<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1998
OR
( ) TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to__________
Commission file number 1-4324
ANDREA ELECTRONICS CORPORATION
(Exact name of registrant as specified in its charter)
New York 11-0482020
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11-40 45th Road, Long Island City, New York 11101
(Address of principal executive offices) (Zip Code)
1-800-442-7787
(Registrant's telephone number, Including area code)
Indicate by check mark whether the registrant: (1) filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12
months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date. 11,124,175.
<PAGE> 2
Item 1 - FINANCIAL STATEMENTS
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1998 1997
------------ -----------
(unaudited) (audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 9,341,861 $ 2,059,338
Marketable securities 646,039 102,717
Accounts receivable, net 4,153,282 4,568,433
Inventories, net 8,116,532 5,766,927
Deferred income taxes 473,000 909,569
Prepaid expenses and other
current assets 1,437,287 1,023,661
---------- ----------
Total current asset s 24,168,001 14,430,645
PROPERTY, PLANT AND EQUIPMENT, net 1,250,088 1,022,342
DEFERRED INCOME TAXES 1,004,572 897,046
OTHER ASSETS 2,014,131 1,439,151
INTANGIBLE 27,305,563 -
---------- ----------
Total assets $55,742,355 $17,789,184
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 1,502,363 $ 966,783
Current portion of long term debt 93,440 -
Convertible notes - current portion - 1,193,472
Other current liabilities 1,854,466 483,731
---------- ----------
Total current liabilities 3,450,269 2,643,986
CONVERTIBLE NOTES 10,018,825 -
LONG TERM DEBT 2,703,188 -
OTHER LIABILITIES 38,500
---------- ----------
Total liabilities 16,172,282 2,682,486
---------- ----------
SHAREHOLDERS' EQUITY:
Common stock, $.50 par value;
authorized: 15,000,000 shares;
issued and outstanding: 11,105,730
and 8,706,692 shares, respectively 5,552,865 4,353,346
Additional paid-in capital 34,595,924 9,881,915
Retained earnings (accumulated
deficit) (578,716) 871,437
---------- ----------
Total shareholders' equity $39,570,073 15,106,698
---------- ----------
Total liabilities and
shareholders' equity $55,742,355 $17,789,184
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
Page 2
<PAGE> 3
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
For the For the
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
SALES $ 4,370,358 $ 6,080,875 $ 8,845,428 $ 11,465,144
COST OF SALES 2,753,932 3,579,233 5,574,154 6,775,141
------------ ------------ ----------- ------------
Gross Profit 1,616,426 2,501,642 3,271,274 4,690,003
RESEARCH AND DEVELOPMENT EXPENSES 582,646 88,809 990,098 241,633
GENERAL, ADMINISTRATIVE AND
SELLING EXPENSES 2,897,114 1,546,168 5,290,448 2,799,242
------------ ------------ ----------- -----------
Income (loss) from operations (1,863,334) 866,665 (3,009,272) 1,649,128
OTHER INCOME (EXPENSE)
Interest income 62,671 22,236 73,315 41,284
Interest expense (85,664) (60,380) (110,119) (126,907)
Rent and miscellaneous income - 58,033 1,924,966 115,783
------------ ------------ ----------- -----------
(22,993) 19,889 1,888,162 30,160
------------ ------------ ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (1,886,327) 886,554 (1,121,110) 1,679,288
PROVISION FOR INCOME TAXES - (208,518) (329,043) (394,811)
------------ ------------ ----------- -----------
NET INCOME (LOSS) $ (1,886,327) $ 678,036 $ (1,450,153) $ 1,284,477
============ ============ =========== ===========
PER SHARE INFORMATION:
Net Income (loss) Per Share
Basic $ .18) $ .08 $ (.15) $ .16
========== ============ ========== ===========
Diluted $ (.18) $ .08 $ (.15) $ .16
========== ============ ========== ===========
Shares used in computing
net income (loss) per share:
Basic 10,339,488 8,060,350 9,641,748 7,880,040
============ ============ ========== ==========
Diluted 10,339,488 8,285,350 9,641,748 8,105,040
============ ============ =========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
Page 3
<PAGE> 4
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
Retained
Additional Earnings/ Total
Shares Common Paid-In (Accumulated Shareholders'
Outstanding Stock Capital Deficit) Equity
<S> <C> <C> <C> <C> <C>
------------ ------------- ------------- ------------- ------------
BALANCE,
December 31, 1997 8,706,692 $ 4,353,346 $ 9,881,915 $ 871,437 $15,106,698
Exercise of stock
options, net of
related costs 343,000 171,500 915,541 - 1,087,041
Issuance of common stock
for acquisition, net of
related costs 1,818,000 909,000 22,519,781 - 23,428,781
Conversion of Convertible
Debentures 238,038 119,019 1,278,687 - 1,397,706
Net Income - - - (1,450,153) (1,450,153)
---------- ----------- ----------- ----------- ----------
BALANCE, June 30, 1998
11,105,730 $ 5,552,865 $34,595,924 $ (578,716) $39,570,073
========== =========== =========== =========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
Page 4
<PAGE> 5
<TABLE>
ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<CAPTION>
For the Six Months Ended
June 30,
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(1,450,153) $ 1,284,477
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,095,693 155,304
Gain on sale of building (1,864,767)
Deferred income taxes 329,043 385,735
Non-cash interest on convertible debt 32,259 126,907
Changes in assets and liabilities, excluding effects of acquisition:
Accounts receivable 436,368 (1,580,969)
Inventories (2,320,982) (82,322)
Prepaid expenses and other current assets (982,470) (189,157)
Other assets (574,980) -
Trade accounts payable 434,643 423,250
Other current and long term liabilities 318,795 (63,369)
---------- -----------
Net cash provided by (used in) operating activities (4,546,551) 459,856
---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net (715,720) (59,331)
Proceeds from sale of building 2,282,563
Maturities (Purchases) of investment securities (543,322) 100,666
Acquisition of business, net of cash acquired (947,276) -
---------- -----------
Net cash provided by investing activities 76,245 41,335
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from convertible debentures 10,000,000 -
Long term debt proceeds 665,788 -
Exercise of stock options 1,087,041 312,938
---------- -----------
Net cash provided by financing activities 11,752,829 312,938
---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,282,523 814,129
---------- -----------
CASH AND CASH EQUIVALENTS - beginning of period 2,059,338 921,065
---------- -----------
CASH AND CASH EQUIVALENTS - end of period $ 9,341,861 $ 1,735,194
========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Conversion of debt into common stock $ 1,397,706 $ 434,636
Issuance of notes payable for acquisition $ 1,564,000 -
Issuance of Common Stock for acquisition $23,428,781 -
</TABLE>
See Notes to Consolidated Financial Statements
Page 5
<PAGE> 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. BASIS OF PRESENTATION. The accompanying consolidated financial statements
include the accounts of the Company and its subsidiaries (collectively, "Andrea
Electronics" or the "Company"). All intercompany balances and transactions
have been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. The
results of operations for any interim period are not necessarily indicative of
the results to be expected for the fiscal year. For further information, refer
to the consolidated financial statements and accompanying footnotes included in
the Company's annual report on Form 10-K for the year ended December 31, 1997.
II. 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.
III. EARNINGS PER COMMON SHARE. Effective December 31, 1997, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share". Basic net income per common share ("Basic EPS") is computed by
dividing net income by the weighted average number of common shares
outstanding.
Diluted net income per common share ("Diluted EPS") is computed by dividing
net income by the weighted average number of common shares and dilutive common
share equivalents and convertible securities then outstanding. SFAS No. 128
requires the presentation of both Basic EPS and Diluted EPS on the face of the
consolidated statements of operations. 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 three months ended June 30, 1998
and 1997:
<TABLE>
<CAPTION>
Net Income Net Income (Loss)
(Loss) Shares Per Share
<S> <C> <C> <C>
1998
Net loss $(1,886,327) 10,339,488 Basic $ (.18)
Effect of dilutive employee stock options - - -
---------- --------
10,339,488 Diluted $ (.18)
========== ========
1997
Net Income $ 678,036 8,060,350 Basic $ .08
Effect of dilutive employee stock options 225,000 -
---------- --------
8,285,350 Diluted $ .08
========== ========
</TABLE>
Page 6
<PAGE> 7
IV. 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 form
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 nonowner changes in equity (or other comprehensive
income) such as unrealized gains/losses on securities available-for-sale,
foreign currency translation adjustments and minimum pension liability
adjustments. Comprehensive and other comprehensive income must be reported on
the face of the annual financial statements or in the case of interim
reporting, in the footnotes to the financial statements. For 1997, and for
the quarters ended June 30, 1998 and 1997, the Company's operations did not
give rise to items includible in comprehensive income which were not already
included in net income (loss). Therefore, the Company's comprehensive income
(loss) is the same as its net income (loss) for all periods presented.
V. DERIVATIVES. In June 1998, the Financial Accounting Standards Board issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities".
The 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 therefore this new pronouncement is not applicable.
VI. DEBT FINANCING. On September 23, 1997, the Company entered into an $8
million credit facility with a financial institution consisting of a revolving
loan based on eligible accounts receivable and inventory, as defined. The
facility, together with the Company's availability under commercial letters of
credit, approximates $10 million. The agreement matures on September 23, 1998
and automatically 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 and, at June 30, 1998,
there was approximately $665 thousand outstanding under the agreement.
VII. PROCUREMENT AGREEMENT. In August 1997, the Company entered into an
agreement with International Business Machines Corporation and its subsidiaries
("IBM") to produce and procure certain products, as defined. The agreement
replaces all previous agreements with IBM and will continue in full force and
effect unless terminated earlier for material breach by either party, as
defined. During the three months ended June 30, 1998, sales of the Company's
computer headsets to IBM and certain of IBM's affiliates, distributors,
licensees, and integrators accounted for approximately 50% of the Company's
total net sales.
VIII. CONVERTIBLE NOTES. 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 will be convertible into shares
of the Company's common stock at a conversion price equal to the average of
the two lowest closing bid prices of the Common Stock during the 30 trading
days preceding any date of conversion, subject to a maximum conversion price
of $16.125 per share. The Notes become convertible on the earlier of
October 8, 1998 and the effectiveness of a registration statement under the
Securities Act of 1933, as amended, covering the sale of the shares of Common
Stock into which the Notes are convertible, which registration statement the
Company filed on August 10, 1998. 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. The Company will use 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.
IX. ACQUISITION. On May 5, 1998, the Company acquired all of the outstanding
shares of capital stock of Lamar Signal Processing, Ltd. ("Lamar"), an Israeli
corporation engaged in the development of digital signal processing (DSP) noise
cancellation microphone solutions for voice-driven interfaces covering a wide
range of audio and acoustic applications. The consideration paid by the Company
for the acquisition of Lamar was 1,800,000 shares of restricted common stock
and $3,000,000. Of the 1,800,000 shares, 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 with the remainder payable in four equal installments on
each of the sixth, twelfth, twenty-four and thirty-six month anniversaries of
the closing. 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 resulted in goodwill of approximately $27.6 million, which is
included in intangible assets in the accompanying consolidated balance sheet
and is being amortized over a 15-year period.
The pro forma results listed below reflect purchase price accounting
adjustments, consisting primarily of amortization of goodwill using a 15-year
amortization period and interest expense on the discounted value of the $2
million in notes payable, 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 herein:
Page 8
<PAGE> 9
<TABLE>
1997 1998
<S> <C> <C>
Net Income (loss) $ 502,821 $(1,819,482)
Net Income (loss) per share:
Basic $ .05 $ (.17)
Diluted $ .05 $ (.17)
</TABLE>
X. RECLASSIFICATIONS. Certain prior year amounts have been reclassified to
conform to the current year presentation.
Page 9
<PAGE> 10
Item 2. 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-activated, natural language-driven,
"human/machine interface" markets that are rapidly emerging from the conver-
gence of the telecommunications and computer industries, and for the defense
electronics markets that are requiring increasingly higher quality voice
communication products. The Company's strategy for serving these markets is to
leverage its expertise in audio communications technology, including its
patented Andrea Anti-Noise Active Noise Cancellation ("ANC") and Andrea
AntiNoise Active Noise Reduction ("ANR") technologies, and to continue
developing, manufacturing and marketing a line of Andrea Anti-Noise headsets,
handsets and other communication devices to cost-effectively enhance voice
communications for end users of the growing number of new, voice-based computer
and computer telephony applications and interfaces. In addition, to extend the
Company's position in technology enhancing communications, the Company has be-
gun to develop its Andrea DSP/Trademark/ products based on digital signal pro-
cessing (DSP) technology. In order to complement internal efforts
surrounding DSP development, on May 5, 1998, the Company acquired all of the
outstanding shares of capital stock of Lamar Signal Processing, Ltd. ("Lamar"),
an Israeli corporation engaged in the development of digital signal processing
(DSP) noise cancellation microphone solutions for voice-driven interfaces
covering a wide range of audio and acoustic applications.
Examples of the applications and interfaces for which Andrea Anti-Noise
products provide benefit 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 indus-
trial communications; and other applications and interfaces that incorporate
natural language processing. The Company believes 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.
An important element of the Company's strategy for expanding the channels of
distribution and broadening the base of users for its products is its set of
collaborative arrangements with software publishers, distributors and retailers
actively engaged in the various markets in which the Company's products have
application, and with hardware OEMs. Under some of these arrangements, the
Company supplies its products for sale by the collaborative partners. Under
others, the collaborative partners supply the Company with software that the
Company includes with its products. In addition, the Company is also seeking
to increase its own direct marketing efforts.
Page 10
<PAGE> 11
The Company outsources the manufacturing of Andrea Anti-Noise products for its
OEM, consumer and commercial customers. The Company also manufactures and
distributes intercom systems and related components for military applications
and industrial applications ("Traditional Military Products"). In contrast to
the outsourced manufacturing of its Andrea Anti-Noise products for the non-
military markets, the Company continues to manufacture its Traditional Military
Products in its own facility. To the extent that the Company succeeds in
developing a new line of products for military use that incorporate ANC and ANR
technology, management anticipates that it will manufacture these new military
products through both outsourcing and self-manufacturing.
The interim results of operations of the Company presented in this report are
not necessarily indicative of the actual sales or results of operations to be
realized for the full year.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this Prospectus or in the information
incorporated by reference herein may constitute forward-looking statements
within the meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act. The words "anticipates," "believes", "estimates," "expects",
"intends," "plans," "seeks," variations of such words, and similar expressions
are intended to identify forward-looking statements. Such forward-looking
statements are based on current expectations, estimates and projections about
the Company's business and industry, management's beliefs and certain
assumptions made by the Company's management. Investors are cautioned that
matters subject to forward-looking statements involve risks and uncertainties
including economic, competitive, governmental, technological and other factors
which may affect the Company's 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. The Company
cautions prospective investors about the following significant factors, which,
among others, have in some cases affected the Company's actual
results and are in the future likely to affect the Company's
actual results and could cause them to differ materially from those
expressed in any such forward-looking statements: the rate at which
the Company's Anti-Noise technology is accepted by the diverse range of users
and applications within the global communications and informatics marketplace;
the ability of the Company to maintain a competitive position for its Andrea
Anti-Noise products in terms of technical specifications, quality, price,
reliability and service and to develop similarly competitive Andrea DSP
(digital signal processing) products, which will require the Company to have
sufficient funds for research and development, marketing and general and
administrative expenses; the ongoing ability of the Company to enter into
and maintain collaborative relationships with larger companies in the fields
of telecommunications, computer manufacturing, software design and publishing,
Internet and online services, defense-related manufacturers and system
providers, and retail and direct marketing distributors; and in the event that
the Company experiences continued significant growth in demand for Andrea Anti-
Noise products, the ability of the Company to raise sufficient external capital
to fund the working capital requirements for meeting such demand. The failure
of the Company to surmount the challenges posed by any one or more of these
factors could have a material adverse effect on the Company's business, results
of operations and financial condition.
Page 11
<PAGE> 12
RESULTS OF OPERATIONS
Sales
Sales for the three months ended June 30, 1998 (the "1998 Second Quarter") were
$4,370,358, a decrease of 28% over the three months ended June 30, 1997 (the
"1997 Second Quarter"). Sales for the 1998 First Half were $8,845,428, a
decrease of 23% over the six months ended June 30, 1997 (the "1997 First
Half"). These decreases in sales over both the three month and six month
periods primarily reflect a shift in product mix to lower-priced and
lower-margin products to original equipment manufacturers (OEMs).
In terms of sales on a per unit basis, the Company realized a 17%
increase over the 1997 Second Quarter, offset by the aforementioned
shift in product mix, reflecting an approximately 45% decrease in
per unit sales prices for the same period. The decrease in sales
during the 1998 Second Quarter reflected an approximate 30% decrease
in sales of Andrea Anti-Noise products to $3,366,948, or 77% of
total sales, and an approximate 20% decrease in sales of the
Company's Traditional Military Products, to $1,003,410,
or 23% of total sales. The decrease in sales during the 1998 First Half
reflected an approximate 25% decrease in sales of Andrea Anti-Noise products
to $6,881,601 or 78% of total sales, and an approximate 15% decrease in
sales of the Company's Traditional Military Products to $1,963,827 or 22% of
total sales. During the 1998 First Half, sales of the Company's computer
headsets to IBM and certain of IBM's affiliates, distributors, licensees, and
integrators accounted for approximately 49% of the Company's total sales.
Management believes that the general slowing of growth rates in PC
sales during the first half of 1998 contributed to the weaker demand
for the Company's products. In addition, specific to retail
efforts, unexpected increases in investments in both time and
money have been required to not only penetrate, but also to
maintain a positive sell-through position of the Company's microphone
technologies. Management expects, however, that the Company will continue
increasing its presence among the top office/computer superstores throughout
1998. Since the fourth quarter of 1997, the Company has established product
presence in five of its targeted superstores including CompUSA, Staples,
Computer City and most recently, OfficeMax. During the First Half of 1998,
total retail sales approximated 7% of Andrea Anti-Noise products. Retail sales
during the First Half of 1997 were nominal.
Cost of Sales
Cost of sales as a percentage of sales for the 1998 Second Quarter and the 1998
First Half increased to 63% from 59% the 1997 Second Quarter and 1997 First
Half. The increase in cost of sales related to product sales during the 1998
Second Quarter is primarily a result of the shift in product mix described
above under "Sales".
Research and Development
Research and development expenses increased to $582,646 for the 1998 Second
Quarter from $88,809 for the 1998 First Quarter. These increases are primarily
a result of the Company's continuing efforts on developing its digital signal
processing technology, coupled with efforts in computer/telephony headset
technologies, which efforts are anticipated to result in nine new
computer/telephony products by the end of 1998. In addition, the second
quarter of 1998 marked the first full quarter of research and
development activities at the recently established, wholly-owned
subsidiary, Andrea Digital Technologies ("ADT") based in Utah.
Research efforts at ADT are primarily focused on the pursuit of
commercializing a natural language-driven human/machine interface by
developing an optimal far-field microphone solution for various voice-driven
interfaces, incorporating the Company's DSDA technology obtained through the
recent acquisition of Lamar Signal Processing, Ltd. ("Lamar") in early May of
this year. Correspondingly, the activities of Lamar since the date of
acquisition provided for approximately 10% of the total research and
development expenses for the second quarter of 1998. Based in Haifa, Israel,
Lamar reinforces the Company's position in digital signal processing by
broadening the Company's exposure to other industries including the consumer
electronics and professional audio markets, among others. Considering all of
the foregoing, through the 1998 First Half, total research and development
expenses approximate 90% of the entire research and development expense for
fiscal 1997. Management anticipates additional sequential quarterly
increases in research and development spending as 1998 progresses.
General, Administrative and Selling Expenses
General, administrative and selling expenses increased 87% to $2,897,114 for the
1998 Second Quarter from $1,546,168 for the 1997 Second Quarter. General,
administrative and selling expenses increased 89% to $5,290,448 for the 1998
First Half from $2,799,242 for the 1997 First Half. These increases, primarily
attributable to the ANC/ANR product lines and the recent acquisition of Lamar,
reflect significant increased business development expenses relating to existing
and prospective collaborative arrangements with hardware OEMs, software
publishers and developers, distributors and retailers. The Company 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 for the
1998 Second Quarter is goodwill amortization of approximately $300,000 related
to the acquisition of Lamar.
Other Income (Expense)
Other income for the 1998 First Half was $1,888,162 compared to other income of
$30,160 for the 1997 First Half. This change is primarily attributable to the
net gain on the sale of the Company's corporate headquarters during the 1998
First Half of $1,864,767.
Page 12
<PAGE> 13
Provision for Income Taxes
The provision for income taxes of $208,518 in the 1997 Second Quarter
represented an effective tax rate of 23.5%, which is comprised of tax expense at
the Company's combined statutory rate of approximately 42%, partially offset by
a reduction in the Company's reserve on previously-generated, fully-reserved
deferred income tax assets. No additional income tax provision or benefit was
recorded in the 1998 Second Quarter, as the Company did not generate taxable
income (the year-to-date provision relates principally to the sale of the
Company's building during the 1998 First Quarter). The Company will be
continually re-assessing its reserves on deferred income tax assets as 1998
progresses. The realization of most of the remaining reserved deferred tax
assets (excluding those generated and fully reserved in the 1998 Second
Quarter), 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.
Net Income (Loss)
Net loss for the 1998 Second Quarter was $1,886,327, compared to net income of
$678,036 for the 1997 Second Quarter. Net loss for the 1998 First Half was
$1,450,153, compared to net income of $1,284,477 for the 1997 First Half. The
levels of net loss for the 1998 Second Quarter and 1998 First Half principally
reflect the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of funds have historically been, and are
expected to continue to be, cash flow from operations and borrowings provided by
certain financial institutions. At June 30, 1998, the Company had cash and cash
equivalents of $9,341,861 compared with $2,059,338 at December 31, 1997. The
significant increase since December 31, 1997 is primarily a result of the
Company's issuance and sale in a private placement, of $10,753,000 aggregate
principal amount of 6% Convertible Notes. The Company will use 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 $3,000,000 cash
consideration to be paid by the Company, $1,000,000 was paid on May 5, 1998, the
closing date, with the remainder payable in four equal installments on each of
the six, twelve, twenty-four and thirty-six month anniversaries of the closing.
Working capital at June 30, 1998 was $20,717,732 compared to $11,786,659 at
December 31, 1997. The increase in working capital reflects an increase in total
current assets of $9,737,356, offset by an increase in total current liabilities
of $806,283. The increase in total current assets reflects an increase in cash
of $7,282,523, an increase in marketable securities of $543,322, a decrease in
accounts receivable of $415,151, an increase in inventory of $2,349,605, a
decrease in deferred income taxes of $436,569 and an increase of $413,626 in
prepaid expenses and other current assets. The increase in current liabilities
reflects a $535,580 increase in trade accounts payable, an increase in the
current portion of long term debt of $98,440 (representing debt assumed as a
result of the acquisition of Lamar), a $1,193,472 decrease in convertible
debentures (which were converted to equity during the 1998 First Quarter) and a
$1,370,735 increase in other current liabilities.
The increase in cash of $7,282,523 reflects $4,546,551 of net cash used in
operating activities, $76,245 of net cash provided by investing activities and
$11,752,829 of cash provided by financing activities. The cash used in operating
activities, excluding non-cash charges, is primarily attributable to the
$1,450,153 operating loss in the 1998 First Half, coupled with an increase in
inventory of the Company's Anti-Noise computer headsets in anticipation of
future sales. Other contributing factors include increases in prepaid expenses
and other assets. The cash provided by investing activities is primarily
attributable to the sale of the Company's 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 include increases in
capital expenditures consisting of the ongoing upgrade of manufacturing dies and
molds for Andrea Anti-noise products, investments in the Company's existing
Page 13
<PAGE> 14
information systems and investments in marketable securities. In connection with
the sale of the Company's primary operating facility, relocation is anticipated
to occur during the third quarter of 1998, and the lease expense associated with
the new facility is anticipated to range between $450,000 to $550,000 per year.
The net cash provided by financing activities resulted from the issuance and
sale of convertible notes, drawdowns on the Company's revolving credit facility
and the exercise of employee stock options.
The decrease in accounts receivable primarily reflects the decrease in sales
during the 1998 First Half coupled with more aggressive collection procedures.
Generally, the Company collects receivables from sales within three months.
The increase in prepaid expenses and other current assets primarily includes the
recognition of increased premiums for prepaid property taxes and insurance,
increased fulfillment costs associated with expansion efforts as well as
increases in other service costs related to the second half of 1998. The
increase in other assets represents increases in patent and trademark costs
associated with the Company's proprietary technology, as well as the
establishment of an escrow account in connection with the sale of the Company's
primary operating facility.
The increase in trade accounts payable and other current liabilities 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 and recently acquired
DSDA technology.
Demand for Andrea Anti-Noise products has required the Company to raise
additional working capital to support its production operations. In addition,
the acquisition of Lamar will require the Company to provide working capital
support Lamar in order to enable it to pay its debts as they become due. In
December 1995, April 1996 and August 1996, the Company raised additional working
capital through the issuance of convertible subordinated debentures. On June 10,
1998, as described above, the Company raised $10 million through the issuance
and sale of convertible notes. In addition, the Company 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, of
which approximately $665,000 was outstanding at June 30, 1998.
Notwithstanding the significance of sales of Andrea Anti-Noise products during
the 1998 First Half, no assurance can be given that demand will continue for
these products or any of the Company's other products at profitable prices or at
all, or that demand will emerge for any future products developed by the
Company, including those based on the Company's recently acquired DSDA
technology, if any, or, that if such demand does so continue or emerge, that the
Company 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.
In anticipation of the year 2000, the Company is developing a plan to ensure
that all of its systems are able to properly recognize the year 2000. The
Company is currently assessing the ability of its recently acquired management
information systems to properly perform, and will be conducting significant
transaction testing throughout the implementation. The Company does not
anticipate any material deficiencies and, further, does not anticipate
difficulty or significant additional expense in achieving full year 2000
capability. The cost of the upgrade to the Company's management information
systems is not expected to exceed $1 million, which upgrade will achieve several
objectives, including, among others, satisfaction of the year 2000 computing
requirements.
Page 14
<PAGE> 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit
Number Description
4.1 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 form of Note attached thereto). (Incorporated herein by
reference to the Registrant's Registration Statement on Form S-3,
File No. 333-61115).
10.1 Registration Rights Agreement, dated as of June 10, 1998, relating
to registration rights granted to the holders of the
Registrant's 6% Convertible Notes due June 10, 2000. (Incorporated
herein by reference to the Registrant's Registration Statement on
Form S-3, File No. 333-61115).
27 Financial Data Schedule
(b) Reports on Form 8-K.
During the three-month period ended June 30, 1998, the registrant filed the
following Current Reports on Form 8-K on the indicated dates: (i) on April 17,
1998, for the purpose of announcing that the registrant had entered into an
agreement to acquire all of the outstanding ordinary shares of capital stock of
Lamar Signal Processing, Ltd., an Israeli corporation ("Lamar"); and (ii) on May
8, 1998, for the purpose of announcing that the registrant had acquired all of
the outstanding ordinary shares of capital stock of Lamar.
Page 15
<PAGE> 16
SIGNATURES
In accordance with the requirements of 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
/s/ John N. Andrea Co-President August 14, 1998
- ----------------------
John N. Andrea
/s/ Patrick D. Pilch Executive Vice President, August 14, 1998
- ---------------------- and Chief Financial Officer
Page 16
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 9,341,861
<SECURITIES> 646,039
<RECEIVABLES> 4,205,803
<ALLOWANCES> 52,521
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<PP&E> 1,466,815
<DEPRECIATION> 216,727
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<CURRENT-LIABILITIES> 3,450,269
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