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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, 1998
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
- - ---------------------------------- ---------------------------------
(State or other jurisdiction (I.R.S. employer identification no.)
of incorporation or organization)
45 Melville Park Road, Melville, New York 11747
- - ----------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 516-719-1800
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- - ------------------------- ------------------------------------------
Common Stock, par value American Stock Exchange
$.50 per share
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 30, 1999, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $94,471,199 (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 30, 1999 was 13,229,640.
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 June 24, 1999, 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
PART I
ITEM 1. BUSINESS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K
ITEM 1. BUSINESS
Overview
Andrea Electronics Corporation ("Andrea") develops, manufactures and
markets its Andrea Anti-Noise/Registered Trademark/ family of electronic
headsets and handsets with noise canceling and noise reducing features and its
new Andrea DSDA/Trademark/ microphone arrays with digital signal processing
(DSP) features.
Noise cancellation enhances voice-activated computing, computerized speech
recognition, and computer and Internet telephony.
Noise reduction enhances the quality of sound heard in noisy environments
and can also be used as a means of environmental sound control.
Digital signal processing converts voice and other audio signals from
analog form into digital form and then processes the signals to improve their
quality. Our DSDA (digital super directional array) products are designed to
provide high quality transmission of voice where the speaker is at a distance
from the microphone. Applications for these "far field" microphones include
voice-activated computing and mobile telephony for automobiles, as well as other
settings where speakers need to be free from the constraint of having a
microphone next to the mouth.
Andrea was established in 1934. After several decades of manufacturing
radios, televisions and high fidelity audio systems, we were engaged primarily
in the manufacture of intercom systems for military and industrial use. We
introduced our first Andrea Anti-Noise microphone products in 1995. Since that
time, sales of our Andrea Anti-Noise microphone products have become our largest
source of revenue, and our sales of intercom products have declined. We are
seeking to apply our knowledge of the military and industrial markets to develop
applications of our Andrea Anti-Noise technologies for those markets, but we
cannot assure that these efforts will succeed and we do not expect any material
revenues from new military and industrial products for the foreseeable future.
Our Strategy
Andrea's strategic objective is to use its expertise in voice-based audio
technology to meet the needs of the emerging markets for voice-activated
computing, computerized speech recognition, and computer-based and
Internet-based telephony. We believe that these markets require enhanced levels
of voice quality, intelligibility, and reliability at increasingly
cost-effective prices. Our strategy for achieving this objective includes the
following elements: maintain and extend our market position with our Andrea
Anti-Noise products through our direct sales force, our collaborative
partnerships with software publishers and original equipment manufacturers of
computers, microprocessors and related equipment, and our relationships with
large retail chains and distributors, some of which are national or global in
their scope of operations; broaden our Andrea Anti-Noise product lines through
internal research and development and, from time to time, strategic
acquisitions, such as our acquisition in May 1998 of Lamar Signal Processing,
Ltd. ("Lamar"), an Israeli corporation engaged in developing DSP noise
cancellation microphones for a wide range of audio and acoustic applications;
design our products to satisfy specific end-user requirements identified by our
collaborative partners, many of which are large computer and electronics
manufacturers and software publishers; and outsource manufacturing of our Andrea
Anti-Noise products in order to achieve economies of scale.
The success of our strategy will depend on our ability to, among other
things, increase sales of our line of existing Andrea Anti-Noise products,
introduce additional Andrea Anti-Noise products, maintain the competitiveness of
our technologies through further research and development, and achieve
widespread adoption of our products and technologies. We cannot assure that we
will be able to accomplish these objectives. See "Competition".
Our Technologies
We design our 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. These include:
Noise Cancellation ("NC") microphone technology based on pressure gradient
microphones that are mechanically and acoustically designed to diminish the
transmission of noise from the speaker's location. Our NC microphones are a less
costly alternative to our ANC microphones and are well-suited for applications
in which there is a lesser degree of background noise in the speaker's
environment.
Active Noise Cancellation ("ANC") microphone technology 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, or very close to, the
speaker's mouth.
Active Noise Reduction ("ANR") earphone technology 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.
Digital Signal Processing microphone technology 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 Digital Super Directional Array (DSDA)
DSP microphones provide clear acoustic and audio input performance where the
desired audio signal is at a distance from the microphone. We believe that our
DSDA DSP microphones achieve far-field microphone performance previously
unattainable through NC-type microphones based on mechanical acoustic designs
and ANC-type microphones based on analog signal processing.
In addition to these microphone and earphone technologies, we are also
developing, manufacturing and marketing products based on two other related
technologies:
our Personal Computer Telephone Interface ("PCTI") technology that
allows the use of one headset for both voice-activated computing on a
personal computer and standard telephone communications.
our Universal Serial Bus ("USB") hardware interface technology that
allows computer peripherals, such as the keyboard, mouse, joystick,
scanner, printer and telephony devices, to be interconnected and
attached to computers using a common connector plug.
Our Products and their Markets and Applications
Our Computer, Internet and Telephony-based Products for the Consumer and
Commercial Markets
For the consumer and commercial markets, we have designed our Andrea
Anti-Noise products for the following applications:
- - - Speech recognition for word processing, database, and similar
applications
- - - Educational software Multimedia Computer telephony
- - - Speech over the Internet
- - - Voice-activated interactive games
- - - Wire-based telecommunications
- - - Cellular and other wireless telecommunications
- - - Auto PCs for use in automobiles
- - - Speech enabled global positioning systems (GPS)
- - - Hands-free car phone kits
- - - Audio/videoconferencing Professional audio systems
- - - Home networking automation systems
- - - Hand-held and other personal assistant devices
- - - Hearing aids
Our Andrea Anti-Noise products have been designed for these voice-based
computer applications and computer-based telephony applications across a broad
range of hardware and software platforms. The following products incorporate our
DSDA, ANC, NC or ANR microphone technologies, and are designed to cancel
background noise in a range of increasingly noisy environments, including, among
others, homes, mobile computing environments, offices and factories.
Andrea AutoArray/Trademark/ Microphone ("AutoArray"). The AutoArray is a
digital, high performance microphone system designed for in-vehicle
computing, specifically enhancing the speech recognition interface. 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. The suggested retail
price of the AutoArray is $199.95.
Andrea DesktopArray/Trademark/ Microphone ("DesktopArray"). Similar to
the AutoArray, the DesktopArray incorporates DSDA technology. The
Desktop Array 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. The suggested retail price of the DesktopArray
is TBD.
Andrea Anti-Noise/Registered Trademark/ ANC-100 Computer Headset. The
ANC-100 is a lightweight, uniquely styled product that has a single,
high fidelity earphone and a dual-function boom ANC microphone. The
earphone is designed to be comfortably worn on the ear or to be placed
on a desktop mount. 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. The suggested retail price
of the ANC-100 is $39.95.
Andrea Anti-Noise/Registered Trademark/ ANC-200 Computer Handset. The
ANC-200 consists of a high fidelity earphone and ANC microphone system
that closely resembles the traditional telephone handset. The ANC-200
also offers features such as near field and far field use and an
"on/mute" function. The suggested retail price of the ANC-200 is $49.95.
Andrea Anti-Noise/Registered Trademark/ ANC-300 Hand-held Microphone.
The ANC-300 is a dual-function ANC hand-held microphone with both near
field and far field capabilities. Near field operation is utilized when
holding the ANC-300; far field operation can be achieved by setting the
microphone in an accompanying stand for amplified desktop performance.
The suggested retail price of the ANC-300 is $39.95.
Andrea Anti-Noise/Registered Trademark/ ANC-500 Computer Headset. The
ANC-500 consists of a headband with a boom ANC microphone and earphone
and an "on/mute" switch. The suggested retail price of the ANC-500 is
$54.95.
Andrea Anti-Noise/Registered Trademark/ ANC-550 Computer Headset. The
ANC-550 consists of a stereo headset with a boom ANC microphone and an
"on/mute" switch. The suggested retail price of the ANC-550 is $64.95.
Andrea ProVoiceSolutions/Trademark/ ANC-600 Computer Headset. The
ANC-600 is an ANC monaural headset with an ultra-flex boom microphone.
Its durable headband and "on/mute" switch differentiate this product.
This headset can be used on either the left or right side of the head.
The suggested retail price of the ANC-600 is $79.95.
Andrea ProVoiceSolutions/Trademark/ ANC-650 Computer Headset. The
ANC-650 is an ANC stereo headset with an ultra-flex boom microphone.
Like the ANC-600, it has a durable headband and "on/mute" switch, and
can be used on either the left or right side of the head. The suggested
retail price of the ANC-650 is $89.95.
Andrea ProVoiceSolutions/Trademark/ ANC-700 Computer Headset. The
ANC-700 is a monaural headset with an ultra-flex boom ANC microphone.
The newly developed speaker housing design that optimizes the acoustic
performance of the earphone's pre-equalized, digital sound
differentiates this product. The suggested retail price of the ANC-700
is $99.95.
Andrea ProVoiceSolutions/Trademark/ ANC-750 Computer Headset. The
ANC-750 is a stereo headset with an ultra-flex boom ANC microphone. The
newly developed speaker housing design that optimizes the acoustic
performance of the earphone's pre-equalized, digital sound
differentiates this product. The suggested retail price of the ANC-750
is $124.95.
Andrea ConnectSolutions/Trademark/ - Personal Computer Telephone
Interface ("PCTI"). The PCTI is a comprehensive desktop device that
integrates speech-centric computing 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. The suggested retail price
of the PCTI is $149.95.
Andrea Wireless VoiceSolutions/Trademark/ AWS-100 ("AWS-100"). The
AWS-100 is a simple head-mounted microphone system that incorporates
infrared (IR) wireless microphone technology, as well as a unique,
untethered design to allow increased mobility and high-quality voice
transmission. The suggested retail price of the AWS-100 is $149.95.
Andrea Anti-Noise/Registered Trademark/QW-1000 Computer Headset. The
QW-1000 is an ANR headphone system with an audio amplifier. Its stereo
sound capabilities differentiate this product. The suggested retail
price of the QW-1000 is $69.95.
Andrea Anti-Noise/Registered Trademark/QW-1000ANC Computer Headset. The
QW-1000ANC is an ANR and ANC headset with an ultra-flex boom microphone.
This product, similar to the QW-1000 comes with an audio amplifier. Its
stereo sound capabilities and "on/mute" switch differentiate this
product. The suggested retail price of the QW-1000ANC is $169.95
Andrea Anti-Noise/Registered Trademark/NC-6 Computer Headset. The NC-6
consists of a back-of- the-head headband with a flex boom NC microphone.
The NC-6 is a microphone-only headset. The suggested retail price of the
NC-6 is $12.95.
Andrea Anti-Noise/Registered Trademark/NC-8 Computer Headset. The NC-8
is a lightweight, uniquely styled headset consisting of a headband with
an around-the-ear style mount, and a flex boom NC microphone. The NC-8
is offered only as an OEM product.
Andrea Anti-Noise/Registered Trademark/NC-10 Computer Headset. The NC-10
is a miniature ear-bud headset with a flex boom NC microphone. The
suggested retail price of the NC-10 is $19.95.
Andrea Anti-Noise/Registered Trademark/NC-12 Computer Headset. The NC-12
is a monaural in-ear headset consisting of a headband with a flex boom
NC microphone. The suggested retail price of the NC-12 is $14.95.
Andrea Anti-Noise/Registered Trademark/NC-14 Computer Headset. The NC-14
is a dual in-ear headset consisting of a headband with a flex boom NC
microphone. The suggested retail price of the NC-14 is $19.95.
Andrea Anti-Noise/Registered Trademark/ NC-50 Computer Headset. The
NC-50 consists of a headband with a boom NC microphone and earphone. The
suggested retail price of the NC-50 is $29.95.
Andrea Anti-Noise/Registered Trademark/ NC-65 Computer Headset. The
NC-65 is a PRO stereo headset with a flex boom NC microphone. Its
durable headband and higher quality stereo sound features differentiate
this headset. The suggested retail price of the NC-65 is $34.95.
Andrea Anti-Noise/Registered Trademark/ NC-80 Computer Headset. The
NC-80 consists of a headband with a boom NC microphone and earphone.
This headset can be used on either the left or right side of the head.
The suggested retail price of the NC-80 is $19.95
Andrea Anti-Noise/Registered Trademark/ NC-100 Computer Headset. The
NC-100 is a lightweight, uniquely styled product that has a single, high
fidelity earphone to which is attached a dual-function boom NC
microphone. The earphone is designed to be comfortably worn on the ear
or to be placed on a desktop mount. When the NC-100 is worn, the
microphone is used in the near field mode; when the NC-100 is placed on
the desktop mount, the microphone is used in the far field mode. The
NC-100 is offered only as an OEM product.
Andrea Anti-Noise/Registered Trademark/ NC-150 Computer Headset. The
NC-150 is an ultralight, PC stereo headset with a flexible NC boom
microphone. The suggested retail price of the NC-150 is $29.95.
Andrea APS-100 Auxiliary Power Supply. The APS-100 consists of a module
housing which holds two "AAA" batteries supplying three volts of power
to the headsets or handsets described above and two female inputs from
the headset and handset connectors and male output plugs to the personal
computer. The APS-100 is used when the computer microphone input has
either no power or insufficient power for correct microphone operation.
The suggested retail price of the APS-100 is $19.95.
Andrea MC-100 Multimedia Audio Controller. The MC-100 consists of a
module housing that 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. The suggested retail
price of the MC-100 is $34.95.
Andrea PC Mini Microphone M-20. The M-20 is a desktop, omni-directional
condenser microphone, which includes a monitor mount and lapel clip. The
suggested retail price of the M-20 is $12.95.
Andrea M-150 Stereo PC Headset. The M-150 is a stereo PC headset with
flexible boom microphone and wide-frequency stereo headphones. The
suggested retail price of the M-150 is $19.95.
Universal Serial Bus Personal Computer Audio Interface ("USB-PCA"). The
USB-PCA offers users of any audio peripheral, the advantages of USB
compatibility. Our USB-PCA interface technology can be integrated into or used
with audio input and connectivity products to transform them into USB-compliant
peripherals, which can combine with the power of USB-ready PCs. USB-PCA
technology provides a cost-effective, convenient means by which audio peripheral
users can achieve better, simpler "plug-and-play" port capacity. The technology
can be integrated into new products to leverage USB compatibility, or can be
incorporated into existing non-USB peripherals to transform them into
USB-compatible tools.
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 with the introduction of the ANC-100. 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 to certain of
our collaborative partners. See "Collaborative Arrangements".
Our Industrial and Military Communication Products
For the industrial and military markets, our traditional intercom and
related components are designed for the following applications:
Avionics
Ground Transportation Communications
Warehouse and Factory Communications
The related components include headsets, amplifiers, electronic control
boxes and panels, and wiring harnesses. The prices of these components range
from $100 to $5,000. 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. We anticipate a downward trend in
sales of our traditional products in both absolute and relative terms.
We have also developed two Andrea Anti-Noise products for various
communications applications in commerce, industry and the military: ANR
Headphone Kits and ANR/ANC Headset Systems. The ANR Headphone Kit is a
lightweight, open backed headphone for use in high-noise environments, such as
airplane cabins, to reduce ambient noise and offer improved audio listening. We
have sold a limited number of these kits to a major producer of headphones. The
ANR/ANC Headset System is a high performance, communication headset system with
both ANR earphone technology and ANC microphone technology. This product is
designed to be adapted to customer specifications for use in extreme high noise
environments, such as in aircraft, manufacturing and warehouse facilities, and
military vehicles.
Our Collaborative Arrangements
An important element of our strategy is to promote widespread adoption of
our Andrea Anti-Noise technology by partnering with large enterprises and market
and technology leaders in telecommunications, computer manufacturing, and
software publishing. We have entered into such arrangements and/or relationships
with International Business Machines Corporation ("IBM"), Microsoft Corporation
("Microsoft"), Intel Corporation, Lernout & Hauspie, Inc. ("L&H"), Clarion
Corporation of America, CompUSA, Office Max, Staples, Mplayer and Multitude. We
are currently discussing additional arrangements with other companies, but we
cannot assure that any of these discussions will result in any definitive
agreements. During the past several years, under an agreement with Grumman
Corporation (now Northrop Grumman Corporation), we have attempted to develop
headset products for military use. As previously reported, we do not expect our
efforts under this agreement to result in revenues.
IBM Procurement Agreement. In June 1995, we entered into a two-year
procurement agreement with IBM covering the sale to IBM of Andrea Anti-Noise
products for inclusion with IBM's personal computers. In 1996, we entered into
an additional agreement with IBM for the sale to IBM of Andrea Anti-Noise
computer headsets for inclusion with all shrink-wrapped copies of IBM's
speech-enabled OS/2 "Merlin" software product. In 1997, we expanded our
relationship with IBM by signing a procurement agreement to supply several
models of Andrea Anti-Noise PC headsets, handsets and microphones to IBM for
packaging with a full line of IBM's speech recognition software programs. We
anticipate that our agreement with IBM will be renewed, but we cannot assure
that this will happen. During 1998, 1997 and 1996, sales of our computer
headsets to IBM and certain of its affiliates, distributors, licensees, and
integrators accounted for 61%, 56%, and 46%, respectively, of our total sales.
Microsoft License Agreements. In October 1996, we entered into a licensing
agreement with Microsoft covering the distribution by Andrea of Microsoft
NetMeeting/Registered Trademark/ Internet and Intranet conferencing software
with our Andrea Anti-Noise retail line of ANC headsets and handsets. This
agreement replaced our prior licensing agreement with Microsoft for Microsoft's
MS Phone/Registered Trademark/ and MSVoice/Registered Trademark/ computer
telephony and speech recognition software. In April 1997, we signed a similar
licensing agreement with Microsoft allowing us to sell Microsoft's NetMeeting
2.0/Registered Trademark/Internet and Intranet conferencing software with Andrea
Anti-Noise headsets which were endorsed and recommended by Microsoft's
NetMeeting Group. In August 1997, Microsoft recommended Andrea's ANC headsets
for use with Internet Explorer 4.0 and, in addition, Microsoft's Windows
Hardware Qualifications Lab certified Andrea ANC products for use with Windows
95 and Windows NT, all of which incorporate NetMeeting 2.0. In June 1998,
certain of our NC and all of our ANC headsets were certified by Microsoft's
Windows Hardware Qualification Lab for use with Windows 98 and Windows NT.
Microsoft Procurement Agreement. In January 1999, we entered a procurement
agreement with Microsoft covering the sale by us to Microsoft of our patented
NC-8 headset for inclusion in Microsoft Encarta Interactive English Learning
software programs that will be marketed in various markets in various languages.
This agreement also covers the inclusion of Andrea product brochures in the
packaging for these and related Microsoft products. We intend to collaborate
with Microsoft in several co-marketing activities and joint promotional efforts
to support these products. The agreement expires in January 2000, but upon
mutual agreement can be extended for successive twelve-month periods.
Intel License Agreement. In October 1998, we entered into an agreement with
Intel Corporation under which we have been provided access to Intel's Pentium
III microprocessor technology for purposes of optimizing the performance of our
Andrea DSDA far-field microphone technology. Our objective for this program is
to significantly reduce the cost of the components required for the Andrea DSDA
microphone product and to improve its overall performance. If we succeeed, we
expect that the benefits of speech recognition can be marketed to a broader base
of end users.
Clarion Purchase Agreement. On February 24, 1999, we entered into a
purchase agreement with Clarion Corporation of America for the Andrea AutoArray,
the first directional, noise canceling audio input device designed specifically
for the natural speech interface for Clarion's Auto PCs. Under this agreement,
Clarion will purchase the Andrea AutoArray and offer it to its authorized Auto
PC dealers nationwide. The agreement has an initial one-year term and
automatically renews for successive one-year terms unless earlier terminated.
Lerner & Hauspie License and Marketing Agreement. In December 1997, Andrea
Electronics entered into a joint licensing and marketing agreement with L&H.
Under this agreement, L&H bundles various Andrea Anti-Noise products with its
continuous speech recognition software products (VoiceXpress and VoiceCommands)
and, in addition, resells various Andrea Anti-Noise products through its direct
sales group to OEM, corporate and retail customers for use with L&H speech
recognition dictation, voice verification and telecommunications software
programs.
Patents, Trademarks, and Other Intellectual Property Rights
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 disclosure of our proprietary
information, and other measures 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 has been granted a total of 12 patents in the United States covering
claims to its Andrea Anti-Noise technology and products, including six utility
patents and six design patents. Counterparts of certain of these patents have
been granted in other jurisdictions. Our six U.S. utility patents cover various
method and apparatus claims to our ANC and ANR technology and products. These
method and apparatus patents expire at various dates, ranging from 2010 to 2017.
Our six U.S. design patents cover claims to the design of various types of
headsets and handsets, including a combined boom microphone headset and stand, a
boom microphone headset, two tethered media/communications handsets with
controls, and an untethered communications/media handset. These design patents
expire at various dates, ranging from 2010 to 2012. In addition, our Lamar
Signal Processing subsidiary has been granted a U.S. patent on the adaptive
interference cancelling system and method used in our Andrea DSDA products. This
patent expires in 2016. In addition, we have other U.S. and non-U.S. patent
applications currently pending. We cannot assure that patents will be issued
with respect to these applications or any other patent applications filed by us
in the future.
Andrea, together with its subsidiaries, has nine U.S. and 70 non-U.S.
trademark registrations and 25 U.S. and 16 non-U.S. pending trademark
applications. The U.S. and non-U.S. registered trademarks include: ANDREA,
ANDREA ANTI-NOISE, ANDREA VOICE SOLUTIONS, ANDREA GAMEWARE, NETSET, QUIETWARE,
TECHNOLOGY ENHANCING COMMUNICATIONS, and TECHNOLOGY ENHANCING VOICE
COMMUNICATIONS. The pending trademark applications cover, among other marks:
AUTOARRAY, DESKTOPARRAY, AUDIO COMMANDER, DSDA, DFTA, LAMAR and PCTI. Andrea has
also obtained two copyright registrations in the United States for its AUDIO
COMMANDER software. The first covers the AUDIO COMMANDER icon. The second covers
the actual software computer program and software code.
Numerous patents have already been granted in the fields of noise cancellation,
noise reduction, digital signal processing, and computer voice recognition. 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. Moreover, the laws of other
countries do not protect our intellectual property rights to the same extent as
the laws of the United States. We cannot assure that any patents issued to us
will provide competitive advantages or will not be infringed, challenged,
invalidated, or circumvented by others, that the patents or proprietary rights
of others will not have an adverse effect on our ability to do business, that we
will be able to obtain licenses to patents of others, if needed, on terms
acceptable to us or at all, or that we will be able to develop additional
patentable technology that may be needed to commercialize successfully our
existing technologies. We are also subject to the risk of adverse claims 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 favorable to us. In November 1998, an
action was brought against us alleging, among other things, that certain of our
ANR patents are invalid. See "Part I - Item 3 - Legal Proceedings".
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 1991, substantially all of our research and
development has been in support of developing Andrea Anti-Noise technology and
applications engineering. Research and development expenses for 1998 increased
82% to $2,016,684 from $1,106,880 for 1997. This increase is primarily a result
of our continuing efforts to develop our digital signal processing technology,
coupled with efforts in computer/telephony headset technologies. These efforts
resulted in ten new products during the year ended December 31, 1998. In 1997,
our research and development expenses represented a 12% increase from $988,483
in 1996. We expect research and development expenses to increase as it seeks to
broaden its line of products. 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 and our traditional
intercom products. Andrea Anti-Noise products are marketed to computer OEMs and
related peripheral devices, distributors of personal computers and
telecommunications equipment, software publishers, computer and consumer
electronic retailers, 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, Internet Content
Developers, and retailers. Under our existing collaborative agreements, our
collaborative partners have various marketing and sales rights to our Andrea
Anti-Noise products. We are seeking to enter additional collaborative
arrangements for marketing and selling our Andrea Anti-Noise products, but we
cannot assure that we will be successful in these efforts. Market acceptance of
the Andrea Anti-Noise products is critical to our success.
We market our traditional intercom 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 are available from several sources and are not
characteristically in short supply. However, certain specialized components,
such as microphones, 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.
We assemble our traditional intercom products at our New York facility from
purchased components. Certain highly specialized components for our traditional
intercom 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 componenets.
Competition
The markets for our Andrea Anti-Noise products and our traditional line of
military and industrial products are highly competitive. Competition in these
markets is based on varying 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.
In the markets for our traditional products, we often compete with major
defense electronics corporations as well as smaller manufacturing firms which
specialize in supplying 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, 1998, we had 123 employees, of whom 44 were engaged in
production and related operations, 42 were engaged in research and development,
and 37 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.
- - --------------
"NetMeeting", "Windows", "MSPhone", and "MSVoice" are registered trademarks of
Microsoft Corporation.
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 for dedicated 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 6 and 12 to our Consolidated
Financial Statements for further information concerning our property, plant and
equipment and leased facilities.
ITEM 3. LEGAL PROCEEDINGS
On November 17, 1998 a complaint was filed against us in the U.S. District
Court for the Eastern District of New York by NCT Group, Inc. ("NCT"; formerly
Noise Cancellation Technologies, Inc.) and NCT Hearing Products, Inc., one of
NCT's subsidiaries. The complaint involves two of Andrea's patents, U.S. Patent
No. 5,732,143 and U.S. Patent No. 5,825,897. These patents relate to certain
active noise reduction technology that is particularly applicable to aircraft
passenger headphones. Andrea does not currently derive any sales or licensing
revenue from aircraft passenger headphones. The complaint requests a declaration
that these two patents are invalid and unenforceable and that NCT's products do
not infringe these two patents. The complaint alleges that Andrea has engaged in
unfair competition by misrepresenting the scope of the two patents, tortuously
interfering with prospective contractual rights between NCT and its existing and
potential customers, making false and disparaging statements about NCT and its
products, and falsely advertising Andrea's ANR products. The complaint 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. On December 30, 1998, we
filed and served an answer to the NCT complaint, denying the allegations and
asserting affirmative defenses and counterclaims. Our counterclaims allege that
NCT has infringed U.S. Patents Nos. 5,732,143 and 5,825,897, and that NCT has
engaged in trademark infringement, false designation of origin, and unfair
competition. The counterclaims also allege that NCT's patent infringement has
been and is willful. 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. 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.
On March 11, 1999, we were notified about a claim approximating $3 million
with respect to environmental matters in connection with a site where we have
been identified as a potential responsible party under federal and state
environmental laws and regulations. We cannot assure that the ultimate outcome
of this matter will not have a material adverse effect on us, but based on a
preliminary review we believe that the suit is without merit and we intend to
mount a vigorous defense.
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 November 13, 1998.
The results of this meeting were reported in a Current Report on Form 8-K, dated
November 24, 1998.
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 23,
1998, there were approximately 573 holders of record of Andrea's Common Stock.
QUARTER ENDED HIGH LOW
- - ------------- ---- ----
March 31, 1997 7 1/2 4 15/16
June 30, 1997 6 7/8 5 1/16
September 30, 1997 34 1/4 5 7/8
December 31, 1997 29 1/8 16 1/8
March 31, 1998 26 1/8 12
June 30, 1998 25 5/8 13 7/8
September 30, 1998 15 3/8 5 1/8
December 31, 1998 14 5/16 4
No dividends were paid in 1998 or 1997. The above prices have been adjusted to
reflect a two-for-one stock split effected in the form of a 100% stock dividend
to stockholders of record on September 10, 1997.
ITEM 6. SELECTED FINANCIAL DATA
DECEMBER 31,
1998 1997 1996 1995 1994
INCOME STATEMENT DATA
Sales 21,304,570 26,429,804 9,244,109 5,440,792 3,278,100
Cost of Sales 14,178,871 16,077,801 5,913,091 3,190,226 2,394,828
---------- ---------- --------- --------- ---------
Gross Profit 7,125,699 10,352,003 3,331,018 2,250,566 883,272
Research and Development 2,016,684 1,106,880 988,483 976,344 1,422,310
General, Administrative
and Selling Expenses 13,002,959 5,753,130 3,872,919 2,925,460 1,995,434
---------- ---------- --------- --------- ---------
Income (Loss) from
Operations (7,893,944) 3,491,993 (1,530,384) (1,651,238) (2,534,472)
Other Income (Expense) 1,447,380 76,864 (13,833) 375,323 234,636
Income (Loss) Before
Provision (Benefit)
for Income Taxes (6,445,955) 3,568,857 (1,544,217) (1,275,915) (2,299,836)
Provision (Benefit) for
Income Taxes - 154,461 (1,222,000) - -
---------- ---------- --------- --------- ---------
Net Income (Loss) (6,445,955) 3,414,396 (322,217) (1,275,915) (2,299,836)
========== ========== ========= ========= =========
Earnings (Loss)
Per Share:
Basic (.61) .42 (.05) (.20) (.42)
Diluted (.61) .39 (.05) (.20) (.42)
BALANCE SHEET DATA
Long Term Capital Lease
Obligations - - - 5,388 17,044
Long Term Obligations,
including current
portions 1,640,511 38,500 2,196,286 2,038,500 38,500
Retained Earnings
(Deficit) (5,574,518) 871,437 (2,542,959) (2,220,742) (944,827)
Total Assets 50,681,941 17,789,184 10,794,250 6,551,110 5,016,581
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Andrea Electronics Corporation's mission is to provide state-of-the-art
communications products for the "voice interface" markets that are rapidly
emerging from the convergence of the telecommunications and computer industries.
These markets require increasingly higher quality voice communication products.
Examples of the applications and interfaces for which Andrea Anti-Noise
products provide benefits include: Internet and other computer-based speech;
telephony communications; multi-point conferencing; multi-player Internet and CD
ROM interactive games; speech recognition; multimedia; military and industrial
communications; and other applications and interfaces that incorporate natural
language processing. We believe that end users of these applications and
interfaces will require high quality microphone and earphone products that
enhance voice transmission, particularly to and from noisy environments, for use
with personal computers, business and residential telephones, military headsets,
cellular and other wireless telephones, personal communication systems and
avionics communications systems. High quality audio communication technologies
will also be required for emerging "far field" voice applications, ranging from
continuous speech dictation, to 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.
Our strategy is to maintain and extend our market position with our Andrea
Anti-Noise products; broaden our Andrea Anti-Noise product lines through
internal research and development and, from time to time, strategic
acquisitions; design our products to satisfy specific end-user requirements
identified by our collaborative partners; and outsource manufacturing of our
Andrea Anti-Noise 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 computer OEMs, software publishers, and distributors and retailers actively
engaged in the various markets in which our products have application. Under
some of these arrangements, we supply our products for sale by our collaborative
partners. Under others, the collaborative partners supply us with software that
we include with our products. 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, increase sales of our line of existing Andrea Anti-Noise products,
introduce additional Andrea Anti-Noise products, maintain the competitiveness of
our technologies through successful research and development, and achieve
widespread adoption of our products and technologies.
In order to complement our internal efforts to develop DSP technology, on
May 5, 1998, we acquired Lamar Signal Processing, Ltd. ("Lamar"), 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. The amoritization of this goodwill has had, and will continue to have,
a 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 products from
purchased components, and we are currently assembling our DSDA products from
purchased components at our New York and Israeli facilities. We manufacture our
traditional intercom systems and related components for military and industrial
applications ("Traditional 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,
1998 and other items set forth in this Report on Form 10K 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:
OUR OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATION
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 mix of products we sell;
- - - the mix of distribution channels we use;
- - - the timing of our new product announcements and releases and those of our
competitors;
- - - fluctuations in the computer and communications hardware and software
marketplace; and
- - - general economic conditions.
We cannot assure that the level of sales and gross profit, if any, that we
achieve in any particular fiscal period will not be significantly lower than in
other fiscal periods. Our revenues for the year ended December 31, 1998 were
approximately $21.3 million compared to approximately $26.4 million in calendar
1997. For the year ended December 31, 1998, we had a net loss of approximately
$6.4 million versus net income of $3.4 million for the year ended December 31,
1997. For the fourth quarter ended December 31, 1998, our revenues were
approximately $7.1 million versus $7.8 million in the same period in 1997. For
the fourth quarter of 1998, we had a net loss of approximately $3.3 million
compared to net income of approximately $0.6 million in the same period in 1997.
While we are examining opportunities for cost-reduction, production
efficiencies and further diversification of our business, we may continue to
accumulate losses and the market price of our common stock could decline. In
order to remain competitive, we intend to continue to incur substantial research
and development, marketing and general and administrative expenses. These
expenses may not be necessarily or easily reduced if sales revenue is below
expectations, and net income or loss, therefore, may be disproportionately
affected by any reduction in sales revenue. Accordingly, we believe that
period-to-period comparisons of our results of operations may not necessarily be
meaningful and should not be relied upon as indications of future performance.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE
The market price of our common stock has historically been highly volatile
and could be subject to wide fluctuations in response to quarterly and annual
variations in our results of operations, losses of significant customers,
announcements of technological innovations or new products by us or our
competitors, changes in the outlook of our industry, our company and our
competitors by securities analysts, or other events or factors, including the
risk factors described in this Report. In addition, the stock market has
experienced significant price and volume fluctuations that have particularly
affected the market prices of equity securities of many high technology
companies and that often have been unrelated to the operating performance of
such companies.
MEETING OUR FUTURE CAPITAL NEEDS MAY ADVERSELY AFFECT OUR BUSINESS AND BE
DILUTIVE TO EXISTING SHAREHOLDERS
Our future capital requirements will depend on numerous factors, including:
- - - the costs associated with developing, manufacturing and commercializing our
products;
- - - maintaining existing, or entering into future, collaborative marketing and
distribution agreements;
- - - protecting intellectual property rights; and
- - - expanding facilities and consummating possible future acquisitions of
technologies, products or businesses.
We expect to raise additional capital through external funding. We are
currently exploring a variety of sources, including private or public financings
through the issuance of debt, convertible debt or equity, or collaborative
arrangements. We cannot assure that additional capital will be available on
favorable terms, if at all. If adequate funds are not available, we may be
required to significantly reduce or refocus our operations or to obtain funds
through arrangements that may require us to relinquish rights to certain of our
products, technologies or potential markets, which would have a material adverse
effect on our business, results of operations and financial condition. To the
extent that additional capital is raised through the sale of equity, the
issuance of such securities would result in ownership dilution to our existing
stockholders.
WE MUST INCREASE SALES AND PROFITABILITY OF OUR PRODUCTS AND COMMERCIALIZE NEW
PRODUCTS
Our business, results of operations and financial condition depend on
successful commercialization of our Andrea Anti-Noise products and technologies.
Sales of the initial Andrea Anti-Noise products began in 1995, and since 1995 we
have been expanding the number of products in this line. 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. To achieve increased sales and profitability, we
must, among other things:
- - - increase market acceptance of our Andrea Anti-Noise products;
- - - respond effectively to competitive pressures with the timely introduction
of new Andrea Anti-Noise products; and
- - - successfully market and support these products.
We cannot assure that we will achieve or sustain significant sales or
profitability of our Andrea Anti-Noise products. Failure to do so would have a
material adverse effect on our business, results of operations and financial
condition.
WE FACE INTENSE COMPETITION
The markets in which we sell our Andrea Anti-Noise products and our
traditional line of military and industrial products are highly competitive.
Competition in the markets for our Andrea Anti-Noise products is based on:
- - - varying combinations of product features;
- - - quality and reliability of performance;
- - - price;
- - - marketing and technical support;
- - - ease of use;
- - - compatibility with evolving industry standards and other systems and
equipment;
- - - brand recognition; and
- - - development of new products and enhancements.
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. We cannot assure that one or more of these
competitors will not independently develop technologies that are substantially
equivalent or superior to our technology.
In the markets for our traditional products, we often compete with major
defense electronics corporations as well as smaller manufacturing firms which
specialize in supplying products and technologies for specific military
initiatives. Our performance in this market 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 administrators.
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 successfully market products, either alone or
through third parties.
We cannot assure that we will be able to compete successfully, and failure
to do so would have a material adverse effect on our business, results of
operations and financial condition.
WE MAY BE UNABLE TO OBTAIN MARKET ACCEPTANCE OF OUR VOICE INTERFACE AND INTERNET
COMMUNICATIONS PRODUCTS
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. The
markets for these products and technologies have only recently begun to develop,
are rapidly evolving, are characterized by a number of competitors, and are
subject to a high level of uncertainty. Broad market acceptance of these
products and technologies is critical to our success and ability to generate
revenues. We cannot assure that we, or our industry in general, will be
successful in obtaining market acceptance of products and technologies. Failure
to do so would have a material adverse effect on our business, results of
operations and financial condition.
WE MAY BE UNABLE TO DEVELOP AND SUCCESSFULLY INTRODUCE NEW PRODUCTS AND
TECHNOLOGIES
The markets for our products are characterized by rapidly changing
technology, and the introduction of products incorporating new technologies
could render our products obsolete and unmarketable and could exert price
pressures on existing products. In particular, we are currently engaged in the
development of digital signal processing products and technologies for the
voice, speech and natural language interface markets. As part of this effort, we
have established our Andrea Digital Technologies subsidiary in the United States
and have acquired Lamar in Israel. We cannot assure that we will succeed in
developing these new DSP products and technologies, or that any such new DSP
products or technologies will gain market acceptance. 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 cannot assure that we will successfully
anticipate and adapt in a cost effective and timely manner to changes in
technology and industry standards, develop, introduce and gain market acceptance
of new and enhanced products and technologies, as well as additional
applications for existing products and technologies, or that the introduction of
new products or technologies by others will not render our products and
technologies obsolete. Our failure to develop new and enhanced products and
technologies would have a material adverse effect on our business, results of
operations and financial condition.
OUR SUCCESS IS HIGHLY DEPENDENT ON OUR COLLABORATIVE MARKETING ARRANGEMENTS
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. Under these collaborative
arrangements, our products are sold to end users through inclusion of the
products of our collaborators. The revenue derived by us from these arrangements
will be based in large part upon the sale of our collaborator's products. Our
success will therefore be dependent to a substantial degree on the efforts of
these collaborators in marketing existing products and new products under
development with which to include our products and technologies. We cannot
assure that any product of any of our collaborators incorporating our products
and technologies will be marketed successfully. Our collaborators generally are
not contractually obligated to any minimum level of sales of our products or
technologies. Furthermore, our collaborators may develop their own microphone or
earphone products or technologies that compete with our products and
technologies. We cannot assure that these collaborators will not replace our
products or technologies with, or give higher priority to, the sales of these
competitive products or technologies. We have also established direct
arrangements with large electronic and computer retail chains in the United
States, as well as with certain distributors in Europe and the Americas. We
cannot assure that any of these channels will devote sufficient resources to
support the sale of our products. We are also currently discussing additional
arrangements with other software companies, several major personal computer
companies, consumer electronic manufacturers, and electronic and compute
rretailers. We cannot assure that any of these discussions will result in any
definitive agreements.
WE DEPEND ON A SINGLE CUSTOMER FOR A SUBSTANTIAL PORTION OF OUR SALES
We are substantially dependent on our product procurement relationship with
IBM. During the years ended December 31, 1996, 1997 and 1998, IBM and certain of
IBM's affiliates, distributors, licensees and integrators accounted for 46%, 56%
and 61%, respectively, of our sales revenue. While we are a party to a
procurement agreement with IBM covering the purchase by IBM of certain of our
Andrea Anti-Noise microphone and earphone products for inclusion with certain of
IBM's personal computer products, IBM is not obligated to purchase these
products and is free to purchase microphone and earphone products and
technologies from our competitors. Our failure to maintain sales of Andrea
Anti-Noise products to IBM would have a material adverse effect on our business,
results of operations and financial condition.
WE MAY NOT BE ABLE TO MAINTAIN NEEDED CONTRACT MANUFACTURING
We conduct assembly operations at our facility in New York and through
subcontractors. During initial production runs of Andrea Anti-Noise products, we
perform assembly operations at our New York facility from purchased components.
As sales of any particular Andrea Anti-Noise product increase, assembly
operations are primarily transferred to a subcontractor in Asia. Any failure on
the part of this subcontractor to meet our production and shipment schedules
could have a material adverse effect on our business, results of operations and
financial condition.
Most of the components for the Andrea Anti-Noise products are available
from several sources and are not characteristically in short supply. However,
certain specialized components for the Andrea AntiNoise products, such as
microphones and DSP boards, are available from a limited number of suppliers and
subject to long lead times. While we have, to date, been able to obtain
sufficient supplies of these more specialized components, 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.
We assemble traditional intercom products at our New York facility from
purchased components. Certain highly specialized components for our traditional
intercom products sold for military and industrial use have limited sources of
supply, the availability of which can affect certain of our projects. While we
do not believe that our results of operations have been, or will be, materially
affected if such components are unavailable, we cannot assure that this will
continue to be the case.
WE RELY ON PATENTS AND PROPRIETARY RIGHTS THAT MAY FAIL TO PROTECT OUR BUSINESS
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. We cannot assure, however, that the steps we have taken to
protect our intellectual property will prevent its misappropriation or
circumvention.
We have been granted 12 patents in the United States covering our Andrea
Anti-Noise technology, and we have other U.S. and non-U.S. patent applications
currently pending. We cannot assure that patents will be issued with respect to
these applications or any patent applications filed by us in the future.
Numerous patents have been granted in the fields of noise cancellation,
noise reduction, computer voice recognition 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. 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.
We cannot assure:
- - - that any patents issued to us will provide us with competitive advantages
or will not be infringed, challenged, invalidated, or circumvented by
others;
- - - that the patents or proprietary rights of others will not have an adverse
effect on our ability to do business;
- - - that we will be able to obtain licenses to patents of others, if needed, on
acceptable terms or at all; or
- - - that we will be able to develop additional patentable technology that may
be needed to successfully commercialize our existing technologies.
We are also 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.
A complaint has been filed against us by NCT Group, Inc. and NCT Hearing
Products, Inc., one of NCT's subsidiaries (collectively, "NCT") involving two of
our patents which relate to certain active noise reduction technology
particularly applicable to aircraft passenger headphones. See "Part I - Item 3 -
Legal Proceedings".
OUR INTERNATIONAL OPERATIONS MAY BE SUBJECT TO CERTAIN RISKS
We have been seeking to increase our sales to regions outside the United
States, particularly in Europe and certain areas in the Americas and Asia. For
the year ended December 31, 1998, sales to customers outside the United States
accounted for approximately 31% of our sales revenue. International sales and
operations are subject to a number of risks, including:
- - - trade restrictions in the form of license requirements;
- - - restrictions on exports and imports and other government controls;
- - - changes in tariffs and taxes;
- - - difficulties in staffing and managing international operations;
- - - problems in establishing or managing distributor relationships;
- - - general economic conditions; and
- - - political and economic instability or conflict.
To date, we have invoiced our international sales in U.S dollars, and have
not engaged in any foreign exchange or hedging transactions. We cannot assure
that this will continue to be the case. 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.
YEAR 2000 ISSUES COULD CAUSE INTERRUPTION OR FAILURE OF OUR COMPUTER SYSTEM
We are currently upgrading our information systems to accomplish several
objectives, including, among others, satisfaction of Year 2000 computing
requirements. We are currently assessing the ability of this upgrade to properly
address Year 2000 criteria, and we will be conducting significant transaction
testing throughout the upgrade process. We do not anticipate any material
deficiencies and, further, we do not anticipate difficulty or significant
additional expense in achieving full Year 2000 capability. The Year 2000 issue
is expected to affect the systems of various entities with which we interact,
including our marketing partners, suppliers, and various vendors, and we are
currently seeking to assess the efforts of these entities to satisfy Year 2000
computing requirements. While we believe that our own upgraded information
systems will satisfy Year 2000 computing requirements, we cannot assure that the
systems of these other entities will do so in a timely manner. A failure by any
of these systems to satisfy Year 2000 computing requirements in a timely manner,
or in a manner that is incompatible with our systems, could have a material
adverse effect on our business, results of operations and financial condition.
QUALIFIED MANAGERIAL AND TECHNICAL PERSONNEL ARE SCARCE IN OUR INDUSTRY
Our performance is substantially dependent on the performance of our
executive officers and key employees. We are dependent on our ability to retain
and motivate high quality personnel, especially management and product and
technology development teams. The loss of the services of any of our executive
officers or other key employees could have a material adverse effect on our
business, results of operations and financial condition. Our future success also
depends on our continuing ability to attract and retain additional highly
qualified technical personnel. Competition for qualified personnel is intense
and we cannot assure that we will be able to attract, assimilate or retain
qualified personnel in the future. Our inability to attract and retain the
necessary technical and other personnel could have a material adverse effect on
our business, results of operations and financial condition.
ANTI-TAKEOVER PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND NEW YORK LAW
MAY ADVERSELY AFFECT OUR STOCKHOLDERS
The New York Business Corporation Law and our Certificate of Incorporation
each contain certain provisions which may, in effect, deter, or make difficult,
a change in control, merger or other acquisition of Andrea. For example, our
Board of Directors may issue up to 5,000,000 shares of preferred stock without
any stockholder vote or action. The preferred stock could have voting,
liquidation, dividend and other rights superior to those of our common stock,
and, therefore, any issuance of preferred stock could adversely affect the
rights of holders of our common stock.
SHARES ELIGIBLE FOR FUTURE SALE MAY HAVE AN ADVERSE EFFECT ON MARKET PRICE; YOU
MAY EXPERIENCE 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 the
our common stock. Of the 25,000,000 shares of common stock presently authorized,
13,229,640 shares of common stock were outstanding on March 30, 1999. This does
not include 3,082,500 shares of common stock reserved for issuance upon exercise
of options granted under our 1991 Performance Equity Plan and 1998 Stock Plan.
To the extent that such options are exercised or we issue additional shares of
capital stock, the ownership interests of holders of common stock would be
diluted. In addition, in May 1998 we issued 1,800,000 shares of common stock as
part of the consideration for our acquisition of Lamar. These shares are subject
to trading restrictions that expire with respect to one-third of these shares in
May 1999, one-third in May 2000, and one-third in May 2001. As the restrictions
expire, the shares are subject to demand and piggyback registration rights.
WE DO NOT ANTICIPATE PAYING CASH DIVIDENDS ON OUR COMMON STOCK
We have not paid any cash dividends on our common stock and do not expect
to pay any cash dividends on our common stock in the foreseeable future.
RESULTS OF OPERATIONS
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Sales
Sales for the year ended December 31, 1998 were $21,304,570, a decrease of
19% over sales of $26,429,804 for the year ended December 31, 1997. The decrease
primarily reflects a shift in product mix to lower-priced and lower-margin
products to original equipment manufacturers (OEMs) with an approximate 45%
decrease in per unit sales prices during the year ended December 31, 1998, and
was offset in part by a 17% increase in unit shipments for the year ended
December 31, 1998 over December 31, 1997. The decrease in sales for the year
ended December 31, 1998 reflects an approximate 22% decrease in sales of Andrea
Anti-Noise products to $17,266,874, or 82% of total sales, and an approximate 6%
decrease in sales of our Traditional Products, to $4,037,696, or 18% of total
sales. For the year ended December 31, 1998, sales of our computer headsets to
one customer and certain of that customer's affiliates, distributors, licensees
and integrators accounted for approximately 61% of our total sales.
Cost of Sales
Cost of sales as a percentage of sales for the year ended December 31, 1998
increased to 67% from 61% for the year ended December 31, 1997. This increase in
cost of sales is primarily a result of the shift in product mix described above.
Research and Development
Research and development expenses for the year ended December 31, 1998
increased 82% to $2,016,684 from $1,106,880 for the year ending December 31,
1997. This increase is primarily a result of our continuing efforts to develop
our digital signal processing technology, coupled with efforts in
computer/telephony headset technologies. These efforts resulted in ten new
products during the year ended December 31, 1998. In addition, 1998 included
research and development activities at our wholly-owned subsidiary, Andrea
Digital Technologies ("ADT"), that was established during the second quarter of
1998 and which operates out of a separate facility in Utah. Research efforts at
ADT are primarily focused on the pursuit of commercializing a natural
language-driven human/machine interface by developing optimal far-field
microphone solutions for various voice-driven interfaces, incorporating the
digital super-directional array microphone technology ("DSDA") obtained through
the acquisition of Lamar in May 1998. Correspondingly, the activities of Lamar,
since the date of acquisition, accounted for approximately 15% of the total
research and development expenses for the year ended December 31, 1998. We
believe that the acquisition of Lamar significantly reinforces our position in
digital signal processing by broadening our exposure to other industries,
including the consumer electronics and professional audio markets, among others.
We anticipate continued significant increases in research and development
expenses, with particular emphasis on digital signal processing efforts.
General, Administrative and Selling Expenses
General, administrative and selling expenses increased 126% to $13,002,959
for the year ended December 31, 1998 from $5,753,130 for the year ended December
31, 1997. This increase, primarily attributable to the ANC/ANR product lines and
the acquisition of Lamar, reflect significant increased business development
expenses relating to existing and prospective collaborative arrangements with
OEMs, software publishers and developers, distributors and retailers. We also
incurred increased promotional, marketing and sales expenses to promote product
awareness and acceptance of the ANC/ANR product lines, particularly in the
retail marketplace, and incurred significant expenses with developing global
expansion efforts. Also included in general, administrative and selling expenses
is goodwill amortization expense of approximately $1.2 million related to the
acquisition of Lamar. In light of our intentions to continue to support sales of
our products, introduce additional products, create new strategic alliances and
further integrate global operations during 1999, high levels of recurring
general, administrative and selling expenses as a percentage of sales may
continue.
Other Income (Expense)
Other income for the year ended December 31, 1998 was $1,447,989 compared
to other income of $76,864 for the year ended December 31, 1997. This change is
primarily attributable to the net gain on the sale of our corporate headquarters
in Long Island City during the year ended December 31, 1998 of $1,864,767,
offset by net interest expense of $476,978, primarily related to the convertible
notes issued and sold in June 1998.
Provision for Income Taxes
We did not record income tax expense for the year ended December 31, 1998
in light of the net loss recorded for the year. The realization of our reserved
deferred tax assets (excluding those generated and reserved during 1998), if and
when realized, will not result in a tax benefit in the consolidated statement of
operations, but will result in an increase in additional paid in capital as they
are related to tax benefits associated with the exercise of stock options. The
income tax expense of $154,461 for the year ended December 31, 1997 resulted
from the effect of a provision for income taxes at our 42% effective income tax
rate, substantially offset by a reduction in our reserve on
previously-generated, fully-reserved deferred income tax assets. We will be
continually re-assessing our reserves on deferred income tax assets on a
quarterly basis. See Note 11 to our Consolidated Financial Statements.
Net Income (Loss)
Net loss for the year ended December 31, 1998 was $6,445,955 compared to
net income of $3,414,396 for the year ended December 31, 1997. The net loss for
the year ended December 31, 1998 principally reflects the factors described
above.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Sales
Sales for the year ended December 31, 1997 were $26,429,804, an increase of
186% over sales of $9,244,109 for the year ended December 31, 1996. The increase
primarily reflects increasing market acceptance of voice interface computer
applications that incorporate our Andrea Anti-Noise technology, coupled with the
strength of new product launches. In addition, revenue was particularly strong
in the latter half of 1997 due to the retail introduction of our products. For
the year ended December 31, 1997, sales from our Andrea Anti-Noise product line
comprised approximately 85 % of total sales while sales from our Traditional
Products comprised approximately 15% of total sales.
Cost of Sales
Cost of sales as a percentage of sales for the year ended December 31, 1997
decreased to 61% from 64% for the year ended December 31, 1996. The improvement
during 1997 principally reflected the efficiencies resulting from our continuing
efforts to globalize our sourcing and manufacturing activities, as well as
maximizing the benefits of shifts in product mix. Also contributing to the
improvement was the higher gross margins realized as a result of the retail
introduction of our products during the latter half of 1997.
Research and Development
Research and development expenses for the year ended December 31, 1997
increased 12% to $1,106,880 from $988,483 for the year ending December 31, 1996.
This increase primarily related to technology investments that resulted in
twelve new products during 1997.
General, Administrative and Selling Expenses
General, administrative and selling expenses for the year ended December
31, 1997 increased 49% to $5,753,130 from $3,872,919 for the year ended December
31, 1996. This increase, primarily attributable to the ANC and ANR product
lines, reflected increased business development expenses related to existing and
prospective collaborative arrangements with hardware OEMs, software publishers,
distributors and retailers. In addition, we incurred increased promotional,
marketing and sales expenses to promote product awareness and acceptance of the
ANC and ANR product lines. As a percentage of sales, however, general,
administrative and selling expenses decreased to 21% for the year ending
December 31, 1997 from 42% for the year ended December 31, 1996.
Other Income (Expense)
Other income for the year ended December 31, 1997 was $76,864 compared to
other expense of $13,833 for the year ended December 31, 1996. This change is
primarily attributable to decreases in interest expense as a result of
conversion rights exercised during 1997, and the lower effective interest rate
on the outstanding convertible debentures during fiscal 1997.
Provision for Income Taxes
The income tax expense of $154,461 for the year ended December 31, 1997
resulted from the effect of a provision for income taxes at our 42% effective
income tax rate, substantially offset by a reduction in our reserve on
previously-generated, fully-reserved deferred income tax assets. As a part of
the normal assessment of our reserves, management determined that it has become
more likely than not that a portion of the previously-reserved deferred tax
assets will be realized and has, accordingly, reduced the valuation allowance on
those previously reserved deferred tax assets. This determination is based on
our profitability in recent quarters and the impact of the sales performance of
its products. Realization of remaining reserved deferred tax assets at December
31, 1997, if and when realized, will not result in a tax benefit in the
consolidated statement of operations, but will result in an increase in
additional paid in capital as they are related to tax benefits associated with
the exercise of stock options. The income tax benefit of $1,222,000 for the year
ended December 31, 1996 represented benefit generated from the 1996 loss as well
as a reduction of the valuation allowance on previously reserved deferred tax
assets at December 31, 1996 (see Note 11 to the financial statements).
Net Income (Loss)
Net income for the year ended December 31, 1997 was $3,414,396, compared to
a net loss of $322,217 for the year ended December 31, 1996. The improvement
principally reflects the factors described above.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of funds have historically been, and are expected to
continue to be, cash flow from operations, borrowings or investments provided by
financial institutions and sales of stock associated with option exercises. At
December 31, 1998, we had cash and cash equivalents of $5,437,423 compared with
$2,059,338 at December 31, 1997. The increase since December 31, 1997 is
primarily a result of our June 1998 private placement of $10.75 million
aggregate principal amount of 6% Convertible Notes ("Notes"). We have been using
the $10 million in net proceeds from the issuance of the Notes for costs
associated with technology acquisition and development, tooling costs,
relocation costs, a new management information system and general working
capital requirements. In connection with the acquisition of Lamar, of the
aggregate cash consideration to be paid by us, $1,000,000 was paid on May 5,
1998, the closing date, $500,000 was paid on November 5, 1998, and the remainder
is payable in three equal installments on each of the twelve, twenty-four and
thirty-six month anniversaries of the closing.
Working capital at December 31, 1998 was $14,337,116 compared to
$11,786,659 at December 31, 1997. The increase in working capital reflects an
increase in total current assets of $4,387,545, offset by an increase in total
current liabilities of $1,837,088. The increase in total current assets reflects
an increase in cash of $3,378,085, a decrease in marketable securities of
$102,717, an increase in accounts receivable of $299,349, an increase in
inventory of $2,247,396, a decrease in prepaid expenses and other current assets
of $524,999 and a decrease in deferred income taxes of $909,569. The increase in
current liabilities reflects a $1,255,129 increase in trade accounts payable, an
increase in the current portion of long term debt of $514,121, a $1,193,472
decrease in convertible debentures (which debentures were converted to equity
during the first quarter of 1998) and a $1,261,310 increase in other current
liabilities.
The increase in cash of $3,378,085 reflects $6,959,490 of net cash used in
operating activities, $772,385 of net cash used by investing activities and
$11,109,960 of net cash provided by financing activities.
The cash used in operating activities, excluding non-cash charges, is
primarily attributable to the $6,445,955 net loss for the year ended December
31, 1998, coupled with an increase in inventory of our Andrea Anti-Noise
computer headsets in anticipation of future sales. Other significant
contributing factors include increases in accounts receivable and other assets.
These increases were offset by a significant increase in trade accounts payable.
The cash provided by investing activities is primarily attributable to the
sale of our primary operating facility in Long Island City, New York, offset by
the cash consideration paid upon closing of the acquisition of Lamar. Also
contributing to the offset were increases in capital expenditures consisting of
the ongoing upgrade of manufacturing dies and molds for Andrea Anti-noise
products and investments in our information systems. In connection with the sale
of our primary operating facility, rent expense associated with the new leased
facility will approximate $532,000 for the year ended December 31, 1999 (see
Note 12 to the financial statements).
The net cash provided by financing activities resulted from the issuance
and sale of the Notes and the exercise of employee stock options. All but $1.5
million of the Notes have been converted to common stock, with the remaining
outstanding principal amount convertible into 3,000 shares of Common Stock.
The increase in accounts receivable primarily reflects the increase in
sales during the fourth quarter of 1998 (relative to prior quarters), offset by
strong collection procedures. Generally, we collect receivables from sales
within two months. The increase in other assets represents increases in patent
and trademark costs associated with our proprietary technology, as well as the
establishment of an escrow account in connection with the sale of our primary
operating facility. The increase in trade accounts payable primarily reflects
differences in the timing related to both the payments for and the acquisition
of raw materials as well as for other services in connection with ongoing
efforts related to the Andrea Anti-Noise products, including our DSDA
technology. The increase in the current portion of long term debt represents the
current portion of debt recorded as a result of the acquisition of Lamar. The
majority of this balance is comprised of $.5 million in cash consideration due
on the twelve month anniversary of the closing. The remaining $1 million in cash
consideration due on the twenty-four and thirty-six month anniversaries of the
closing is recorded as long term debt on the accompanying consolidated balance
sheet.
Demand for Andrea Anti-Noise products has required us to raise additional
working capital to support our operations. In addition, the acquisition of Lamar
will require us to continue to provide working capital to support Lamar's
operations and to repay notes to the sellers of Lamar. In December 1995, April
1996 and August 1996, we raised working capital through the issuance of
convertible subordinated debentures. In June 1998, we raised $10 million through
the issuance and sale of the Notes. In addition, we entered into a revolving
credit agreement in September 1997 that provides maximum borrowings of up to $8
million based on eligible accounts receivable and inventory, as defined. At
December 31, 1998, there were no outstanding amounts under the agreement. We
believe that our current levels of cash, as well as our access to borrowing
sources, provides sufficient liquidity and capital resources to fund working
capital requirements for at least twelve to eighteen months. Notwithstanding the
significance of sales of Andrea Anti-Noise products during the year ended
December 31, 1998, we cannot assure that demand will continue for these products
or any of our other products, including future products related to our DSDA
technology, or, that if such demand does exist, that we will be able to obtain
the necessary working capital to increase production and marketing resources to
meet such demand on favorable terms, or at all.
YEAR 2000 COMPLIANCE PLAN
In anticipation of the year 2000, Andrea has developed and begun to
implement a plan to ensure that all of its information systems are able to
properly recognize and handle dates after December 31, 1999. Our significant
management information systems consist of our financial and inventory systems.
These systems are currently being upgraded with a recently acquired software
package, with a scheduled implementation date of April 1999. All of our material
hardware, including our AS/400 mainframe, telephone systems and networks are
being tested for year 2000 compliance. With respect to significant future system
hardware or software purchases and/or modifications, we will conduct similar
testing prior to implementation in an effort to ensure year 2000 compliance.
Currently, we do not anticipate any material deficiencies and, further, we do
not anticipate difficulty or significant additional expense in achieving full
year 2000 capability. The cost of the upgrade to our management information
systems is not expected to exceed $1 million. We expect this upgrade to achieve
several business and operational objectives, including, among others,
satisfaction of the year 2000 computing requirements. Although we believe that
our own systems will be year 2000 compliant in April 1999, we cannot assure
this, nor can we assure that, even if we complete our year 2000 compliance plan
in a timely manner, that the systems, when actually implemented in full, will
work properly independently or in conjunction with the systems of any of our
suppliers, service providers, strategic partners or customers.
We will bear the risk of a material adverse affect if any of our suppliers,
service providers, strategic partners or customers do not appropriately address
their own year 2000 compliance issues. Accordingly, we have inquired our
suppliers, service providers, strategic partners and major customers about their
year 2000 compliance. We believe that our strategic partners and major customers
will be year 2000 compliant, and we are still in the process of reviewing the
compliance programs of our suppliers and service providers. We cannot assure
that these other companies will achieve year 2000 compliance or that any
conversions by them to become year 2000 compliant will be made in a timely
manner. Failure of these companies to become year 2000 compliant in a timely
manner could have a material adverse effect on our financial condition or
results of operations. If our suppliers and service providers are not year 2000
compliant, we may have to arrange for alternative sources of supply for
inventory procurement and contract manufacturers in the fall of 1999 in
preparation for the year 2000. We do not have any other contingency plans with
respect to other problems that could arise in our business as a result of the
year 2000. Any of these could have a material adverse effect on our financial
condition or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our principal source of financing activities includes debt under a
revolving credit facility that provides for interest at a spread above the prime
rate, as well as the issuance of convertible debt with major financial
institutions. We are affected by market risk exposure primarily through the
effect of changes in interest rates on amounts payable in cash by us under the
revolving credit facility, as well as the amount payable in stock by us under
convertible debt. A significant rise in interest rates could materially
adversely affect our financial condition and results of operations. At December
31, 1998, there were no outstanding borrowings under our credit facility, and
approximately $1.5 million of remaining unconverted debt (see Notes 9 and 12 to
the financial statements). We do not utilize derivative financial instruments to
hedge against changes in interest rates or for any other purpose. In addition,
substantially all transactions by us are denominated in U.S. dollars. As such,
we have shifted foreign currency exposure onto its foreign customers. As a
result, if exchange rates move against foreign customers, we could experience
difficulty collecting unsecured accounts receivable, the cancellation of
existing orders or the loss of future orders. The foregoing could materially
adversely affect our business, financial condition and results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedule listed in Item 14(a)(1) and (2) are
included in this Report beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 as to directors and executive
officers is incorporated by reference to the information captioned "Election of
Directors" included in the Company's definitive proxy statement in connection
with the meeting of shareholders to be held on June 24, 1999. The information
regarding compliance with Section 16 of the Securities and Exchange Act of 1934
and the Rules promulgated thereunder is incorporated by reference therein to the
Company's definitive proxy statement in connection with the meeting of
shareholders to be held on June 24, 1999.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to
the information captioned "Election of Directors - Executive Compensation"
included in the Company's definitive proxy statement in connection with the
meeting of shareholders to be held on June 24, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is incorporated by reference to
the information captioned "Security Ownership" included in the Company's
definitive proxy statement in connection with the meeting of shareholders to be
held on June 24, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
The information required by this Item 13 is incorporated by reference to
the information captioned "Certain Relationships and Related Party Transactions"
included in the Company's definitive proxy statement in connection with the
meeting of shareholders to be held on June 24, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS
The following financial statements of Andrea Electronics Corporation, the
notes thereto, the related reports thereon of independent public accountants,
and financial statement schedules are filed under Item 8 of this Report.
Page
----
Reports of Independent Public Accountants F-1
Consolidated Balance Sheets at December 31, 1998 and 1997 F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Shareholders' Equity for the
three years ended December 31, 1998 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
(2) INDEX TO FINANCIAL STATEMENT SCHEDULES
Report of Independent Public Accountants on Schedule S-1
Schedule II - Valuation and Qualifying Accounts S-2
(3) EXHIBITS
See (c) below.
(b) REPORTS ON FORM 8-K
On November 30, 1998, the Registrant filed a Current Report on Form 8-K
relating to: the Registrant's press release, dated November 24, 1998, announcing
the appointment of Christopher P. Sauvigne to the office of President and Chief
Operating Officer of the Registrant; the results of the the annual meeting of
shareholders of the Registrant held on November 13, 1998; the conversion into
Common Stock of $9,253,000, together with related accrued interest, of the
$10,753,000 aggregate principal amount of 6% Convertible Notes ("Notes") due
June 10, 2000.
On November 23, 1998, the Registrant filed a Current Report on Form 8-K
relating to the Registrant's press release, dated November 23, 1998, stating
that the Registrant had received a complaint, involving two of Andrea's patents,
that had been filed against the Registrant by NCT Group, Inc. and NCT Hearing
Products, Inc., one of NCT's subsidiaries.
(c) EXHIBITS
INDEX TO EXHIBITS
Exhibit
Number Description
- - ------------------
3.1 Amended and Restated Certificate of Incorporation of Registrant
(incorporated by reference to Exhibit 3.1 of the Registrant's Form 10-K
for the year ended December 31, 1992)
3.2 Certificate of Amendment of the Restated Certificate of Incorporation
of Registrant (incorporated by reference to Exhibit 3.2 of the
Registrant's Form 10-K for the year ended December 31, 1997)
3.3 Certificate of Amendment of the Restated Certificate of Incorporation
of Registrant (incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed November 30, 1998)
3.4 Amended By-Laws of Registrant (incorporated by reference to Exhibit 3.2
of the Registrant's Current Report on Form 8-K filed November 30, 1998)
4.1 Securities Purchase Agreement, dated as of December 22, 1995, relating
to the sale of the Registrant's 15% Convertible Subordinated Debentures
due 1997 (with form of Debenture attached thereto) (incorporated by
reference to Exhibit 4.1 of the Registrant's Form 10-K for the year
ended December 31, 1995)
4.2 Registration Rights Agreement, dated as of December 22, 1995, relating
to registration rights granted to the holders of the Registrant's 15%
Convertible Subordinated Debentures due 1997 (incorporated by reference
to Exhibit 4.2 of the Registrant's Form 10-K for the year ended
December 31, 1995)
4.3 Securities Purchase Agreement, dated as of April 16, 1996, relating to
the sale of the Registrant's 15% Convertible Subordinated Debentures
due October 16, 1997 (with forms of Debenture and Registration Rights
Agreement attached thereto) (incorporated by reference to Exhibit 4.1
of the Registrant's Form 10-Q for the Six Months ended June 30, 1996)
4.4 Securities Purchase Agreement, dated as of August 7, 1996, relating to
the sale of the Registrant's 10% Convertible Subordinated Debentures
due February 9, 1998 (with forms of Debenture and Registration Rights
Agreement attached thereto) (incorporated by reference to Exhibit 4.1
of the Registrant's Form 10-Q for the Nine Months ended September 30,
1996)
4.5 Securities Purchase Agreement, dated as of June 10, 1998, relating to
the sale of the Registrant's 6% Convertible Notes due June 10, 2000
(with forms of Note and Registration Rights Agreement attached thereto)
(incorporated by reference To Exhibit 4.1 of the Registrant's Form S-3,
File No. 333-61115)
10.1 1991 Performance Equity Plan, as amended (incorporated by
reference to Exhibit 4 of Registrant's Registration Statement
on Form S-8, No. 333-45421, filed February 2, 1998)
10.2 1998 Stock Plan
10.3* Procurement Agreement, dated June 16, 1995, by and between
International Business Machines Corporation and the Registrant
(incorporated by reference to Exhibit 10.1 of the Registrant's Form
10-Q for the Three Months ended June 30, 1995)
10.4* Memorandum of Agreement, dated as of September 14, 1993, by and between
Grumman Aerospace Corporation and the Registrant (incorporated by
reference to Exhibit 10.3 of the Registrant's Form 10-K for the year
ended December 31, 1995)
10.5* License and Technical Support Agreement, dated as of October 3, 1995,
by and between BellSouth Products, Inc. and the Registrant
(incorporated by reference to Exhibit 10.4 of the Registrant's Form
10-K for the year ended December 31, 1995)
10.6* Software License Bundling Agreement, dated as of March 29, 1996, by and
between Voxware, Inc., and the Registrant
(incorporated by reference to Exhibit 10.1 of the Registrant's
Form 10-Q for the Six Months ended June 30, 1996)
10.7 Employment Agreement, dated as of January 1, 1998, by and between John
N. Andrea and the Registrant (incorporated by reference to Exhibit 10.6
of the Registrant's Form 10-K for the year ended December 31, 1998)
10.8 Employment Agreement, dated as of January 1, 1998, by and between
Douglas J. Andrea and the Registrant (incorporated by reference to
Exhibit 10.7 of the Registrant's Form 10-K for the year ended December
31, 1998)
10.9 Employment Agreement, dated as of January 1, 1998, by and between
Patrick D. Pilch and the Registrant (incorporated by reference to
Exhibit 10.8 of the Registrant's Form 10-K for the year ended December
31, 1998)
10.10 Employment Agreement, dated as of November 20, 1998, by and between
Christopher P. Sauvigne and the Registrant (incorporated by reference
to Exhibit 10.1 of the Registrant's Current Report on Form 8-K filed
November 30, 1998)
10.11* Direct Sales and License Agreement, dated as of October 13, 1997, by
and between Lernout & Hauspie Speech Products and the Registrant
(incorporated by reference to Exhibit 10.8 of the Registrant's Form
10-K for the year ended December 31, 1998)
10.12* Production Procurement Agreement, dated as of June 11, 1997, by and
between International Business Machines Corporation and the Registrant
(incorporated by reference to Exhibit 10.9 of the Registrant's Form
10-K for the year ended December 31, 1998)
10.13 Revolving Loan and Security Agreement, dated as of September 23, 1997,
by and between IBM Credit Corporation and the Registrant
10.14 Stock Purchase Agreement, dated April 6, 1998, as amended by Amendment
No. 1 thereto dated May 5, 1998, relating to the purchase of the shares
of Lamar Signal Processing, Ltd. (including form of Registration Rights
Agreement)(incorporated by reference to Exhibits 2.1 and 2.2 of the
Registrant's Current Report on Form 8-K filed May 8, 1998)
10.15** Procurement Agreement, dated as of January 13, 1999, by and between the
Registrant and Microsoft Corporation
10.16** Purchase Agreement, dated as of February 25, 1999, by and between the
Company and Clarion Corporation of America
10.17** Source Code License Agreement, dated as of October 29, 1998, between
the Company and Intel Corporation
21 Subsidiaries of Registrant
22 Consent of Independent Public Accountants
27 Financial Data Schedule
- - ---------------
* Certain portions of this Agreement have been accorded
confidential treatment.
** Confidential treatment has been requested for certain portions
of this Agreement.
(d) Financial Statement Schedules
See Item 14(a)(2).
INDEX TO FINANCIAL STATEMENTS
Page
----
Reports of Independent Public Accountants F-1
Consolidated Balance Sheets at December 31, 1998 and 1997 F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Shareholders' Equity for the
three years ended December 31, 1998 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To Andrea Electronics Corporation:
We have audited the accompanying consolidated balance sheets of Andrea
Electronics Corporation (a New York corporation) and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Andrea Electronics
Corporation and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Melville, New York
January 26, 1999 (except with respect to the matter discussed in the last
paragraph of Note 12, as to which the date is March 29, 1999)
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
-----------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31,
-----------------------------------
ASSETS 1998 1997
------ ---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 5,437,423 $ 2,059,338
Marketable securities - 102,717
Accounts receivable, net of allowance for doubtful accounts of $202,251
and $52,251, respectively 4,867,782 4,568,433
Inventories 8,014,323 5,766,927
Deferred income taxes - 909,569
Prepaid expenses and other current assets 498,662 1,023,661
---------------- ----------------
Total current assets 18,818,190 14,430,645
PROPERTY, PLANT AND EQUIPMENT, net 1,919,966 1,022,342
DEFERRED INCOME TAXES 1,806,615 897,046
OTHER ASSETS 1,751,501 1,439,151
GOODWILL 26,385,668 -
---------------- ----------------
Total assets $ 50,681,940 $ 17,789,184
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Trade accounts payable $ 2,221,912 $ 966,783
Current portion of long term debt (Note 8) 514,121 -
Convertible debentures, net (Note 9) - 1,193,472
Other current liabilities 1,745,041 483,731
---------------- ----------------
Total current liabilities 4,481,074 2,643,986
LONG TERM DEBT (Note 8) 1,126,390 -
CONVERTIBLE NOTES, net (Note 9) 1,455,231 -
OTHER LIABILITIES 40,345 38,500
---------------- ----------------
Total liabilities 7,103,040 2,682,486
---------------- ----------------
COMMITMENTS AND CONTINGENCIES (Note 12)
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value; authorized: 5,000,000 shares; none
issued and outstanding - -
Common stock, $.50 par value; authorized: 25,000,000 shares; issued
and outstanding: 13,210,038 and 8,706,692 shares, respectively 6,605,019 4,353,346
Additional paid-in capital 42,548,399 9,881,915
Retained earnings (accumulated deficit) (5,574,518) 871,437
---------------- ----------------
Total shareholders' equity 43,578,900 15,106,698
---------------- ----------------
Total liabilities and shareholders' equity $ 50,681,940 $ 17,789,184
=============== ===============
The accompanying notes are an integral part of these
consolidated balance sheets.
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
-----------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
For the Years Ended December 31,
------------------------------------------------------
1998 1997 1996
---- ---- ----
NET SALES $ 21,304,570 $ 26,429,804 $ 9,244,109
COST OF SALES 14,178,871 16,077,801 5,913,091
------------- ------------- -------------
Gross profit 7,125,699 10,352,003 3,331,018
RESEARCH AND DEVELOPMENT EXPENSES 2,016,684 1,106,880 988,483
GENERAL, ADMINISTRATIVE AND SELLING EXPENSES
13,002,959 5,753,130 3,872,919
------------- ------------- -------------
Income (loss) from operations (7,893,944) 3,491,993 (1,530,384)
------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest income 233,346 64,873 57,599
Interest expense (710,324) (228,029) (293,290)
Rent and miscellaneous income 1,924,967 240,020 221,858
------------- ------------- -------------
1,447,989 76,864 (13,833)
------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT)
(6,445,955) 3,568,857 (1,544,217)
INCOME TAX PROVISION (BENEFIT) (Note 11) - 154,461 (1,222,000)
------------- ------------- -------------
NET INCOME (LOSS) $ (6,445,955) $ 3,414,396 $ (322,217)
============= ============= =============
PER SHARE INFORMATION (Note 4):
Net Income (Loss) Per Share :
Basic $ (.61) $ .42 $ (.05)
============ ============ ============
Diluted $ (.61) $ .39 $ (.05)
============ ============ ============
Shares used in computing net income (loss) per share:
Basic 10,614,237 8,148,153 7,129,534
============= ============= =============
Diluted 10,614,237 8,862,263 7,129,534
============= ============= =============
The accompanying notes are an integral
part of these consolidated statements.
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
-----------------------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
-----------------------------------------------
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
-------------------------------------------
Retained
Additional Earnings Total
Shares Common Paid-In (Accumulated Shareholders'
Outstanding Stock Capital Deficit) Equity
----------- ----- ------- -------- ------
BALANCE, December 31, 1995 6,573,720 $ 3,286,860 $ 2,899,162 $ (2,220,742) $ 3,965,280
Conversion of convertible debt 635,674 317,837 3,267,905 - 3,585,742
Exercise of stock options, net of related
costs 375,000 187,500 91,656 - 279,156
Net loss - - - (322,217) (322,217)
------------ ------------- ------------- ------------- --------------
BALANCE, December 31, 1996 7,584,394 3,792,197 6,258,723 (2,542,959) 7,507,961
Conversion of convertible debt 189,548 94,774 1,108,521 - 1,203,295
Exercise of stock options, net of related
costs 932,750 466,375 2,514,671 - 2,981,046
Net income - - - 3,414,396 3,414,396
------------ ------------- ------------- ------------- --------------
BALANCE, December 31, 1997 8,706,692 4,353,346 9,881,915 871,437 15,106,698
Conversion of convertible debt 2,334,846 1,167,423 9,211,993 - 10,379,416
Exercise of stock options, net of related
costs 350,500 175,250 934,710 - 1,109,960
Issuance of common stock for acquisition
of subsidiary (Note 3) 1,818,000 909,000 22,519,781 - 23,428,781
Net loss - - - (6,445,955) (6,445,955)
------------ ------------- ------------- ------------- -------------
BALANCE, December 31, 1998 13,210,038 $ 6,605,019 $ 42,548,399 $ (5,574,518) $ 43,578,900
============ ============= ============= ============= =============
The accompanying notes are an integral part of these consolidated
statements.
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
-----------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the Years Ended December 31,
----------------------------------------------------
1998 1997 1996
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (6,445,955) $ 3,414,396 $ (322,217)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Non-cash interest expense 646,650 203,204 162,543
Depreciation and amortization 2,594,519 322,499 353,308
Gain on sale of building (1,864,767) - -
Barter transaction - (750,000) -
Deferred income taxes - 154,461 (1,222,000)
(Increase) decrease in:
Accounts receivable, net (278,132) (1,889,984) (1,632,527)
Inventories (2,218,773) (1,492,752) (3,651,182)
Prepaid expenses and other current assets (128,400) (714,399) 57,954
Other assets (312,350) (439,151) -
Increase (decrease) in:
Trade accounts payable 1,154,192 144,383 567,757
Other current liabilities (106,474) 247,514 14,862
-------------- -------------- --------------
Net cash used in operating activities (6,959,490) (799,829) (5,671,502)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities - - (98,474)
Proceeds from sale of marketable securities 102,717 100,000 -
Acquisition of business, net of cash acquired (947,276) - -
Proceeds from sale of building 2,282,563 - -
Purchases of property, plant and equipment (1,710,389) (408,259) (393,998)
-------------- -------------- --------------
Net cash used in investing activities (272,385) (308,259) (492,472)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of capital lease obligations - (4,685) (39,946)
Payment of acquisition installment notes (Note 3 and 8) (500,000) - -
Net proceeds from convertible debentures (Note 9) - - 3,445,000
Net proceeds from convertible notes (Note 9) 10,000,000 - -
Issuance of common stock upon exercise of stock options, net of related
costs 1,109,960 2,251,046 279,156
-------------- -------------- --------------
Net cash provided by financing activities 10,609,960 2,246,361 3,684,210
-------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
3,378,085 1,138,273 (2,479,764)
CASH AND CASH EQUIVALENTS, beginning of year 2,059,338 921,065 3,400,829
-------------- -------------- --------------
CASH AND CASH EQUIVALENTS, end of year $ 5,437,423 $ 2,059,338 $ 921,065
============== ============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Non-cash investing and
financing activities:
Conversion of convertible debentures and related accrued interest into
common stock (Note 9) $ 10,379,416 $ 1,203,295 $ 3,585,742
============== ============== ==============
Issuance of common stock for acquisition (Note 3) $ 23,428,781 $ - $ -
============== ============== ==============
Issuance of notes payable for acquisition (Note 3 and 8) $ 1,672,212 $ - $ -
============== ============== ==============
Cash paid for:
Interest $ 3,261 $ - $ -
============== ============== ==============
Income taxes $ 32,503 $ 5,200 $ 3,145
============== ============== ==============
The accompanying notes are an integral part of these
consolidated statements.
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
-----------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
DECEMBER 31, 1998
-----------------
1. ORGANIZATION AND BUSINESS:
-------------------------
Andrea Electronics Corporation (together with its subsidiaries, the
"Company") has been engaged in the electronic communications industry since
1934. The Company is presently focused on the development, manufacture and
marketing of its Andrea Anti-Noise family of electronic headsets and handsets
with noise canceling and noise reducing properties. Noise cancellation enhances
voice-activated computing, computerized speech recognition, and computer and
Internet telephony. In addition, the Company is currently developing and
marketing a new line of digital signal processing products to further its role
in technology enhanced communications, and in May 1998, acquired Lamar Signal
Processing, Ltd. ("Lamar"), an Israeli corporation engaged in the development of
digital signal processing (DSP), noise cancellation microphone solutions (Note
3). Prior to the Company's entry into the voice-activated computing market in
the 1990s, its primary business was selling intercom systems for military and
industrial use. The Company continues to manufacture for these systems and is
seeking to apply its knowledge of the military and industrial markets to develop
applications of its Andrea Anti-Noise technologies for these markets.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
------------------------------------------
Principles of Consolidation
- - ---------------------------
The financial statements include the accounts of the Company and its
subsidiaries. All intercompany balances and transactions have been eliminated in
consolidation.
Cash and Cash Equivalents
- - -------------------------
Cash and cash equivalents include cash and highly liquid investments with
original maturities of three months or less.
Marketable Securities
- - ---------------------
The Company accounts for investments according to the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". Accordingly, marketable
securities used as part of the Company's asset management that may be sold in
response to changes in interest rates, prepayments, and other factors have been
classified as available-for-sale. Such securities are reported at fair value,
with unrealized gains and losses excluded from earnings and reported in a
separate component of stockholders' equity (on an after-tax basis). Gains and
losses on the disposition of securities are recognized on the specific
identification method in the period in which they occur. During 1998,
approximately $102,000 of the Company's marketable securities matured. Sales of
securities were $100,000 in 1997. There were no sales of securities in 1998 or
1996. At December 31, 1998 and 1997, the carrying values of the Company's
marketable securities approximate fair value.
Concentration of Credit Risk
- - ----------------------------
The Company is a manufacturer of audio communications equipment for several
industries. During 1998, the Company primarily generated sales from its noise
canceling and active noise canceling products as well as through sales to the
federal government. Sales of noise canceling and active noise canceling products
were significant to one customer and its affiliates, accounting for
approximately 60% and 52% of total accounts receivable at December 31, 1998 and
1997, respectively, and approximately 61%, 56% and 46% of the total sales for
1998, 1997 and 1996, respectively. Sales to federal governments and related
subcontractors aggregated approximately 9% and 10% of total accounts receivable
at December 31, 1998 and 1997, respectively, and approximately 19%, 15% and 47%
of the total sales for 1998, 1997 and 1996, respectively.
Inventories
- - -----------
Inventories are stated at the lower of cost (on a first-in, first-out) or
market basis.
Property, Plant and Equipment
- - -----------------------------
Property, plant and equipment is stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are provided using
the straight-line method over the estimated useful-lives of the assets which are
as follows:
Building 25 years
Building improvements 10 - 32 years
Machinery and equipment 3 - 7 years
Expenditures for maintenance and repairs which do not materially prolong
the normal useful life of an asset are charged to operations as incurred.
Improvements which substantially extend the useful lives of the assets are
capitalized. Upon sale or other disposition of assets, the cost and related
accumulated depreciation and amortization are removed from the accounts and the
resulting gain or loss, if any, is reflected in the statement of operations.
Intangible Assets
- - -----------------
Patents and trademarks associated with the Company's proprietary technology
are carried at cost less accumulated amortization which is calculated on a
straight-line basis over the estimated useful lives of the assets, not to exceed
17 years. The recoverability of carrying values of intangible assets is
evaluated on a recurring basis. Patents and trademarks approximated $778,000 and
$415,000 at December 31, 1998 and 1997, respectively, and are included in other
assets on the accompanying consolidated balance sheets. Goodwill associated with
the Company's acquisition (Note 3) is carried at cost less accumulated
amortization which is calculated on a straight-line basis over 15 years.
Long-Lived Assets
- - -----------------
The Company accounts for long-lived assets according to the provisions of
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of". In accordance with SFAS No. 121, the
Company periodically reviews long-lived assets, including identifiable
intangibles (patents) and goodwill, whenever events or changes in circumstances
indicate that the carrying amount of the asset may not be recoverable.
Management believes there is no impairment to goodwill and certain identifiable
intangibles as of December 31, 1998.
Revenue Recognition
- - -------------------
Revenue is recognized upon shipment and acceptance of goods. The Company
reports its sales levels on a net sales basis, with net sales being computed by
deducting from gross sales the amount of actual sales returns and the amount of
reserves established for anticipated sales returns.
Barter Transaction
- - ------------------
The Company records barter transactions at the estimated fair market value
of the services received. Revenue from a barter transaction approximated
$1,250,000 during 1997. The value received in this transaction was recorded as a
deferred charge and, at December 31, 1998, $770,000 is included in other assets.
The remaining balance will be amortized over the lesser of the period of benefit
or the program period, not to exceed five years. The Company did not engage in
any barter transactions during 1998 or 1996.
Income Taxes
- - ------------
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". This pronouncement established financial
accounting and reporting standards for the effects of income taxes that result
from the Company's activities during the current and preceding years. It
requires an asset and liability approach for financial accounting and reporting
for income taxes.
The provision for income taxes is based upon income after adjustment for
those permanent items that are not considered in the determination of taxable
income. Deferred taxes result when the Company recognizes revenue or expenses
for income tax purposes in a different year than for financial reporting
purposes.
Stock-Based Compensation
- - ------------------------
The Company complies with the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), by continuing to apply the
provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," while providing the required pro forma
disclosures as if the fair value method had been applied (Note 13).
Research and Development
- - ------------------------
The Company expenses all research and development costs as incurred.
Advertising Expenses
- - --------------------
The Company charges all media costs of newspaper and magazine
advertisements to the consolidated statements of operations when advertisements
are run. Prepaid advertising at December 31, 1998 and 1997, which represents
costs for media services purchased but not yet run, is included in prepaid
expenses and other current assets in the accompanying consolidated balance
sheets.
Fair Value of Financial Instruments
- - -----------------------------------
The Company calculates the fair value of financial instruments and includes
this additional information in the notes to financial statements when the fair
value is different than the book value of those financial instruments. When the
fair value approximates book value, no additional disclosure is made. The
Company uses quoted market prices whenever available to calculate these fair
values. When quoted market prices are not available, the Company uses standard
pricing models for various types of financial instruments which take into
account the present value of estimated future cash flows. At December 31, 1998
and 1997, the carrying value of all financial instruments approximated fair
value.
Stock Split
- - -----------
On September 2, 1997, the Company's Board of Directors authorized a
two-for-one stock split effected in the form of a 100% stock dividend that was
distributed on September 17, 1997 to shareholders of record on September 10,
1997. All share and per share data included in the accompanying financial
statements have been restated to reflect the stock split for all periods
presented.
Comprehensive Income
- - --------------------
In the first quarter of 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income", which requires companies to report all changes in equity
during a period, except those resulting from investment by owners and
distribution to owners, in a financial statement for the period in which they
are recognized. Comprehensive income is the total of net income and all other
non owner changes in equity (or other comprehensive income) such as unrealized
gains/losses on securities available-for-sale, foreign currency translation
adjustments and minimum pension liability adjustments. Comprehensive and other
comprehensive income must be reported on the face of the annual financial
statements or, in the case of interim reporting, in the footnotes to the
financial statements. The Company's operations did not give rise to items
includible in comprehensive income which were not already included in net income
(loss). Accordingly, the Company's comprehensive income (loss) is the same as
its net income (loss) for all periods presented.
Recently Issued Accounting Standard
- - -----------------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". This statement
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. This Statement is effective for fiscal years beginning after
June 15, 1999. A company may also implement the Statement as of the beginning of
any fiscal quarter after issuance (that is, fiscal quarters beginning June 16,
1998 and thereafter). SFAS No. 133 cannot be applied retroactively. SFAS No. 133
must be applied to (a) derivative instruments and (b) certain derivative
instruments embedded in hybrid contracts that were issued, acquired, or
substantively modified after December 31, 1997. While the Company operates in
international markets, it does so presently without the use of derivatives and,
accordingly, this new pronouncement is not applicable.
Reclassifications
- - -----------------
Certain prior year amounts have been reclassified to conform to the current
year presentation.
Use of Estimates
- - ----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.
Actual results could differ from those estimates.
3. ACQUISTION OF BUSINESS:
----------------------
On May 5, 1998, the Company acquired all of the outstanding shares of
capital stock of Lamar (the "Acquisition"). The consideration paid by the
Company for the Acquisition was 1,800,000 shares of restricted common stock and
$3,000,000 in cash and notes payable. Of the approximately 1,800,000 shares
issued to the sellers, one-third becomes freely transferable on the first
anniversary of the closing, an additional one-third on the second anniversary
and the last one-third on the third anniversary. Of the aggregate cash
consideration to be paid by the Company, $1,000,000 was paid on May 5, 1998,
$500,000 was paid on November 5, 1998, and the remainder is payable in the form
of promissory notes in three equal installments on each of the twelve,
twenty-four and thirty-six month anniversaries of the closing (Note 8). The
Acquisition was accounted for under the purchase method of accounting and,
accordingly, the operating results of Lamar have been included in the
consolidating operating results since the date of acquisition. The Acquisition
was valued using an independent appraisal of the fair value of the consideration
paid and the assets purchased, and resulted in goodwill of approximately $27.6
million, which will be amortized over fifteen years. Goodwill at December 31,
1998 is approximately $26.4 million, which is net of approximately $1.2 million
in amortization expense. The Company made no acquisitions in 1997 or 1996.
The pro forma results listed below, for the years ended December 31, 1998
and 1997, reflect pro forma adjustments, consisting primarily of amortization of
goodwill and interest expense on the discounted value of the $2 million in
promissory notes, assuming the acquisition occurred at the beginning of each
period presented. Pro forma sales amounts would not be materially different from
the historical results reported for 1998 and 1997.
For the Year Ended December 31,
-------------------------------
1998 1997
---- -----
Net income (loss) $ (7,143,660) $ 1,166,506
Net income (loss) per share:
Basic $ (.64) $ .12
Diluted $ (.64) $ .11
Shares used in computing net income (loss) per share:
Basic 11,236,840 9,966,153
Diluted 11,236,840 10,680,263
4. NET INCOME (LOSS) PER SHARE:
---------------------------
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings
Per Share". Basic net income (loss) per common share ("Basic EPS") is computed
by dividing net income (loss) by the weighted average number of common shares
outstanding. Diluted net income (loss) per common share ("Diluted EPS") is
computed by dividing net income (loss) by the weighted average number of common
shares and dilutive common share equivalents and convertible securities then
outstanding. The impact of the adoption of this statement was not material to
all previously reported EPS amounts.
The following chart provides a reconciliation of information used in
calculating the per share amounts for the twelve months ended December 31, 1997.
No additional information is presented for 1998 or 1996 as diluted EPS is the
same as Basic EPS for those years, and the inclusion of the impact of stock
options, warrants and convertible securities then outstanding would be
anti-dilutive:
Net Income
Net Income Shares Per Share
---------- ------ ---------
Basic EPS
---------
Net income $ 3,414,396 8,148,153 $.42
Effect of dilutive employee stock options - 714,110 (.03)
-------------- -------------- -----
Diluted EPS
-----------
Net income $ 3,414,396 8,862,263 $.39
============== ============== ====
5. INVENTORIES, NET:
----------------
Inventories, net, consists of the following:
December 31,
---------------------------------
1998 1997
---- ----
Raw materials $ 2,795,893 $ 2,438,290
Work-in-process 194,289 276,745
Finished goods 5,454,651 3,332,403
------------ --------------
8,444,833 6,047,438
Less: reserve for obsolescence 430,510 280,511
------------ --------------
$ 8,014,323 $ 5,766,927
============ ==============
6. PROPERTY, PLANT AND EQUIPMENT, NET:
----------------------------------
Property, plant and equipment, net, consists of the following:
December 31,
-----------------------------------
1998 1997
---- ----
Land $ - $ 109,000
Building - 453,000
Building improvements 23,672 372,928
Machinery and equipment 3,283,572 1,406,389
------------ ----------------
3,307,244 2,341,317
Less: accumulated depreciation 1,387,278 1,318,975
------------ ----------------
$ 1,919,966 $ 1,022,342
============ ================
During the first quarter of 1998, the Company sold its primary operating
facility in Long Island City, New York. The Company received approximately $2.2
million in cash paid at the closing and $200,000 in cash in an escrow account
(the "Escrow Funds"). The gain on the sale of the building was $1,864,767, which
is included in rent and miscellaneous income in the accompanying consolidated
statement of operations for 1998. The Escrow Funds are governed by an escrow
agreement whereby the buyer could claim certain expenses, as defined. The Escrow
Funds, which are included in other assets at December 31, 1998, will remain with
the escrow agent until such time as those conditions are met (Note 12).
7. OTHER CURRENT LIABILITIES:
-------------------------
Other current liabilities consists of the following: December 31,
------------------------------------
1998 1997
---- ----
Accrued professional fees $ 831,545 $ 266,999
Accrued interest expense 62,097 132,739
Accrued other 851,399 83,993
---------------- ----------------
$ 1,745,041 $ 483,731
================ ================
8. LONG TERM DEBT:
--------------
Long term debt consists of the following:
December 31,
------------------------------
1998 1997
---- ----
Notes payable to sellers, net (a) $ 1,167,111 $ -
Bank note (b) 473,400 -
---------------- ---------
1,640,511 -
Less: current portion 514,121 -
---------------- ----------
$ 1,126,390 $ -
================ ========
(a) As part of the aggregate purchase price of the Acquisition (Note 3), the
Company issued $2 million in non-interest bearing promissory notes (the
"Promissory Notes") to the former shareholders of Lamar, of which
$500,000 has been paid as of December 31, 1998. The Promissory Notes are
recorded net of an unaccreted discount of $332,889, which discount
reflects a 10.5% effective interest rate. In accordance with the terms of
the Acquisition, the remaining obligation is payable on each of the
twelve, twenty-four and thirty six month anniversaries of the closing
date.
(b) In connection with the Acquisition (Note 3), the Company assumed the
outstanding obligations of Lamar which, at December 31, 1998, includes
Israeli government-guaranteed loans in the amount of $473,400, bearing
interest at 8.7% per annum. These loans are part of a $1 million
government-guaranteed credit facility approved for Lamar, which is
subject to the implementation of an investment program in accordance with
Israeli law. The approval associated with the investment program requires
certain conditions to be met, as defined. In the event Lamar fails to
meet the conditions, immediate repayment may be required. At December 31,
1998, management believes that Lamar was in compliance with those
conditions.
Scheduled maturities of long term debt are as follows:
1999 $ 514,121
2000 587,247
2001 683,064
2002 151,953
2003 20,488
Thereafter 16,527
----------------
1,973,400
Less: imputed interest on notes 332,889
current portion 514,121
----------------
Total $ 1,126,390
================
9. CONVERTIBLE DEBT:
-----------------
Convertible Notes, net
- - ----------------------
On June 10, 1998, the Company issued and sold in a private placement,
$10,753,000 aggregate principal amount of 6% Convertible Notes ("Notes") due
June 10, 2000. The Notes are convertible into shares of the Company's common
stock at a conversion price equal to the average of the two lowest closing
prices of the common stock during the thirty trading days preceding any date of
conversion, subject to a maximum conversion price of $16.125 per share. At the
option of the Company, interest is payable in the form of cash or shares of
common stock at the conversion price then in effect. The maximum number of
shares issuable upon conversion is 2,100,000 shares, and if this maximum number
of shares is issued, any remaining unconverted principal amount of the Notes
will bear interest at 17% per annum. During 1998, $9,253,000 of the Notes,
together with related accrued interest, were converted into 2,097,000 shares of
the Company's common stock. At December 31, 1998, the remaining obligation from
the Notes is recorded net of an unaccreted discount of $44,769.
Convertible Debentures, net
- - ---------------------------
On August 7, 1996, the Company issued $1,687,500 of 10% Convertible
Subordinated Debentures (the "Series C Debentures") due on February 9, 1998. The
bonds and the related accrued interest were convertible into shares of the
Company's common stock at a price of the lesser of (i) $12.075 per share (the
maximum conversion price) and (ii) the closing price, which is defined as the
last reported bid price for a given day on the exchange the Company's common
stock is listed. In no event was the conversion price to be less than $5.75 per
share (the minimum conversion price). Conversion of these Series C Debentures
into the Company's common stock could, at the holder's option, have been
effected in an amount of up to $843,750 beginning 135 days following the date of
original issuance and up to the entire original principal amount beginning 180
days following the date of original issuance through maturity. These Series C
Debentures were subordinated in right of payment to all future senior
indebtedness, as incurred by the Company. During 1997, $437,500 of the Series C
Debentures, together with the related accrued interest, were converted into the
Company's common stock. At December 31, 1997, the remaining obligation from
converted debentures is recorded net of an unaccreted discount of $56,528.
During 1998, the remainder of the debentures, together with the related accrued
interest, were converted into 238,038 shares of the Company's common stock.
10. RETIREMENT PLAN:
---------------
The Company has a defined contribution profit sharing plan that is
qualified under Section 401(k) of the Internal Revenue Code and is available to
substantially all of its employees. The Company's contributions, which serve to
match a portion of participant contributions, were $152,487, $161,203 and
$110,831 for 1998, 1997and 1996, respectively.
11. INCOME TAXES:
------------
Income tax provision (benefit) consists of the following:
Year Ended December 31,
--------------------------------------------------
1998 1997 1996
---- ---- ----
Federal:
Current $ - $ - $ -
Deferred (1,733,867) 1,213,411 (525,000)
State and Local:
Current - - -
Deferred (254,980) 285,509 (144,000)
Adjustment to valuation allowance related to net
deferred tax assets 1,988,847 (1,344,459) (553,000)
-------------- -------------- --------------
$ - $ 154,461 $ (1,222,000)
============== ============== ==============
A reconciliation between the effective rate for income taxes and the amount
computed by applying the statutory Federal income tax rate to income (loss)
before income taxes is as follows:
Year Ended December 31,
---------------------------------------------
1998 1997 1996
---- ---- ----
Tax provision (benefit) at statutory rate 34% 34% 34%
State and local taxes 5% 8% 9%
Change in valuation allowance for net deferred tax assets
(39%) (38%) 36%
----------- ----------- ---------
- 4% 79%
=========== =========== =========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax asset, net, at December 31, 1998 and 1997, are as
follows:
1998 1997
---- ----
Allowance for doubtful accounts $ 79,000 $ 22,000
Depreciation 87,000 -
Reserve for obsolescence 168,000 118,000
NOL carryforward 7,407,000 2,147,000
--------------- ---------------
7,741,000 2,287,000
Less: valuation allowance (5,934,385) (480,385)
--------------- ---------------
Deferred tax asset, net $ 1,806,615 $ 1,806,615
=============== ===============
At December 31, 1998, the Company had net operating loss and credit
carryforwards of approximately $19.0 million expiring in varying amounts
beginning in 2006 through 2011. In 1997 and 1996, management of the Company
determined that, more likely than not, a portion of its previously reserved
deferred tax assets would be realized and, accordingly, reduced the valuation
allowance. The reduction in the valuation allowance is included in the income
tax provision (benefit) in the accompanying consolidated statement of operations
for 1997 and 1996, as well as in additional paid-in capital at December 31,
1997, for the portion of those deferred tax assets ($730,000) which are related
to tax benefits associated with the exercise of stock options. The determination
that the net deferred tax asset of $1,806,615 at December 31, 1998 and 1997 is
realizable is based on the Company's expectations of future earnings. Of the
remaining fully reserved deferred tax assets of approximately $5.9 million,
approximately $4.5 million relate to tax benefits associated with the exercise
of stock options, which will not result in a tax benefit in the consolidated
statement of operations in future periods but, rather, will result in further
increases to additional paid in capital, if and when realized.
12. COMMITMENTS AND CONTINGENCIES:
-----------------------------
Letters of Credit
- - -----------------
Letters of credit are issued by the Company during the ordinary course of
business through a major domestic bank as required by certain vendor contracts.
At December 31, 1998, the Company had outstanding letters of credit of
approximately $650,000, which are fully collateralized by cash held with the
same bank.
Line of Credit
- - --------------
On September 30, 1997, the Company entered into an $8,000,000 credit
facility (the "Agreement") with a financial institution consisting of a
revolving loan based on eligible accounts receivable and inventory, as defined,
with an interest rate of the prime rate plus .75% on any amounts outstanding.
The Agreement matures on September 23, 1999 and renews on an annual basis unless
terminated by either party, as provided in the Agreement. The facility is
subject to normal banking terms and conditions, including financial covenant
compliance. At December 31, 1998, there were no outstanding borrowings under the
Agreement.
Leases
- - ------
During the first quarter of 1998, the Company sold its primary operating
facility in Long Island City, New York. The Company, as lessor for the rental of
approximately one-third of its building, realized rental income of $240,000 in
1997 and 1996. The Company's new corporate headquarters is located in Melville,
New York, leasing space for manufacturing, research and development, sales and
executive offices from an unrelated party. The current lease is for
approximately 40,000 square feet and expires in June, 2008. Rent expense under
this operating lease was approximately $145,000 in 1998. At December 31, 1998,
the minimum future lease commitments, under this lease and all other
noncancellable operating leases, are as follows:
1999 $ 532,000
2000 553,000
2001 575,000
2002 598,000
2003 622,000
Thereafter 2,660,000
Legal Proceedings
- - -----------------
On November 17, 1998, a complaint was filed against the Company in the U.S.
District Court for the Eastern District of New York by NCT Group, Inc. ("NCT";
formerly Noise Cancellation Technologies, Inc.) and NCT Hearing Products, Inc.,
one of NCT's subsidiaries. The complaint involves two of the Company's patents
relating to certain active noise reduction technology. The Company does not
currently derive significant sales or licensing revenue from this technology.
The complaint requests a declaration that the two patents are invalid and
unenforceable and that NCT's products do not infringe the patents. The complaint
alleges that the Company has engaged in unfair competition by misrepresenting
the scope of the two patents, tortuously interfering with prospective
contractual rights between NCT and its existing and potential customers, making
false and disparaging statements about NCT and its products, and falsely
advertising certain of the Company's technology. The complaint seeks to enjoin
the Company 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.
On December 30, 1998, the Company filed and served an answer to the NCT
complaint, denying the allegations and asserting affirmative defenses and
counterclaims. The affirmative defenses include that NCT failed to allege fraud
or inequitable conduct or misrepresentation with the particularity required by
Rule 9(b) of the Federal Rules of Civil Procedure, that NCT failed to state
claims upon which relief can be granted and that the statements made by the
Company were true. The counterclaims allege that NCT has infringed the two
patents, and that NCT has engaged in trademark infringement, false designation
of origin, and unfair competition with respect the Company's mark ANR READY. The
counterclaims also allege that NCT's patent infringement has been and is
willful. The counterclaims seek injunctive relief with respect to the
allegations of patent infringement, trademark infringement, false designation of
origin and unfair competition. The Company also seeks exemplary and punitive
damages, prejudgment interest on all damages, costs, reasonable attorneys' fees
and expenses.
While it is not feasible to predict or determine the final outcome of the
claims against the Company, management does not believe that they should result
in a materially adverse effect on the Company's financial position, results of
operations or liquidity.
In addition to the litigation noted above, the Company is from time to time
subject to routine litigation incidental to its business. These lawsuits
primarily involve claims for damages arising out of the use of the Company's
products and/or technologies, some of which include claims for punitive as well
as compensatory damages. The Company believes that the results of the above
noted litigation and other pending legal proceedings will not have a material
adverse effect on the Company's financial condition.
Claim Subsequent to Yearend
- - ---------------------------
In March 1999, the Company was notified about a claim with respect to
environmental matters in connection with a site where the Company has been
identified as a potential responsible party under federal and state
environmental laws and regulations. Based on a preliminary review of the
complaint, and while no assurance can be given as to the ultimate outcome of
this matter, the Company believes that the claim is without merit and intends to
vigorously defend itself.
13. STOCK PLANS:
-----------
On December 31, 1991, the Board of Directors of the Company (the "Board")
adopted the 1991 Performance Equity Plan ("1991 Plan"), which was approved by
the shareholders. The 1991 Plan authorizes the granting of awards, the exercise
of which would allow up to an aggregate of 1,000,000 shares of the Company's
common stock to be acquired by the holders of those awards. The awards can take
the form of stock options, stock appreciation rights, restricted stock, deferred
stock, stock reload options or other stock-based awards. Awards may be granted
to key employees, officers, directors and consultants. On September 12, 1994,
the Board approved an increase in the number of shares available for grant under
the 1991 Plan to 1,500,000 shares, which subsequently was approved by the
shareholders of the Company. In addition, on April 1, 1997, the Board approved
another increase in the number of shares available for grant under the 1991 Plan
to 2,000,000 shares, which was subsequently approved by the shareholders of the
Company. Stock options granted to employees and directors under the 1991 Plan
were granted for terms of up to 10 years at an exercise price equal to the
market value at the date of grant and are exercisable in whole or in part at
stated times from the date of grant up to four years from the date of grant.
On May 5, 1998, the Board adopted the 1998 Stock Option Plan ("1998 Plan"),
which was subsequently approved by the shareholders. The 1998 Plan authorizes
the granting of awards, the exercise of which would allow up to an aggregate of
2,000,000 shares of the Company's common stock to be acquired by the holders of
those awards. Similar to the 1991 Plan, the awards can take the form of stock
options, stock appreciation rights, restricted stock, deferred stock, stock
reload options or other stock-based awards. Awards may be granted to key
employees, officers, directors and consultants.
The Company accounts for equity-based awards granted to employees and
directors under APB Opinion No. 25, under which no compensation cost has been
recognized for stock options granted at market value (Note 2). Had compensation
cost for these stock options been determined consistent with SFAS No. 123, the
Company's net income (loss) and net income (loss) per share would have been
reduced to the following pro forma amounts:
Year Ended December 31,
-------------------------------------------------
1998 1997 1996
---- ---- ----
Net income (loss): As Reported $ (6,445,955) $ 3,414,396 $ (322,217)
Pro Forma (11,378,844) 1,526,874 (1,093,868)
Basic net income (loss) per share: As Reported (.61) $.42 $(.05)
Pro Forma (1.07) .19 (.16)
Diluted net income (loss) per share: As Reported (.61) $.39 $(.05)
Pro Forma (1.07) .17 (.16)
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. Option activity during 1998, 1997 and 1996 is
summarized as follows:
Year Ended December 31,
------------------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ----- -----
Outstanding at beginning of
period 1,824,750 5.57 2,200,250 3.41 2,130,000 4.12
Granted 1,637,000 11.73 720,000 6.97 445,250 5.51
Exercised (351,000) 3.49 (932,750) 3.21 (375,000) .75
Canceled (28,250) 5.44 (162,750) .68 - -
-------- ---------- ----------
Outstanding at end of period
3,082,500 9.06 1,824,750 5.57 2,200,250 3.41
========= ========= =========
Exercisable at end of year 753,500 5.45 625,500 4.68 1,442,000 1.83
========= ========== =========
Weighted average fair value of
options granted $9.55 $5.38 $4.07
===== ===== =====
The fair value of the stock options granted is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions:
1998 1997
---- ----
Expected life (years) 6.5 7.5
Risk-free interest rates 5.32% 6.87%
Volatility 96% 74%
Dividend yield 0% 0%
The following table summarizes information about stock options outstanding
at December 31, 1998:
Options Outstanding Options Exercisable
---------------------------------------------------- -------------------------------
Number Weighted Weighted Number Weighted
Outstanding Average Average Exercisable Average
at December Remaining Exercise at December Exercise
Range of Exercise Prices 31, 1998 Contractual Life Price 31, 1998 Price
------------------------ -------- ---------------- ----- -------- -----
$ 0.68 to $ 1.02 173,500 3.49 $0.68 173,500 0.68
1.03 to 3.51 - - - - -
3.52 to 5.29 41,500 7.58 5.00 17,000 5.00
5.30 to 7.94 1,009,000 7.46 5.59 416,500 5.78
7.95 to 11.93 893,500 9.42 8.87 121,500 8.85
11.94 to 17.91 965,000 9.29 14.54 25,000 16.75
----------- ----------- -------- ---------- ---------
.68 to 17.91 3,082,500 8.38 9.06 753,500 5.45
=========== =========== ========= =========== =========
Warrants
- - --------
In connection with an overseas equity offering in 1994, the Company issued
5 year warrants to purchase 47,500 shares of common stock at prices of $4.92 to
$5.49 per share. During 1997, 5,000 of these warrants were exercised into an
equivalent number of common shares. During 1996, 50% of the original number of
warrants were converted into an equal number of options at an equivalent value.
As of December 31, 1998, all of these 23,750 options are exercisable, and will
expire on July 30, 2006. As of December 31, 1998, all of the remaining 18,750
warrants are exercisable and will expire on June 15, 1999.
14. SEGMENT INFORMATION:
-------------------
Effective December 31, 1998, the Company adopted SFAS No. 131,"Disclosures
about Segments of an Enterprise and Related Information." Reportable operating
segments are determined based on the Company's management approach. The
management approach, as defined by SFAS No. 131, is based on the way that the
chief operating decision-maker organizes the segments within an enterprise for
making operating decisions and assessing performance. While the Company's
results of operations are primarily reviewed on a consolidated basis, the chief
operating decision-maker also manages the enterprise in two segments: (i) Andrea
Anti-Noise Products and (ii) military intercom products (Traditional Military
Products). The following represents selected consolidated financial information
for the Company's segments for the years ended December 31, 1998, 1997 and 1996:
Traditional
Andrea Anti- Military
Segment Data Noise Products Products Total 1998
------------ -------------- -------- ----------
Net Sales $ 17,266,874 $ 4,037,696 $ 21,304,570
Income (loss) from operations (8,418,844) 524,900 (7,893,944)
Depreciation 1,096,229 93,683 1,189,912
Traditional
Andrea Anti- Military
Noise Products Products Total 1997
Net Sales $ 22,404,069 $ 4,025,735 $ 26,429,804
Income from operations 2,968,647 523,346 3,491,993
Depreciation 257,727 64,772 322,499
Traditional
Andrea Anti- Military
Noise Products Products Total 1996
Net Sales $ 5,403,299 $ 3,840,810 $ 9,244,109
Income (loss) from operations (2,029,689) 499,305 (1,530,384)
Depreciation 251,189 102,119 353,308
Management of the Company assesses assets on a consolidated basis only, and
the Company has not restated any other prior period information, as it would be
impracticable. For the years ended December 31, 1998, 1997 and 1996, and as of
each respective yearend, sales and accounts receivable by geographic area are as
follows:
Geographic Data 1998 1997 1996
--------------- ---- ---- ----
Sales:
United States $ 14,720,470 $ 14,949,334 $ 7,109,180
Europe 3,723,609 8,129,621 1,653,612
Other foreign 2,860,491 3,350,849 481,317
---------------- ---------------- ----------------
$ 21,304,570 $ 26,429,804 $ 9,244,109
=============== =============== ===============
Accounts receivable:
United States $ 3,264,958 $ 2,749,591 $ 1,877,170
Europe 898,428 1,400,144 535,139
Other foreign 704,396 418,698 266,140
---------------- ---------------- ----------------
$ 4,867,782 $ 4,568,433 $ 2,678,449
=============== =============== ===============
INDEX TO FINANCIAL STATEMENT SCHEDULE
Report of Independent Public Accountants on Schedule S - 1
Schedule II - Valuation and Qualifying Accounts S - 2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
----------------------------------------------------
To Andrea Electronics Corporation:
We have audited, in accordance with generally accepted auditing standards,
the financial statements of Andrea Electronics Corporation included in this
filing and have issued our report thereon dated January 26, 1999 (except with
respect to the matter discussed in the last paragraph of Note 12, as to which
the date is March 29, 1999). Our audit was made for the purpose of forming an
opinion on the basic financial statements taken as a whole. The schedule of
valuation and qualifying accounts is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in our audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
Melville, New York
January 26, 1999
ANDREA ELECTRONICS CORPORATION
------------------------------
SCHEDULE II
-----------
VALUATION AND QUALIFYING ACCOUNTS
---------------------------------
Charged to Charged to
Balance at Costs and Other Balance at
1998 January 1 Expenses Accounts Deductions December 31
---- --------- -------- -------- ---------- -----------
Allowance for doubtful
accounts $ 52,521 $ 150,000 $ - $ - $ 202,521
========== ========== ========= ======== ============
1997
Allowance for doubtful
accounts $ 52,521 $ - $ - $ - $ 52,521
========= ========== ========= ======== ==========
1996
Allowance for doubtful
Accounts $ 32,183 $ 51,483 $ - $ 31,145 $ 52,521
========= ========== ========= ======== ============
SIGNATURES
In accordance with the requirements of the Section 13 and 15(d) of the
Exchange Act, the Registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
ANDREA ELECTRONICS CORPORATION
By: /s/ John N. Andrea
------------------------------------
Date: March 31, 1999 John N. Andrea
Co-Chairman of the Board
and Co-Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant and in the capabilities and on
the dates indicated.
/s/ Frank A.D. Andrea, Jr. Chairman Emeritus March 31, 1999
- - --------------------------- and Director
Frank A.D. Andrea, Jr.
/s/ John N. Andrea Co-Chairman, March 31, 1999
- - --------------------------- Co-Chief Executive Officer
John N. Andrea and Director
/s/ Douglas J. Andrea Co-Chairman, March 31, 1999
- - --------------------------- Co-Chief Executive Officer
Douglas J. Andrea and Director
/s/ Christopher P. Sauvigne President and March 31, 1999
- - --------------------------- Chief Operating Officer
Christopher P. Sauvigne
/s/ Patrick D. Pilch Executive Vice President, March 31, 1999
- - --------------------------- Chief Financial Officer
Patrick D. Pilch and Director
/s/ Richard A. Maue Vice President, Controller, March 31, 1999
- - --------------------------- Treasurer and Corporate
Richard A. Maue Secretary
/s/ Frank A.D. Andrea, Jr. Director March 31, 1999
- - ---------------------------
Frank A.D. Andrea, Jr.
/s/ Christopher Dorney Director March 31, 1999
- - ---------------------------
Christopher Dorney
/s/ Gary A. Jones Director March 31, 1999
- - ---------------------------
Gary A. Jones
/s/ Scott Koondel Director March 31, 1999
- - ---------------------------
Scott Koondel
/s/ Paul M. Morris Director March 31, 1999
- - ---------------------------
Paul M. Morris
/s/ Jack Lahav Director March 31, 1999
- - ---------------------------
Jack Lahav
INDEX TO EXHIBITS
Exhibit
Number Description
- - ------------------
3.1 Amended and Restated Certificate of Incorporation of Registrant
(incorporated by reference to Exhibit 3.1 of the Registrant's Form 10-K
for the year ended December 31, 1992)
3.2 Certificate of Amendment of the Restated Certificate of Incorporation
of Registrant (incorporated by reference to Exhibit 3.2 of the
Registrant's Form 10-K for the year ended December 31, 1997)
3.3 Certificate of Amendment of the Restated Certificate of Incorporation
of Registrant (incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed November 30, 1998)
3.4 Amended By-Laws of Registrant (incorporated by reference to Exhibit 3.2
of the Registrant's Current Report on Form 8-K filed November 30, 1998)
4.1 Securities Purchase Agreement, dated as of December 22, 1995, relating
to the sale of the Registrant's 15% Convertible Subordinated Debentures
due 1997 (with form of Debenture attached thereto) (incorporated by
reference to Exhibit 4.1 of the Registrant's Form 10-K for the year
ended December 31, 1995)
4.2 Registration Rights Agreement, dated as of December 22, 1995, relating
to registration rights granted to the holders of the Registrant's 15%
Convertible Subordinated Debentures due 1997 (incorporated by reference
to Exhibit 4.2 of the Registrant's Form 10-K for the year ended
December 31, 1995)
4.3 Securities Purchase Agreement, dated as of April 16, 1996, relating to
the sale of the Registrant's 15% Convertible Subordinated Debentures
due October 16, 1997 (with forms of Debenture and Registration Rights
Agreement attached thereto) (incorporated by reference to Exhibit 4.1
of the Registrant's Form 10-Q for the Six Months ended June 30, 1996)
4.4 Securities Purchase Agreement, dated as of August 7, 1996, relating to
the sale of the Registrant's 10% Convertible Subordinated Debentures
due February 9, 1998 (with forms of Debenture and Registration Rights
Agreement attached thereto) (incorporated by reference to Exhibit 4.1
of the Registrant's Form 10-Q for the Nine Months ended September 30,
1996)
4.5 Securities Purchase Agreement, dated as of June 10, 1998, relating to
the sale of the Registrant's 6% Convertible Notes due June 10, 2000
(with forms of Note and Registration Rights Agreement attached thereto)
(incorporated by reference To Exhibit 4.1 of the Registrant's Form S-3,
File No. 333-61115)
10.1 1991 Performance Equity Plan, as amended (incorporated by
reference to Exhibit 4 of Registrant's Registration Statement
on Form S-8, No. 333-45421, filed February 2, 1998)
10.2 1998 Stock Plan
10.3* Procurement Agreement, dated June 16, 1995, by and between
International Business Machines Corporation and the Registrant
(incorporated by reference to Exhibit 10.1 of the Registrant's Form
10-Q for the Three Months ended June 30, 1995)
10.4* Memorandum of Agreement, dated as of September 14, 1993, by and between
Grumman Aerospace Corporation and the Registrant (incorporated by
reference to Exhibit 10.3 of the Registrant's Form 10-K for the year
ended December 31, 1995)
10.5* License and Technical Support Agreement, dated as of October 3, 1995,
by and between BellSouth Products, Inc. and the Registrant
(incorporated by reference to Exhibit 10.4 of the Registrant's Form
10-K for the year ended December 31, 1995)
10.6* Software License Bundling Agreement, dated as of March 29, 1996, by and
between Voxware, Inc., and the Registrant
(incorporated by reference to Exhibit 10.1 of the Registrant's
Form 10-Q for the Six Months ended June 30, 1996)
10.7 Employment Agreement, dated as of January 1, 1998, by and between John
N. Andrea and the Registrant (incorporated by reference to Exhibit 10.6
of the Registrant's Form 10-K for the year ended December 31, 1998)
10.8 Employment Agreement, dated as of January 1, 1998, by and between
Douglas J. Andrea and the Registrant (incorporated by reference to
Exhibit 10.7 of the Registrant's Form 10-K for the year ended December
31, 1998)
10.9 Employment Agreement, dated as of January 1, 1998, by and between
Patrick D. Pilch and the Registrant (incorporated by reference to
Exhibit 10.8 of the Registrant's Form 10-K for the year ended December
31, 1998)
10.10 Employment Agreement, dated as of November 20, 1998, by and between
Christopher P. Sauvigne and the Registrant (incorporated by reference
to Exhibit 10.1 of the Registrant's Current Report on Form 8-K filed
November 30, 1998)
10.11* Direct Sales and License Agreement, dated as of October 13, 1997, by
and between Lernout & Hauspie Speech Products and the Registrant
(incorporated by reference to Exhibit 10.8 of the Registrant's Form
10-K for the year ended December 31, 1998)
10.12* Production Procurement Agreement, dated as of June 11, 1997, by and
between International Business Machines Corporation and the Registrant
(incorporated by reference to Exhibit 10.9 of the Registrant's Form
10-K for the year ended December 31, 1998)
10.13 Revolving Loan and Security Agreement, dated as of September 23, 1997,
by and between IBM Credit Corporation and the Registrant
10.14 Stock Purchase Agreement, dated April 6, 1998, as amended by Amendment
No. 1 thereto dated May 5, 1998, relating to the purchase of the shares
of Lamar Signal Processing, Ltd. (including form of Registration Rights
Agreement)(incorporated by reference to Exhibits 2.1 and 2.2 of the
Registrant's Current Report on Form 8-K filed May 8, 1998)
10.15** Procurement Agreement, dated as of January 13, 1999, by and between the
Registrant and Microsoft Corporation
10.16** Purchase Agreement, dated as of February 25, 1999, by and between the
Company and Clarion Corporation of America
10.17** Source Code License Agreement, dated as of October 29, 1998, between
the Company and Intel Corporation
21 Subsidiaries of Registrant
22 Consent of Independent Public Accountants
27 Financial Data Schedule
- - ---------------
* Certain portions of this Agreement have been accorded
confidential treatment.
** Confidential treatment has been requested for certain portions
of this Agreement.