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ANDREA ELECTRONICS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Overview Our mission is to provide the emerging "voice interface" markets with state-of-the-art communications products that facilitate natural language, human/machine interfaces. Examples of the applications and interfaces for which Andrea DSP Microphone and Audio Software Products and Andrea Anti-Noise Products provide benefit include: Internet and other computer-based speech; telephony communications; multi-point conferencing; speech recognition; multimedia; multi-player Internet and CD ROM interactive games; 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 in noisy environments, for use with personal computers, mobile personal computing devices, cellular and other wireless communication devices and automotive communication systems. Our Andrea DSP Microphone and Audio Software Products use "far-field" digital signal processing technology to provide high quality transmission of voice where the user is at a distance from the microphone. High quality audio communication technologies will be required for emerging far-field voice applications, ranging from continuous speech dictation, to Internet telephony and multiparty video teleconferencing and collaboration, to natural language-driven interfaces for automobiles, home and office automation and other machines and devices into which voice-controlled microprocessors are expected to be introduced during the next several years. We outsource to Asia high volume assembly for most of our products from purchased components. We assemble some low volume Andrea DSP Microphone and Audio Software Products from purchased components. As sales of any particular Andrea DSP Microphone and Audio Software Product increases, assembly operations are transferred to a subcontractor in Asia. Our Critical Accounting Policies Our unaudited condensed consolidated interim financial statements and the notes to our unaudited condensed consolidated interim financial statements contain information that is pertinent to management's discussion and analysis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. On a continual basis, management reviews its estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such reviews, and if deemed appropriate, those estimates are adjusted accordingly. Actual results may vary from these estimates and assumptions under different and/or future circumstances. Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2010. A discussion of our critical accounting policies and estimates are included in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2010. Management has discussed the development and selection of these policies with the Audit Committee of the Company's Board of Directors, and the Audit Committee of the Board of Directors has reviewed the Company's disclosures of these policies. There have been no material changes to the critical accounting policies or estimates reported in the Management's Discussion and Analysis section of the Annual Report on Form 10-K for the year ended December 31, 2010. Cautionary Statement Regarding Forward-Looking Statements This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe", "expect", "intend", "anticipate", "estimate", "project" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in economic, competitive, governmental, technological and other factors that may affect our business and prospects. Additional factors are discussed below under "Risk Factors" and in Part I, "Item 1A - Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2010. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events. 15-------------------------------------------------------------------------------- Risk Factors Our operating results are subject to significant fluctuation, period-to-period comparisons of our operating results may not necessarily be meaningful and you should not rely on them as indications of our future performance. Our results of operations have historically been and are subject to continued substantial annual and quarterly fluctuations. The causes of these fluctuations include, among other things: - the volume of sales of our products under our collaborative marketing arrangements; - the cost of development of our products; - the mix of products we sell; - the mix of distribution channels we use; - the timing of our new product releases and those of our competitors; - fluctuations in the computer and communications hardware and software marketplace; and - general economic conditions. We cannot assure that the level of revenues and gross profit, if any, that we achieve in any particular fiscal period will not be significantly lower than in other fiscal periods. Our net revenues for the three months ended June 30, 2011 were $876,363 compared to $1,223,497 for the three months ended June 30, 2010. Net loss for the three months ended June 30, 2011 was $175,883, or $0.00 loss per share on a basic and diluted basis compared to net income of $2,918, or $0.00 earnings per share on a basic and diluted basis for the three months ended June 30, 2010. Our revenues for the six months ended June 30, 2011 were $1,875,376 compared to $2,465,737 for the six months ended June 30, 2010. Net loss for the six months ended June 30, 2011 was $313,506 or $.01 loss per share on a basic and diluted basis, compared to net loss of $18,225, or $.00 loss per share on a basic and diluted basis for the six months ended June 30, 2010. We continue to explore opportunities to grow sales in other business areas; we are also examining additional opportunities for cost reduction, production efficiencies and further diversification of our business. Shares Eligible For Future Sale May Have An Adverse Effect On Market Price and Andrea Shareholders May Experience Substantial Dilution. Sales of a substantial number of shares of our common stock in the public market could have the effect of depressing the prevailing market price of our common stock. Of the 200,000,000 shares of common stock presently authorized, 63,721,035 were outstanding as of August 9, 2011. The number of shares outstanding does not include an aggregate of 27,681,991 shares of common stock that are issuable. This number of issuable common shares is equal to approximately 43% of the 63,721,035 outstanding shares. These issuable common shares are comprised of: a) 17,760,321 shares of our common stock reserved for issuance upon exercise of outstanding awards granted under our 1998 Stock Plan and 2006 Stock Plan; b) 4,269,436 shares reserved for future grants under our 2006 Stock Plan; c) 2,023,658 shares of common stock that are issuable upon conversion of the Series C Preferred Stock; and d) 3,628,576 shares of common stock issuable upon conversion of the Series D Preferred Stock. In addition to the risk factors set forth above and the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A - Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2010, which could materially affect our business, financial condition or future results. The risks described in this report and in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. 16-------------------------------------------------------------------------------- Results Of Operations Three and Six Months ended June 30, 2011 compared to Three and Six Months ended June 30, 2010 Net Revenues For the Three Months For the Six Months Ended Ended June 30, June 30, 2011 2010 % Change 2011 2010 % Change Andrea Anti-Noise Products net Product revenues Sales of products to OEM customers for use with educational software $ 67,888 $ 111,984 (40 ) $ 136,161 $ 156,801 (14 ) (a ) All other Andrea Anti-Noise net product revenues 437,134 472,524 (8 ) 893,281 1,032,261 (14 ) (b ) Total Andrea Anti-Noise Products net Product revenues $ 505,022 584,508 (14 ) $ 1,029,442 $ 1,189,062 (14 ) Andrea DSP Microphone and Audio Software Products revenues Sales of automotive array microphone products 45,166 200,192 (78 ) 59,955 367,934 (84 ) (c ) All other Andrea DSP Microphone and Audio product revenues 23,276 50,779 (55 ) 86,273 87,471 (2 ) (d ) License revenues 302,899 388,018 (22 ) 699,706 821,270 (15 ) (e ) Total Andrea DSP Microphone and Audio Software Products revenues 371,341 638,989 (42 ) 845,934 1,276,675 (34 ) Total Revenues $ 876,363 $ 1,223,497 (29 ) $ 1,875,376 $ 2,465,737 (24 ) (a)These decreases of approximately $44,000 and $21,000 represent decreased product sales to our educational customers for use with their distance learning products as compared to the three and six months ended June 30, 2010. We believe that these decreases in product sales relate to the timing of the customers purchases. (b)The decreases of approximately $35,000 and $139,000 for the three and six month periods, respectively, as compared to the same periods in 2010 in all other Andrea Anti-noise product revenues is related to decreased demand from our distance learning customers as well as distributor and reseller customers who sell both to distance learning customers and speech recognition end users. (c)The approximate $155,000 and $308,000 decreases in sales of automotive array microphone products are primarily the result of decreased product sales to integrators of public safety vehicle solutions. These decreases are related to our fulfillment of a contract in 2010. (d)The decrease of approximately $28,000 for the three month period ended June 30, 2011 as compared to the same period in 2010 in all other Andrea DSP Microphone and Audio Software product revenues is related to demand from our distance learning customers as well as distributor and reseller customers who sell both to distance learning customers and speech recognition end users. (e)The decreases in license revenues are the result of decreased royalties reported for the three and six months ending June 30, 2011 as compared to the same period last year. We believe this decrease is related to a decrease in sales of PC models which feature the full capacities of our technology. Cost of Revenues Cost of revenues as a percentage of net revenues for the three months ended June 30, 2011 decreased to 34% from 38% for the three months ended June 30, 2010. The cost of revenues as a percentage of net revenues for the three months ended June 30, 2011 for Andrea Anti-Noise Products is 55% compared to 52% for the three months ended June 30, 2010. The cost of revenues as a percentage of net revenues for the three months ended June 30, 2011 for Andrea DSP Microphone and Audio Software Products is 5% compared to 25% for the three months ended June 30, 2010. Cost of revenues as a percentage of net revenues for the six months ended June 30, 2011 decreased to 34% from 37% for the six months ended June 30, 2010. The cost of revenues as a percentage of net revenues for the six months ended June 30, 2011 for Andrea Anti-Noise Products is 57% compared to 54% for the six months ended June 30, 2010. The cost of revenues as a percentage of net revenues for the six months ended June 30, 2011 for Andrea DSP Microphone and Audio Software Products is 5% compared to 21% for the six months ended June 30, 2010. The increases for the Andrea Anti-Noise Products revenues for the three and six month periods 17 -------------------------------------------------------------------------------- were a result of a decreases in revenues related to this segment. The increases in cost of sales as a percentage of sales for Andrea DSP Microphone and Audio Software products segment for the three and six month periods relate to decreased product sales of automotive array microphone products to integrators of public safety vehicle solutions. Research and Development Research and development expenses for the three months ended June 30, 2011 increased 3% to $186,816 from $182,378 for the three months ended June 30, 2010. For the three months ended June 30, 2011, the increase in research and development expenses reflects a 6% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $106,643, or 57% of total research and development expenses and a 2% decrease in our Andrea Anti-Noise Headset Product efforts to $80,173, or 43% of total research and development expenses. Research and development expenses for the six months ended June 30, 2011 increased 12% to $395,128 from $354,033 for the six months ended June 30, 2010. For the six months ended June 30, 2011, the increase in research and development expenses reflects a 17% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $228,733, or 58% of total research and development expenses and a 5% increase in our Andrea Anti-Noise Headset Product efforts to $166,395, or 42% of total research and development expenses. These increases primarily relate to ongoing development of new products. General, Administrative and Selling Expenses General, administrative and selling expenses increased 4% to $557,152 for the three months ended June 30, 2011 from $538,293 for the three months ended June 30, 2010. For the three months ended June 30, 2011, the expenses reflect a 5% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $260,752, or 47% of total general, administrative and selling expenses and a 3% increase in our Andrea Anti-Noise Headset Product efforts to $296,401, or 53% of total general, administrative and selling expenses. General, administrative and selling expenses decreased 2% to, $1,148,674 for the six months ended June 30, 2011 from $1,176,558 for the six months ended June 30, 2010. For the six months ended June 30, 2011, the expenses in our Andrea DSP Microphone and Audio Software Technology efforts remained relatively flat at $528,122, or 46% of total general, administrative and selling expenses and a 4% decrease in our Andrea Anti-Noise Headset Product efforts to $620,553, or 54% of total general, administrative and selling expenses. The quarter over quarter increase relates to promotional and marketing expenses related to our newly engaged distribution channels. The year over year decreases relate to timing of legal and professional expenses. Interest Income, net Interest income, net for the three months ended June 30, 2011 was $1,988 compared to $1,353 for the three months ended June 30, 2010. Interest income, net for the six months ended June 30, 2011 was $3,689 compared to $3,159 for the six months ended June 30, 2010. The increases in interest income, net is the result of decreased interest expense on our long term debt. Provision for Income Taxes The provision for income taxes for the three months ended June 30, 2011 was $11,625 compared to a provision for income taxes of $40,872 for the three months ended June 30, 2010. The provision for income taxes for the six months ended June 30, 2011 was $16,961 compared to a provision for income taxes of $49,157 for the three months ended June 30, 2010. The decrease is a result of a decreased estimated taxable income. Net (loss) income Net loss for the three months ended June 30, 2011 was $175,883 compared to net income of $2,918 for the three months ended June 30, 2010. Net loss for the six months ended June 30, 2011 was $313,506 compared to net loss of $18,225 for the six months ended June 30, 2010. The net loss for the three months ended June 30, 2011, net income for the three months ended June 30, 2010 and net loss for the six months ended June 2011 and 2010 principally reflects the factors described above. Off-Balance Sheet Arrangements The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. 18-------------------------------------------------------------------------------- Liquidity And Capital Resources Andrea's principal sources of funds are and are expected to continue to be gross cash flows from operations. At June 30, 2011, we had cash of $2,049,989 compared with $2,220,994 at December 31, 2010. The cash balance at June 30, 2011 is primarily a result of our cash that we historically generated from operations. Our working capital balance at June 30, 2011 was $3,076,570 compared to a working capital of 3,039,308 at December 31, 2010. The increase in working capital reflects a decrease in total current assets of $238,350 and a decrease in total current liabilities of $275,612. The decrease in total current assets reflects a decrease in cash of $171,005, an increase in accounts receivable of $75,928, a decrease in inventory of $144,719, an increase in deferred income tax assets of $16,891, and a decrease in prepaid expenses of $15,445. The decrease in total current liabilities reflects a decrease in trade accounts payable of $146,875, a decrease in the current portion in long-term debt of $4,374, a decrease in short-term deferred revenue of $109,632 and a decrease of $14,731 in other current liabilities. The decrease in cash of $171,005 reflects $114,345 of net cash used in operating activities, $38,881 of net cash used in investing activities and $17,779 of cash used in financing activities. The cash used in operating activities of $114,345, excluding non-cash charges for the six months ended June 30, 2011, is attributable to a $78,668 increase in accounts receivable, a $140,233 decrease in inventories, a $15,445 increase in prepaid expenses and other current assets, a $146,875 decrease in accounts payable, a $109,632 decrease in short-term deferred revenue and a $14,731 decrease in other current liabilities. The changes in receivables, inventory, prepaid expenses and accounts payable primarily reflect differences in the timing related to both the payments for and the acquisition of inventory as well as for other services in connection with ongoing efforts related to Andrea's various product lines. The cash used in investing activities of $38,881 reflects purchases of property and equipment of $27,470 and an increase in patents and trademarks of $11,411. The significant increase in property and equipment reflects capital expenditures associated with information technology purchases including and, to a lesser extent, molds associated with our Andrea Anti-Noise Headset Products. The increase in patents and trademarks reflects capital expenditures associated with our intellectual property. The cash used in financing activities of $17,779, reflects repayments to finance a significant upgrade to our information technologies systems. We plan to continue to improve our cash flows in 2011 by aggressively pursuing additional licensing opportunities related to our Andrea DSP Audio Software and increasing the sales of our Andrea Anti-Noise Headset Products through the introduction of new products as well as the increased efforts we are putting into our sales and marketing efforts. However, there can be no assurance that we will be able to successfully execute the aforementioned plans. As of August 9, 2011, Andrea has approximately $2,100,000 of cash deposits. We believe that we have sufficient liquidity available to continue in operation through at least June 2012. To the extent that we do not generate sufficient cash flows from our operations in the next twelve months, additional financing might be required. Although we have improved cash flows by reducing overall expenses, if our revenues decline, these reductions may impede our ability to be cash flow positive and our net income or loss may be disproportionately affected. We have no commitment for additional financing and may experience difficulty in obtaining additional financing on favorable terms, if at all. Any financing we obtain may contain covenants that restrict our freedom to operate our business or may have rights, preferences or privileges senior to our common stock and may dilute our current shareholders' ownership interest in Andrea. We cannot assure that demand will continue for any of our products, including future products related to our Andrea DSP Microphone and Audio Software technologies, or, that if such demand does exist, that we will be able to obtain the necessary working capital to increase production and provide marketing resources to meet such demand on favorable terms, or at all. |