives was a reduction
in workforce which was implemented during February of 2001, representing a
reduction of approximately 25% of Andrea's then total workforce.
Other Income (Expense)
Other income for the year ended December 31, 2000 was $204,774 compared
to other expense of $26,258 for the year ended December 31, 1999. The increase
is due to interest earned on higher cash balances throughout 2000, coupled with
other miscellaneous income generated during 2000.
Provision for Income Taxes
We did not record income tax expense for the year ending December 31,
2000 in light of the net loss recorded for the period. 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 its reserves on deferred income tax assets in
future periods on a quarterly basis. The determination as to the realization of
additional reserves is, and will be, based on Andrea's expectations of future
earnings. To the extent Andrea's management believes that, more likely than not,
previously reserved deferred tax assets will be realized, Andrea will reduce the
reserve accordingly. See Note 12 to our Consolidated Financial Statements.
Net Loss
Net loss for the year ended December 31, 2000 was $9,574,352 compared
to a net loss of $7,176,993 for the year ended December 31, 1999. The net loss
for the year ended December 31, 2000 principally reflects 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 or potential industry partners. At December 31, 2001, we
had cash and cash equivalents of $3,724,130 compared with $9,151,835 at December
31, 2000. The balance of cash and cash equivalents at December 31, 2001, is
primarily a result of Andrea's issuance and sale in a private placement of
$7,500,000 of its Series C Redeemable Convertible Preferred Stock (the "Series C
Preferred Stock") in October 2000. Andrea is using the net proceeds from the
issuance of the Series C Preferred Stock primarily for costs associated with:
1) research and development,
2) creating and maintaining strategic alliances, which includes,
among other things, sales and marketing salaries, substantial
travel costs to market our products and technologies, product
fulfillment costs and technical assistance, and other general
support costs for existing and potential partners,
3) payment of certain debt obligations,
25
4) professional fees, and
5) general working capital requirements.
In connection with the acquisition of Lamar, of the aggregate cash
consideration to be paid by Andrea, $1,000,000 was paid on May 5, 1998, the
closing date, and $500,000 was paid on each of the six, twelve, twenty-four and
thirty-six month anniversaries of the closing date. The final payment was paid
on May 5, 2001.
Working capital at December 31, 2001 was $5,630,915 compared to
$15,035,051 at December 31, 2000. The decrease in working capital reflects
decreases in total current assets and total current liabilities of $9,405,948,
and $1,812, respectively. The decrease in total current assets reflects
decreases in cash and cash equivalents of $5,427,705, a decrease in accounts
receivable of $1,409,567, and a decrease in inventory of $2,895,309 partially
offset by increase in prepaid expenses and other current assets of $326,633. The
decrease in current liabilities primarily reflects a decrease in accounts
payable of $960,500 and a decrease in our current portio