UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C.  20549




FORM 10-Q




(Mark One)




(X)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE

ACT OF 1934




For the quarterly period ended June 30, 2010




(   )
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934





OR







(   )
TRANSITION REPORT PURSUANT TO 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

incorporation or organization)

(I.R.S. employer identification no.)65 Orville Drive, Bohemia, New York

11716(Address of principal executive offices)

(Zip Code)Registrant’s telephone number (including area code):
631-719-1800




Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No  ̈




Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ̈ No  ̈




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one)




Large Accelerated Filer  ̈
Accelerated Filer                    ̈Non-Accelerated Filer    ̈
Smaller Reporting Company x(Do not check if a smaller reporting company)





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


Yes  ̈  No x




Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date:  As of August 6, 2010, there were 63,721,035 common shares outstanding.










PART I.                           FINANCIAL INFORMATION




ITEM 1.                           FINANCIAL STATEMENTS




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES


CONDENSED CONSOLIDATED BALANCE SHEETS




June 30,


December 31,2010


2009(unaudited)ASSETSCurrent assets:Cash

$
2,055,621


$
1,805,091Accounts receivable, net of allowance for doubtful accounts of $9,210 and $6,262,

respectively


555,238



514,327Inventories, net


765,467



842,428Short term customer deposits


79,632



93,168Deferred income taxes, net


94,029



143,130Prepaid expenses and other current assets


76,390



93,552Total current assets


3,626,377



3,491,696Property and equipment, net


232,707



215,974Intangible assets, net


1,868,350



2,106,507Other assets, net


12,864



12,864Total assets

$
5,740,298


$
5,827,041LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent liabilities:Trade accounts payable

$
225,388


$
392,128Current portion of long-term debt


21,908



21,214Accrued Series C Preferred Stock Dividends


80,606



80,606Short-term deferred revenue


109,632



123,168Other current liabilities


177,973



156,503Total current liabilities


615,507



773,619Long term debt, net of current portion


88,544



99,786Series B Redeemable Convertible Preferred Stock, $.01 par value; authorized: 1,000 shares;

issued and outstanding: 0 shares


-



-Commitments and contingenciesShareholders’ equity:Preferred stock, $.01 par value; authorized: 2,497,500 shares; none issued and outstanding


-



-Series C Convertible Preferred Stock, net, $.01 par value; authorized: 1,500 shares; issued

and outstanding: 48.2 shares; liquidation value: $482,314


1



1Series D Convertible Preferred Stock, net, $.01 par value; authorized: 2,500,000 shares;

issued and outstanding: 907,144 shares; liquidation value:  $907,144


9,072



9,072Common stock, $.01 par value; authorized:  200,000,000 shares; issued and outstanding:

63,538,029 shares


635,380



635,380Additional paid-in capital


77,197,013



77,096,177Accumulated deficit


(72,805,219
)


(72,786,994
)Total shareholders’ equity


5,036,247



4,953,636Total liabilities and shareholders’ equity

$
5,740,298


$
5,827,041




See Notes to Condensed Consolidated Financial Statements.
  2
 
 ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
  For the Three Months Ended


For the Six Months EndedJune 30,

2010


June 30,

2009


June 30,

2010


June 30,

2009RevenuesNet product revenues

$
835,479


$
915,554


$
1,644,467


$
1,538,293License revenues


388,018



282,007



821,270



480,848Revenues


1,223,497



1,197,561



2,465,737



2,019,141Cost of revenues


460,389



535,898



907,373



858,643Gross margin


763,108



661,663



1,558,364



1,160,498Research and development expenses


182,378



142,853



354,033



292,366General, administrative and selling expenses


538,293



538,658



1,176,558



1,173,079Income (loss) from operations


42,437



(19,848
)


27,773



(304,947
)Interest income, net


1,353



2,444



3,159



4,936Income (loss) before provision for

income taxes


43,790



(17,404
)


30,932



(300,011
)Provision for income taxes


40,872



308



49,157



1,565Net income (loss)

$
2,918


$
(17,712
)

$
(18,225
)

$
(301,576
)Basic weighted average shares


63,538,029



60,978,373



63,538,029



60,978,373Diluted weighted average shares


72,362,964



60,978,373



63,538,029



60,978,373Basic and diluted net income (loss) per share

$
.00


$
(.00
)

$
(.00
)

$
(.01
)




See Notes to Condensed Consolidated Financial Statements.
  3
 
 ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
 FOR SIX MONTHS ENDED JUNE 30, 2010
 (UNAUDITED)
  Series C Convertible Preferred

Stock

Outstanding

Series C Convertible Preferred

Stock

Series D Convertible Preferred

Stock Outstanding

Series D Convertible Preferred

Stock

Common

Stock

Shares

Outstanding

Common

Stock

Additional

Paid-In

Capital


Accumulated

Deficit


Total

Shareholders’

EquityBalance, January 1, 2010


48.231432

$
1


907,144

$
9,072


63,538,029

$
635,380

$
77,096,177


$
(72,786,994
)

$
4,953,636Stock-based Compensation Expense related to Stock Option Grants


-


-


-


-


-


-


100,836



-



100,836Net loss


-


-


-


-


-


-


-



(18,225
)


(18,225
)Balance, March 31, 2010


48.231432

$
1


907,144

$
9,072


63,538,029

$
635,380

$
77,197,013


$
(72,805,219
)

$
5,036,247
 See Notes to Condensed Consolidated Financial Statements.
  4
 
 ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 
 For the Six Months EndedJune 30, 2010


June 30, 2009Cash flows from operating activities:Net loss

$
(18,225
)

$
(301,576
)Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization


271,950



257,303Stock based compensation expense


100,836



118,663Bad debt expense


2,948



-Inventory reserve


15,111



(45,324
)Deferred income taxes


49,101



-Change in:Accounts receivable


(43,859
)


170,440Inventories


61,850



352,335Short term customer deposit


13,536



(130,854
)Prepaid expenses and other current assets


17,162



1,694Trade accounts payable


(166,740
)


251,610Short-term deferred revenue


(13,536
)


130,854Other current liabilities


21,470



3,448Net cash provided by operating activities


311,604



808,593Cash flows from investing activities:Purchases of property and equipment


(50,076
)


(27,649
)Purchases of patents and trademarks


(450
)


(23,289
)Net cash used in investing activities


(50,526
)


(50,938
)Cash flows from financing activities:Principal repayments of long term debt


(10,548
)


-Net cash used in financing activities


(10,548
)


-Net increase in cash


250,530



757,655Cash, beginning of year


1,805,091



1,006,951Cash, end of period

$
2,055,621


$
1,764,606Supplemental disclosures of cash flow information:Cash paid for:Income Taxes

$
2,656


$
6,327Interest

$
3,623


$
-
 
 See Notes to Condensed Consolidated Financial Statements.
  5




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




Note 1.                 Basis of Presentation and Management’s Liquidity Plans
 
 Basis of Presentation - The accompanying unaudited condensed consolidated interim financial statements include the accounts of Andrea Electronics Corporation and its subsidiaries ("Andrea" or the “Company”). All intercompany balances and transactions have been eliminated in consolidation.
 
 These unaudited, condensed consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In addition, the December 31, 2009 balance sheet data was derived from the audited consolidated financial statements, but does not include all disclosures required by GAAP.  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 of any interim period are not necessarily indicative of the results of operations to be expected for any other interim period or for the fiscal year.
 
 These unaudited condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2009 included in the Company's Form 10-K for the fiscal year ended December 31, 2009, filed on March 16, 2010.  The accounting policies used in preparing these unaudited condensed consolidated interim financial statements are consistent with those described in the December 31, 2009 audited consolidated financial statements.
 
 Management's Liquidity Plans - As of June 30, 2010, Andrea had working capital of $3,010,870 and cash on hand of $2,055,621.  Andrea’s income from operations was $42,437 and $27,773 for the three and six months ended June 30, 2010, respectively.  Andrea plans to continue to improve its cash flows during 2010 by aggressively pursuing additional licensing opportunities related to Andrea DSP Audio Software and increasing its Andrea Anti-Noise Headset Products sales through new products that are currently being offered and that are under development, as well as the increased efforts of the Company to its sales and marketing efforts.  However, there can be no assurance that Andrea will be able to successfully execute the aforementioned plans.
 
 As of August 6, 2010, Andrea had approximately $2,100,000 of cash. Management projects that Andrea has sufficient liquidity available to operate through at least June 2011.  While Andrea explores opportunities to increase revenues in new business areas, the Company also continues to examine additional opportunities for cost reduction and further diversification of its business.  Since the third quarter of 2006, Andrea has generated cash flows from operations.  If Andrea fails to develop additional revenues from sales of its products and licensing of its technology or to generate adequate funding from operations, or if Andrea fails to obtain additional financing through a capital transaction or other type of financing, Andrea will be required to continue to significantly reduce its operating expenses and/or operations or Andrea may have to relinquish its products, technologies or markets which could have a materially adverse effect on revenue and operations. Andrea has no commitment for additional financing and may experience difficulty in obtaining additional financing on favorable terms, if at all.
 
 Note 2.                 Summary of Significant Accounting Policies
 
 Earnings (loss) Per Share - Basic earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted average number of common shares outstanding during the period.  Diluted earnings (loss) adjusts basic earnings (loss) per share for the effects of convertible securities, stock options and other potentially dilutive financial instruments, only in the periods in which such effect is dilutive.  Securities that could potentially dilute basic earnings per share (“EPS”) in the future that were not included in the computation of the diluted EPS because to do so would have been anti-dilutive for the periods presented, consist of the following:
 
 For the Three Months Ended


For the Six Months EndedJune 30, 2010


June 30, 2009


June 30, 2010


June 30, 2009Total potential common shares as of:Options to purchase common stock (Note 8)


8,706,821



14,526,820



16,031,821



14,526,820Series C Convertible Preferred Stock and related

accrued dividends (Note 3)


-



4,103,984



2,206,664



4,103,984Series D Convertible Preferred Stock and related

warrants (Note 4)


-



4,200,004



3,628,576



4,200,004Total potential common shares


8,706,821



22,830,808



21,867,061



22,830,808
 
 6




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
  The following table sets forth the components used in the computation of basic and diluted earnings (loss) per share:
 
 For the Three Months Ended


For the Six Months EndedJune 30, 2010


June 30, 2009


June 30, 2010


June 30, 2009Numerator:Net income (loss)

$
2,918


$
(17,712
)

$
(18,225
)

$
(301,576
)Denominator:Weighted average shares


63,538,029



60,978,373



63,538,029



60,978,373Effect of dilutive securities:Series C Convertible Preferred Stock


2,206,664



-



-



-Series D Convertible Preferred Stock


3,628,576



-



-



-Employee stock options


2,989,695



-



-



-Denominator for diluted income (loss) per

share-adjusted weighted average shares after

assumed conversions


72,362,964



60,978,373



63,538,029



60,978,373
 
 Cash - Cash includes cash and highly liquid investments with original maturities of three months or less.  At times during the periods ended June 30, 2010 and December 31, 2009, the Company had cash deposits in excess of the maximum amounts insured by the Federal Deposit Insurance Corporation insurance limits.  At June 30, 2010, the Company’s cash is held at three financial institutions.
 
 Concentration of Credit Risk – The following customers accounted for 10% or more of Andrea’s consolidated net revenues during at least one of the periods presented below:
 
 For the Three Months Ended


For the Six Months EndedJune 30,

2010


June 30,

2009


June 30,

2010


June 30,

2009Customer A


*



17
%


*



12
%Customer B


15
%


*



13
%


*Customer C


28
%


19
%


29
%


19
%
 _________________
  * Amounts are less than 10%
 
 Customer B and C accounted for approximately 14% and 27%, respectively of total accounts receivable at June 30, 2010.  Customer A accounted for approximately 55% of total accounts receivable at December 31, 2009.
 
 The following suppliers accounted for 10% or more of Andrea’s purchases during the periods presented below:
 
 For the Three Months Ended


For the Six Months EndedJune 30,

2010


June 30,

2009


June 30,

2010


June 30,

2009Supplier A


90
%


100
%


91
%


84
%Supplier B


*



*



*



16
%
 _________________
  * Amounts are less than 10%
 
 At June 30, 2010 and December 31, 2009, Supplier A accounted for approximately 72% and 63% of accounts payable, respectively.
 
 Allowance for Doubtful Accounts - The Company performs on-going credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by the review of their current credit information.  Collections and payments from customers are continuously monitored.  The Company maintains an allowance for doubtful accounts, which is based upon historical experience as well as specific customer collection issues that have been identified.  While such bad debt expenses have historically been within expectations and allowances established, the Company cannot guarantee that it will continue to experience the same credit loss rates that it has in the past.  If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
  7




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




Inventories - Inventories are stated at the lower of cost (on a first-in, first-out) or market basis.  The cost of inventory is based on the respective cost of materials.  Andrea reviews its inventory reserve for obsolescence on a quarterly basis and establishes reserves on inventories based on the specific identification method as well as a general reserve.  Andrea records changes in inventory reserves as part of cost of revenues.
 
 June 30,


December 31,2010


2009Raw materials

$
44,196


$
54,351Finished goods


1,389,390



1,441,0851,433,586



1,495,436Less: reserve for obsolescence


(668,119
)


(653,008
)$
765,467


$
842,428
 
 Intangible and Lived Assets - Andrea accounts for its long-lived assets in accordance with Statement of Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 360 “Plant, Property and Equipment, ” for purposes of determining and measuring impairment of its long-lived assets (primarily intangible assets) other than goodwill. Andrea’s policy is to review the value assigned to its long lived assets to determine if they have been permanently impaired by adverse conditions which may affect Andrea whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  If Andrea identifies a permanent impairment such that the carrying amount of Andrea’s long lived assets is not recoverable using the sum of an undiscounted cash flow projection (gross margin dollars from product sales), the impaired asset is adjusted to its estimated fair value, based on an estimate of future discounted cash flows which becomes the new cost basis for the impaired asset.  Considerable management judgment is necessary to estimate undiscounted future operating cash flows and fair values and, accordingly, actual results could vary significantly from such estimates.  No impairment charges were recognized during the three and six month periods ended June 30, 2010 and 2009.
 
 Revenue Recognition - Non software-related revenue, which is generally comprised of microphones and microphone connectivity product revenues, is recognized when title and risk of loss pass to the customer, which is generally upon shipment.  With respect to licensing revenues, Andrea recognizes revenue in accordance with ASC 985, “Software” and ASC 605 “Revenue Recognition.”  License revenue is recognized based on the terms and conditions of individual contracts.  In addition, fee based services, which are short-term in nature, are generally performed on a time-and-material basis under separate service arrangements and the corresponding revenue is generally recognized as the services are performed.
 
 Income Taxes - The provision for income taxes is a result of certain licensing revenues that are subject to withholding of income tax as mandated by the foreign jurisdiction in which the revenues are earned.  For all other income taxes, Andrea accounts for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”).  ASC 740 requires an asset and liability approach for financial accounting and reporting for income taxes and establishes for all entities a minimum threshold for financial statement recognition of the benefit of tax positions, and requires certain expanded disclosures.  The provision for income taxes is based upon income or loss after adjustment for those permanent items that are not considered in the determination of taxable income, which includes amortization expense, stock based compensation and other permanent differences. These permanent items result in a difference between income taxes at the statutory Federal income tax rate and income taxes reported in the condensed consolidated income statement.  Deferred income taxes represent the tax effects of differences between the financial reporting and tax bases of the Company’s assets and liabilities at the enacted tax rates in effect for the years in which the differences are expected to reverse.  The Company evaluates the recoverability of deferred tax assets and establishes a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Accordingly, and after considering changes in previously existing positive evidence, the Company reduced its valuation allowance to recognize a deferred tax asset of approximately $143,000 for the year ended December 31, 2009.  In addition, Andrea expects it will reduce its valuation in future periods to the extent that it can demonstrate its ability to utilize the assets.  Management makes judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability.  In management’s opinion, adequate provisions for income taxes have been made for all years.  If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.  Income tax expense consists of the tax payable for the period and the change during the period in deferred tax assets and liabilities.  The Company has identified its federal tax return and its state tax return in New York as "major" tax jurisdictions.  Based on the Company's evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company's condensed consolidated financial statements.  The Company's evaluation was performed for tax years ended 2006 through 2009.  The Company believes that its income tax positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position.
  8




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




Stock-Based Compensation -At June 30, 2010, Andrea had two stock-based employee compensation plans, which are described more fully in Note 8.  Andrea accounts for stock-based compensation in accordance with ASC 718, “Compensation – Stock Compensation” (“ASC 718”).  ASC 718 establishes accounting for stock-based awards exchanged for employee services.  Under the provisions of ASC 718, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the employee’s requisite service period (generally the vesting period of the equity grant).  The fair value of the Company’s common stock options are estimated using the Black Scholes option-pricing model with the following assumptions:  expected volatility, dividend rate, risk free interest rate and the expected life.  The Company expenses stock-based compensation by using the straight-line method.  In accordance with ASC 718, excess tax benefits realized from the exercise of stock-based awards are classified in cash flows from financing activities.  The future realization of the reserved deferred tax assets related to these tax benefits associated with the exercise of stock options will result in a credit to additional paid in capital if the related tax deduction reduces taxes payable.  The Company has elected the “with and without approach” regarding ordering of windfall tax benefits to determine whether the windfall tax benefit did reduce taxes payable in the current year.   Under this approach, the windfall tax benefit would be recognized in additional paid-in-capital only if an incremental tax benefit is realized after considering all other benefits presently available.
 
 Recently Issued Accounting Pronouncements
 
 In October 2009, the FASB issued new accounting guidance, under FASB Accounting Standard Update (“ASU”) No. 2009-13 “Revenue Recognition,” which amends revenue recognition policies for arrangements with multiple deliverables. This guidance eliminates the residual method of revenue recognition and allows the use of management’s best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence, vendor objective evidence or third-party evidence is unavailable. This guidance is effective for all new or materially modified arrangements entered into on or after January 1, 2011 with earlier application permitted as of the beginning of a fiscal year. Full retrospective application of the new guidance is optional.  The Company has not completed their assessment of this new guidance on their financial condition, results of operations or cash flows.
 
 In October 2009, the FASB issued new accounting guidance, under ASU No. 2009-14 “Software”, which amends the scope of existing software revenue recognition accounting. Tangible products containing software components and non-software components that function together to deliver the product’s essential functionality would be scoped out of the accounting guidance on software and accounted for based on other appropriate revenue recognition guidance.  For the Company, this guidance is effective for all new or materially modified arrangements entered into on or after January 1, 2011 with earlier application permitted as of the beginning of a fiscal year. Full retrospective application of this new guidance is optional. This guidance must be adopted in the same period that the Company adopts the amended accounting for arrangements with multiple deliverables described in the preceding paragraph. The Company has not completed their assessment of this new guidance on their financial condition, results of operations or cash flows.
 
 Use of Estimates
 
 The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
 
 Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  The most significant estimates, among other things, are used in accounting for allowances for bad debts, inventory valuation and obsolescence, product warranty, depreciation, deferred income taxes, expected realizable values for assets (primarily intangible assets), contingencies, revenue recognition as well as the recording and presentation of the Company’s convertible preferred stock. Estimates and assumptions are periodically reviewed and the effects of any material revisions are reflected in the consolidated financial statements in the period that they are determined to be necessary. Actual results could differ from those estimates and assumptions.
 
 Reclassifications - Certain prior year amounts have been reclassified to conform to the current year presentation.
 
 Subsequent Events - The Company evaluates events that occurred after the balance sheet date but before the financial statements are issued.  Based upon the evaluation, except as disclosed in Note 3, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure in the consolidated financial statements.
  9




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




Note 3.                 Series C Redeemable Convertible Preferred Stock
 
 On October 10, 2000, Andrea issued and sold in a private placement $7,500,000 of Series C Redeemable Convertible Preferred Stock (the “Series C Preferred Stock”).  Each of these shares of Series C Preferred Stock had a stated value of $10,000 plus a $1,671 increase in the stated value, which sum is convertible into Common Stock at a conversion price of $0.2551.  On February 17, 2004, Andrea announced that it had entered into an Exchange and Termination Agreement and an Acknowledgment and Waiver Agreement, which eliminated the dividend of 5% per annum on the stated value.  The additional amount of $1,671 represents the 5% per annum from October 10, 2000 through February 17, 2004.  The shares of Series C Preferred Stock are subject to antidilution provisions, which are triggered in the event of certain stock splits, recapitalizations, or other dilutive transactions.  In addition, issuances of common stock at a price below the conversion price then in effect (currently $0.2551), or the issuance of warrants, options, rights, or convertible securities which have an exercise price or conversion price less than that conversion price, other than for certain previously outstanding securities and certain “excluded securities” (as defined in the certificate of amendment), require the adjustment of the conversion price to that lower price at which shares of common stock have been issued or may be acquired.  In the event that Andrea issues securities in the future which have a conversion price or exercise price which varies with the market price and the terms of such variable price are more favorable than the conversion price in the Series C Preferred Stock, the purchasers may elect to substitute the more favorable variable price when making conversions of the Series C Preferred Stock.
 
 In accordance with Sub Topic 815-40, Andrea evaluated the Series C Preferred Stock and concluded that it is not indexed to the Company’s stock because of the conversion price adjustment feature described above.  Accordingly, under the provisions of ASC 815, “Derivatives and Hedging” (“ASC 815”), Andrea evaluated the Series C Preferred Stock embedded conversion feature.  The Company has concluded that the embedded conversion feature would be classified in stockholders’ equity if it were a freestanding instrument as the Series C Preferred Stock is more akin to equity and as such it should not be bifurcated from the Series C instrument and accounted for separately.
 
 As of June 30, 2010, there were 48.231432 shares of Series C Preferred Stock outstanding, which were convertible into 2,206,664 shares of Common Stock and remaining accrued dividends of $80,606.
 
 On July 16, 2010, 4.0 shares of Series C Preferred Stock, together with related accrued dividends, were converted into 183,006 shares of Common Stock at a conversion price of $0.2551.
 
 As of August 6, 2010, there were 44.231432 shares of Series C Preferred Stock outstanding, which were convertible into 2,023,658 shares of Common Stock and remaining accrued dividends of $73,921.
 
 Note 4.                 Series D Redeemable Convertible Preferred Stock
 
 On February 17, 2004, Andrea entered into a Securities Purchase Agreement (including a Registration Rights Agreement) with certain holders of the Series C Preferred Stock and other investors (collectively, the “Buyers”) pursuant to which the Buyers agreed to invest a total of $2,500,000.  In connection with this agreement, on February 23, 2004, the Buyers purchased, for a purchase price of $1,250,000, an aggregate of 1,250,000 shares of a new class of preferred stock, the Series D Preferred Stock, convertible into 5,000,000 shares of Common Stock (an effective conversion price of $0.25 per share) and Common Stock warrants exercisable for an aggregate of 2,500,000 shares of Common Stock.  These warrants were exercisable at any time after August 17, 2004, at an exercise price of $0.38 per share.  On February 23, 2009, these warrants expired without being exercised.
 
 In addition, on June 4, 2004, the Buyers purchased for an additional $1,250,000, an additional 1,250,000 shares of Series D Preferred Stock convertible into 5,000,000 shares of Common Stock (an effective conversion price of $0.25 per share) and Common Stock warrants exercisable for an aggregate of 2,500,000 shares of Common Stock.  The warrants were exercisable at any time after December 4, 2004 and before June 4, 2009 at an exercise price of $0.17 per share.  On June 4, 2009, these warrants expired without being exercised.
 
 The shares of Series D Preferred Stock are also subject to antidilution provisions, which are triggered in the event of certain stock splits, recapitalizations, or other dilutive transactions. In addition, issuances of common stock at a price below the conversion price then in effect (currently $0.25), or the issuance of warrants, options, rights, or convertible securities which have an exercise price or conversion price less than that conversion price, other than for certain previously outstanding securities and certain “excluded securities” (as defined in the certificate of amendment), require the adjustment of the conversion price to that lower price at which shares of common stock have been issued or may be acquired. In the event that Andrea issues securities in the future which have a conversion price or exercise price which varies with the market price and the terms of such variable price are more favorable than the conversion price in the Series D Preferred Stock, the purchasers may elect to substitute the more favorable variable price when making conversions of the Series D Preferred Stock.  The Company is required to maintain an effective registration statement from the time of issuance until the earlier of (i) the date as of which the investors may sell all of the securities for the common stock issuable under the Series D Preferred Stock covered by the registration statement without restriction under SEC rules or (ii) the date on which the investors shall have sold all the securities covered by the registration statement.  In addition, the Company is required to use its best efforts to secure the inclusion for quotation on the Over the Counter Bulletin Board for the common stock issuable under the Series D Preferred Stock and to arrange for at least two market makers to register with the Financial Industry Regulatory Authority.  In the event that the holder of the Series D Preferred Stock and related warrants is unable to convert these securities into Andrea Common Stock, the Company shall pay to each such holder of such registrable securities a Registration Delay Payment.  This payment is to be paid in cash and is equal to the product of (i) the stated value of such Preferred Shares multiplied by (ii) the product of (1) .0005 multiplied by (2) the number of days that sales cannot be made pursuant to the Registration Statement (excluding any days during that may be considered grace periods as defined by the Registration Rights Agreement).




10




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




In accordance with Sub Topic 815-40, Andrea evaluated the Series D Preferred Stock and concluded that it is not considered to be indexed to the Company’s stock because of the conversion price adjustment feature described above.  Accordingly, under the provisions of ASC 815, Andrea evaluated the Series D Preferred Stock embedded conversion feature.  The Company has concluded that the embedded conversion feature would be classified in stockholders’ equity if it were a freestanding instrument as the Series D Preferred Stock is more akin to equity and as such it should not be bifurcated from the Series D instrument and accounted for separately.
 
 Additionally, Andrea reviewed the Series D Preferred Stock warrants and concluded that they are considered to be indexed to the Company’s stock within the provisions of ASC 815-40 and were properly classified.
 
 Prior to December 31, 2009, 281,250 shares of common stock have been issued as a result of exercises of the Series D Preferred Stock Warrants.
 
 As of June 30, 2010, there were 907,144 shares of Series D Preferred Stock outstanding which were convertible into 3,628,576 shares of Common Stock.
 
 Note 5.                 Licensing Agreements
 
 The Company has entered into various licensing, production and distribution agreements with manufacturers of PC and related components.  These agreements provide for revenues based on the terms of each individual agreement.  The Company's two largest licensing customers accounted for $343,638 and $22,920 of license revenues for the three months ended June 30, 2010 and $230,376 and $48,410 of license revenues for the three months ended June 30, 2009.  The Company's two largest licensing customers accounted for $726,837 and $63,448 of license revenues for the six months ended June 30, 2010 and $386,429 and $48,410 of license revenues for the six months ended June 30, 2009.
 
 Note 6.                 Long Term Debt
 
 Long-term debt consists of the following:
 
 June 30,


December 31,2010


2009Long-term debt

$
110,452


$
121,000Less: Current Maturities of Long-Term Debt


21,908



21,214Long-Term Debt, net of Current Maturities

$
88,544


$
99,786
 HSBC unsecured bank loan, dated December 9, 2009, is due in 60 monthly installments of $2,362 including principal and interest at 6.4%.
 
 As of June 30, 2010, maturities of long term debt are as follows:
 
 July, 2010 – June 30, 2011

$
21,908July, 2011 – June 30, 2012


23,352July, 2012 – June 30, 2013


24,892July, 2013 – June 30, 2014


26,532July, 2014 – June 30, 2015


13,768Total

$
110,452




11




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




Note 7.                 Commitments And Contingencies
 
 Leases
 
 Andrea leases its corporate headquarters located in Bohemia, New York.  The lease from an unrelated party, which currently expires in April 2015, is for approximately 11,000 square feet and houses Andrea’s warehousing, sales and executive offices.  Rent expense under this operating lease was $24,465 and $46,180 for the three and six-month periods ended June 30, 2010, respectively.  Rent expense under this operating lease was $21,715 and $42,798 for the three and six-month periods ended June 30, 2009, respectively.
 
 As of June 30, 2010, the minimum annual future lease payments, under this lease and all other noncancellable operating leases, are as follows:
 
 2010 (July 1 – December 31)

$
53,5932011


108,9742012


105,7282013


96,8142014


99,718Thereafter


33,565Total

$
498,392
 Employment Agreements
 
 In November 2008, the Company entered into an employment agreement with the President, Chief Executive Officer and Chairman of the Board, Douglas J Andrea.  The effective date of the employment agreement was August 1, 2008 and expired on July 31, 2010.  At June 30, 2010, the future minimum cash commitments under this agreement aggregated $27,083.
 
 In July 2010, the Company entered into an employment agreement with the President, Chief Executive Officer and Chairman of the Board, Douglas J Andrea.  The effective date of the employment agreement is August 1, 2010 and expires July 31, 2012 and is subject to renewal as approved by the Compensation Committee of the Board of Directors.  Pursuant to his employment agreement, Mr. Andrea will receive an annual base salary of $337,500 for the period of August 1, 2010 through July 31, 2011 and for the period of August 1, 2011 through July 31, 2012 Mr. Andrea will receive an annual base salary of $350,000.  The employment agreement provides for quarterly bonuses equal to 25% of the Company’s pre-bonus net after tax quarterly earnings in excess of $25,000 for a total quarterly bonus amount not to exceed $12,500; and annual bonuses equal to 10% of the Company’s annual pre-bonus net after tax earnings in excess of $300,000.  All bonuses shall be payable as soon as the Company's cash flow permits.  All bonus determinations or any additional bonus in excess of the above will be made in the sole discretion of the Compensation Committee. On August 1, 2010, the Board granted Mr. Andrea 1,000,000 stock options with an aggregate fair value of $130,000 (fair value was estimated using the Black-Scholes option-pricing model).  The 1,000,000 grant vests in three equal annual installments over a three year period commencing August 1, 2011.  These 1,000,000 stock options have an exercise price of $0.13 per share, which was the fair market value of the Company’s common stock at the date of grant, and a term of 10 years.  Pursuant to the employment agreement and subject to the approval of the Board of Directors, the Compensation Committee will recommend a second grant of 1,000,000 stock options as soon as practical after August 1, 2011, with an exercise price equal to the per share fair market value of the Company’s common stock on the date of grant.  Mr. Andrea is also entitled to a change in control payment equal to two times his salary with continuation of health and medical benefits for two years in the event of a change in control, as defined in the agreement.  At June 30, 2010, the future minimum cash commitments under this agreement aggregate $687,500.
 
 In November 1999, as amended August 2008, the Company entered into a change in control agreement with the Chief Financial Officer, Corisa L. Guiffre.  This agreement provides for a change in control payment equal to three times her average annual compensation for the five preceding taxable years, with continuation of health and medical benefits for three years in the event of a change in control of the Company, as defined in the agreement, and subsequent termination of employment other than for cause.
 
 Legal Proceedings
 
 Andrea is not currently involved in any pending legal proceedings.
 
 Note 8.                 Stock Plans and Stock Based Compensation
  In 1998, the Board adopted the 1998 Stock Option Plan (“1998 Plan”), which was subsequently approved by the shareholders. The 1998 Plan, as amended, authorizes the granting of awards, the exercise of which would allow up to an aggregate of 6,375,000 shares of Andrea’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.  No further awards will be granted under the 1998 Plan.
  12




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




In October 2006, the Board adopted the Andrea Electronics Corporation 2006 Equity Compensation Plan (“2006 Plan”), which was subsequently approved by the shareholders.  The 2006 Plan authorizes the granting of awards, the exercise of which would allow up to an aggregate of 10,000,000 shares of Andrea’s Common Stock to be acquired by the holders of those awards.  On July 24, 2009, shareholders approved an amendment to the 2006 Plan to increase the number of shares issuable under the 2006 Plan to 18,000,000.  The awards can take the form of stock options, stock appreciation rights, restricted stock or other stock-based awards. Awards may be granted to key employees, officers, directors and consultants.  At June 30, 2010, there were 6,267,936 shares available for further issuance under the 2006 Plan.
 
 The stock option awards granted under these plans have been granted with an exercise price equal to the market price of the Company’s stock at the date of grant; with vesting periods of up to four years and 10-year contractual terms.
 
 The fair values of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model that uses the weighted-average assumptions noted in the following table.  Expected volatilities are based on implied volatilities from historical volatility of the Company’s stock.  The expected term of options granted represents the period of time that options granted are expected to be outstanding.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
 
 There were no options granted during the three and six months ended June 30, 2010 and 2009.
 
 Option activity during 2010 is summarized as follows:
 
 Options Outstanding

Options ExercisableOptions Outstanding


Weighted Average Exercise

Price


Weighted Average Fair

Value

Weighted Average Remaining Contractual

Life

Options Exercisable


Weighted Average Exercise

Price


Weighted Average Fair

Value

Weighted Average Remaining Contractual

LifeAt January 1, 2010


16,141,821


$
0.20


$
0.16

7.32 years


9,891,470


$
0.29


$
0.22

6.37 yearsExpired


(110,000
)

$
7.10


$
4.94At June 30, 2010


16,031,821


$
0.16


$
0.13

6.87 years


9,923,222


$
0.21


$
0.17

5.98 years
 
 During the three months ended June 30, 2010, 33,300 options vested with a weighted average exercise price and a weighted average fair value of $0.05 per option.  During the six months ended June 30, 2010, 141,752 options vested with a weighted average exercise price and a weighted average fair value of $0.06 per option.  Based on the June 30, 2010 fair market value of the Company’s common stock of $0.10, the aggregate intrinsic value for the 16,031,821 options outstanding and 9,923,222 shares exercisable is $423,500 and $210,357, respectively.
 
 Total compensation expense recognized related to stock option awards was $50,001 and $53,773 for the three months ended June 30, 2010 and 2009, respectively.  In the accompanying consolidated statement of operations for the three months ended June 30, 2010, $37,086 of expense is included in general, administrative and selling expenses, $8,805 is included in research and development expenses and $4,110 is included in cost of revenues.  In the accompanying consolidated statement of operations for the three months ended June 30, 2009, $43,162 of expense is included in general, administrative and selling expenses, $10,389 is included in research and development expenses and $222 is included in cost of revenues.  Total compensation expense recognized related to all stock option awards was $100,836 and $108,662 for the six months ended June 30, 2010 and 2009, respectively.  In the accompanying consolidated statement of operations for the six months ending June 30, 2010, $75,006 of expense is included in general, administrative and selling expenses, $17,610 is included in research and development expenses and $8,220 is included in cost of revenues.  In the accompanying consolidated statement of operations for the six months ending June 30, 2009, $87,440 of expense is included in general, administrative and selling expenses, $20,778 is included in research and development expenses and $444 is included in cost of revenues.
 
 As of June 30, 2010, there was $120,825 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 1998 and 2006 Plans.  This unrecognized compensation cost is expected to be recognized over the next 3 years ($53,475 in 2010, $54,097 in 2011 and $13,253 in 2012).
  13




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




In  July 24, 2009 and August 8, 2008, Andrea granted 90,908 shares of Common Stock with a fair market value of $0.11 and 500,000 shares of Common Stock with a fair market value of $0.04, respectively.  These stock grants were fully vested on the date of grant.  Compensation expense related to these awards was $0 and $5,001 for the three months ended June 30, 2010 and 2009, respectively.   Compensation expense related to these awards was $0 and $10,002 for the six months ended June 30, 2010 and 2009, respectively.
 
 Note 9.                 Segment Information
 
 Andrea follows the provisions of ASC 280 “Segment Reporting” (“ASC 280”).  Reportable operating segments are determined based on Andrea’s management approach. The management approach, as defined by ASC 280, is based on the way that the chief operating decision-maker organizes the segments within an enterprise for making operating decisions and assessing performance. While Andrea’s results of operations are primarily reviewed on a consolidated basis, the chief operating decision-maker also manages the enterprise in two segments: (i) Andrea DSP Microphone and Audio Software Products and (ii) Andrea Anti-Noise Products.  Andrea DSP Microphone and Audio Software Products primarily include products based on the use of some, or all, of the following technologies: Andrea Digital Super Directional Array microphone technology (DSDA), Andrea Direction Finding and Tracking Array microphone technology (DFTA), Andrea PureAudio noise filtering technology, and Andrea EchoStop, an advanced acoustic echo cancellation technology.  Andrea Anti-Noise Products include noise cancellation and active noise cancellation computer headset products and related computer peripheral products.
 
 The following represents selected condensed consolidated financial information for Andrea’s segments for the three-month periods ended June 30, 2010 and 2009.
 
 2010 Three Month Segment Data

Andrea DSP Microphone and

Audio Software Products


Andrea Anti-

Noise Products


2010 Three

Month TotalNet revenues from external customers

$
250,971


$
584,508


$
835,479License Revenues


388,018



-



388,018Income (loss) from operations


130,629



(88,192
)


42,437Depreciation and amortization


117,435



18,461



135,896Purchases of property and equipments


7,671



16,159



28,830Purchases of patents and trademarks


-



299



299Assets


3,294,342



2,445,956



5,740,298Total long lived assets


1,805,122



308,799



2,113,9212009 Three Month Segment Data

Andrea DSP Microphone and

Audio Software Products


Andrea Anti-

Noise Products


2009Three

Month TotalNet revenues from external customers

$
111,507


$
804,047


$
915,554License Revenues


282,007



-



282,007Loss from operations


6,114



13,734



19,848Depreciation and amortization


117,900



11,762



129,662Capital expenditures


6,030



-



6,030Purchases of patents and trademarks


1,391



8,321



9,712December 31, 2009 Year End Segment Data

Andrea DSP Microphone and

Audio Software Products


Andrea Anti-

Noise Products


2009 Year End

TotalAssets


3,555,990



2,271,051



5,827,041Total long lived assets


2,023,353



311,992



2,335,345




14




ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




The following represents selected condensed consolidated financial information for Andrea’s segments for the six-month periods ended June 30, 2010 and 2009:
 
 2010 Six Month Segment Data

Andrea DSP Microphone and Audio Software Products


Andrea Anti-

Noise Products


2010 Six Month

TotalNet revenues from external customers

$
455,405


$
1,189,062


$
1,644,467License Revenues


821,270



-



821,270Income (loss) from operations


283,483



(255,710
)


27,773Depreciation and amortization


234,921



37,029



271,950Purchases of property and equipments


16,691



33,385



50,076Purchases of patents and trademarks


-



450



4502009 Six Month Segment Data

Andrea DSP Microphone and Audio Software Products


Andrea Anti-

Noise Products


2009Six Month

TotalNet revenues from external customers

$
186,918


$
1,351,375


$
1,538,293License Revenues


480,848



-



480,848Loss from operations


198,263



106,684



304,947Depreciation and amortization


235,554



21,749



257,303Capital expenditures


2,560



25,089



27,649Purchases of patents and trademarks


8,423



14,866



23,289
 
 Management assesses non-operating income statement data on a consolidated basis only.  International revenues are based on the country in which the end-user is located.  For the three-month periods ended June 30, 2010 and 2009, and as of each respective period-end, net revenues and accounts receivable by geographic area are as follows:
 
 Geographic Data

June 30, 2010


June 30, 2009Net revenues:United States

$
1,094,019


$
1,131,135Foreign(1)


129,478



66,426$
1,223,497


$
1,197,561
  (1)
Net revenues to any one foreign country did not exceed 10% of total net revenues for the three months ended June 30, 2010 and June 30, 2009.
  For the six-month periods ended June 30, 2010 and 2009, and as of each respective period-end, net revenues and accounts receivable by geographic area are as follows:
 
 Geographic Data

June 30, 2010


June 30, 2009Net revenues:United States

$
2,190,717


$
1,866,974Foreign(1)


275,020



152,167$
2,465,737


$
2,019,141
  (1)
Net revenues to any one foreign country did not exceed 10% of total net revenues for the six months ended June 30, 2010 and June 30, 2009.
  As of June 30, 2010 and December 31, 2009, accounts receivable by geographic area is as follows:
 
 Geographic Data

June 30, 2010


December 31, 2009Accounts receivable:United States

$
495,936


$
453,777Foreign(1)


59,302



60,550$
555,238


$
514,327




15




ITEM 2.                      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 Overview
 
 Our mission is to provide the emerging “voice interface” markets with state-of-the-art communications products that facilitate natural language, human/machine interfaces.
 
 Examples of the applications and interfaces for which Andrea DSP Microphone and 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 financial statements and the notes to our unaudited condensed consolidated financial statements contain information that is pertinent to management's discussion and analysis.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities.  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, 2009.  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, 2009. 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, 2009.
 
 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, 2009.  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.
  16
 
 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, 2010 were $1,223,497 compared to $1,197,561 for the three months ended June 30, 2009.  Net income for the three months ended June 30, 2010 was $2,918, or $0.00 earnings per share on a basic and diluted basis compared to net loss of $17,712, or $0.00 loss per share on a basic and diluted basis for the three months ended June 30, 2009.  Our revenues for the six months ended June 30, 2010 were $2,465,737 compared to $2,109,141 for the six months ended June 30, 2009.  Net loss for the six months ended June 30, 2010 was $18,225 or $.00 loss per share on a basic and diluted basis, compared to net loss of $301,576, or $.01 loss per share on a basic and diluted basis for the six months ended June 30, 2009.  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.  Although we have improved cash flows by reducing overall expenses, if our revenues continue to decline we may not continue to generate positive cash flows and our net income or loss may be affected.
 
 If we fail to obtain additional capital or maintain access to funds sufficient to meet our operating needs, we may be required to significantly reduce, sell, or refocus our operations, and our business, results of operations and financial condition could be materially and adversely effected.
 
 In order to be a viable entity we need to maintain and increase profitable operations.  To continue to achieve profitable operations we need to maintain or increase current net revenues and continue to look for ways to control expenses.  We might also need to sell additional assets or raise capital as a means of funding continued operations.  In recent years, we have sustained significant operating losses.  We may have to raise additional capital from external sources.  These sources may include private or public financings through the issuance of debt, convertible debt or equity, or collaborative arrangements.  Such additional capital and funding may not be available on favorable terms, if at all.  Additionally, we may only be able to obtain additional capital or funds through arrangements that require us to relinquish rights to our products, technologies or potential markets, in whole or in part, or result in our sale.  As a result of the past few years of performance, we believe that we have sufficient liquidity to continue our operations at least through June 2011, provided our net revenues do not materially decline and our operating expenses do not materially increase.  Although we have revised our business strategies to reduce our expenses and capital expenditures, we cannot assure you that we will be successful in generating positive cash flows or obtaining access to additional sources of funding in amounts necessary to continue our operations.  Failure to maintain sufficient access to funding may also result in our inability to continue operations.
 
 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 6, 2010. The number of shares outstanding does not include an aggregate of 27,816,991 shares of common stock that are issuable.  This number of issuable common shares is equal to approximately 44% of the 63,721,035 outstanding shares.  These issuable common shares are comprised of:  a) 16,896,821 shares of our common stock reserved for issuance upon exercise of outstanding awards granted under our 1998 Stock Plan and 2006 Stock Plan; b) 5,267,936 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, 2009, 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.
  17
 
 Results Of Operations
 
 Three and Six Months ended June 30, 2010 compared to Three and Six Months ended June 30, 2009
 
 Net Revenues
 
 For the Three Months





For the Three MonthsEnded June 30,


%


Ended June 30,


%2010


2009


Change


2010


2009


ChangeAndrea Anti-Noise Products net Product revenuesSales of products to an OEM customer for usewithspeech recognition software

$
-


$
204,353



(100
)

$
5,666


$
232,877



(98
)
(a)All other Andrea Anti-Noise net product revenues


584,508



599,694



(3
)


1,183,396



1,118,498



6

(b)Total Andrea Anti-Noise Products net Product revenues

$
584,508


$
804,047



(27
)

$
1,189,062


$
1,351,375



(12
)Andrea DSP Microphone and Audio Software Products revenuesSales of automotive array microphone products


200,192



34,019



488



367,934



46,137



697

(c)All other Andrea DSP Microphone and Audio

product revenues


50,779



77,488



(34
)


87,471



140,781



(38
)
(d)License revenues


388,018



282,007



38



821,270



480,848



71

(e)Total Andrea DSP Microphone and Audio Software

Products revenues


638,989



393,514



62



1,276,675



667,766



91Total Revenues

$
1,223,497


$
1,197,561



2


$
2,465,737


$
2,019,141



22
  (a)
The decreases in sales of Andrea Anti-Noise Products is directly related to decreased purchases by an OEM customer for use with speech recognition software during the three and six months ended June 30, 2010 as compared to the same periods in 2009.
  (b)
The decrease of approximately $15,000 and increase of approximately $65,000 for the three and six month periods, respectively as compared to the same period in 2009 in all other Andrea Anti-noise 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.
  (c)
The increases of approximately $166,000 and $322,000 for the three and six month periods, respectively as compared to the same period in 2009 relate to increases in sales of automotive array microphone products is due to increased product sales to integrators of public safety vehicle solutions.
  (d)
The decreases of approximately $27,000 and $54,000 for the three and six month periods, respectively as compared to the same period in 2009 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 increases in license revenues are the result of increased royalties reported for the three and six months ending June 30, 2010 as compared to the same period last year.  We believe this increase is related to an increase of PC models which feature our technology.
  Cost of Revenues
 
 Cost of revenues as a percentage of net revenues for the three months ended June 30, 2010 decreased to 38% from 45% for the three months ended June 30, 2009.  The cost of revenues as a percentage of net revenues for the three months ended June 30, 2010 for Andrea Anti-Noise Products is 52% compared to 59% for the three months ended June 30, 2009.  The cost of revenues as a percentage of net revenues for the three months ended June 30, 2010 for Andrea DSP Microphone and Audio Software Products is 25% compared to 15% for the three months ended June 30, 2009.  Cost of revenues as a percentage of net revenues for the six months ended June 30, 2010 decreased to 37% from 43% for the six months ended June 30, 2009.  The cost of revenues as a percentage of net revenues for the six months ended June 30, 2010 for Andrea Anti-Noise Products is 54% compared to 56% for the six months ended June 30, 2009.  The cost of revenues as a percentage of net revenues for the six months ended June 30, 2010 for Andrea DSP Microphone and Audio Software Products is 21% compared to 15% for the six months ended June 30, 2009. The decreases for the Andrea Anti-Noise Products revenues for the three and six month periods are a result of decreases in sales of products to an OEM customer for use with speech recognition software.  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 relates to increased product sales of automotive array microphone products to integrators of public safety vehicle solutions.
  18
 
 Research and Development
 
 Research and development expenses for the three months ended June 30, 2010 increased 28% to $182,378 from $142,853 for the three months ended June 30, 2009.  For the three months ended June 30, 2010, the increase in research and development expenses reflects a 25% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $100,924, or 55% of total research and development expenses and a 31% increase in our Andrea Anti-Noise Headset Product efforts to $81,454, or 45% of total research and development expenses.  Research and development expenses for the six months ended June 30, 2010 increased 21% to $354,033 from $292,366 for the six months ended June 30, 2009.  These increases primarily relate to increases in employee compensation and related benefit costs.  For the six months ended June 30, 2010, the increase in research and development expenses reflects a 20% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $195,848, or 55% of total research and development expenses and a 23% increase in our Andrea Anti-Noise Headset Product efforts to $158,185, or 45% of total research and development expenses.  With respect to DSP Microphone and Audio Software technologies, research efforts are primarily focused on the pursuit of commercializing a natural language-driven human/machine interface by developing optimal far-field microphone solutions for various voice-driven interfaces, incorporating Andrea’s digital super directional array microphone technology, and certain other related technologies such as noise suppression and stereo acoustic echo cancellation.  We believe that continued research and development spending should provide Andrea with a competitive advantage.
 
 General, Administrative and Selling Expenses
 
 General, administrative and selling expenses were $538,293 for the three months ended June 30, 2010 from $538,658 for the three months ended June 30, 2009.  For the three months ended June 30, 2010, the expenses reflect a 4% decrease in our Andrea DSP Microphone and Audio Software Technology efforts to $249,166, or 46% of total general, administrative and selling expenses and a 4% increase in our Andrea Anti-Noise Headset Product efforts to $289,127, or 54% of total general, administrative and selling expenses.  General, administrative and selling expenses remained relatively flat, $1,176,558 for the six months ended June 30, 2010 from $1,173,079 for the six months ended June 30, 2009.  For the six months ended June 30, 2010, the expenses reflect a 12% decrease in our Andrea DSP Microphone and Audio Software Technology efforts to $529,321, or 45% of total general, administrative and selling expenses and a 13% increase in our Andrea Anti-Noise Headset Product efforts to $647,237, or 55% of total general, administrative and selling expenses.
 
 Interest Income, net
 
 Interest income, net for the three months ended June 30, 2010 was $1,353 compared to $2,444 for the three months ended June 30, 2009.  Interest income, net for the six months ended June 30, 2010 was $3,159 compared to $4,936 for the six months ended June 30, 2009.  The year to date decrease in interest income, net is the result of interest expense from our long term debt.
 
 Provision for Income Taxes
 
 The provision for income taxes for the three months ended June 30, 2010 was $40,872 compared to a provision for income taxes of $308 for the three months ended June 30, 2009.  The provision for income taxes for the six months ended June 30, 2010 was $49,157 compared to a provision for income taxes of $1,565 for the three months ended June 30, 2009.  The increase is a result of an increased estimated taxable income.
 
 Net income (loss)
 
 Net income for the three months ended June 30, 2010 was $2,918 compared to net loss of $17,712 for the three months ended June 30, 2009.  Net loss for the six months ended June 30, 2010 was $18,225 compared to net loss of $301,576 for the three months ended June 30, 2009.  The net income for the three months ended June 30, 2010, net loss for the three months ended June 30, 2009 and net loss for the six months ended June 2010 and 2009 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.
  19
 
 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, 2010, we had cash of $2,055,621 compared with $1,805,091 at December 31, 2009.  The cash balance at June 30, 2010 is primarily a result of our cash provided from operations.
 
 Our working capital balance at June 30, 2010 was $3,010,870 compared to a working capital of 2,718,077 at December 31, 2009.  The increase in working capital reflects an increase in total current assets of $134,681 and a decrease in total current liabilities of $158,112. The increase in total current assets reflects an increase in cash of $250,530, an increase in accounts receivable of $40,911, a decrease in inventory of $76,961, a decrease in short term customer deposits of $13,536, a decrease in deferred income tax assets of $49,101, and a decrease in prepaid expenses of $17,162.  The decrease in total current liabilities reflects a decrease in trade accounts payable of $166,740, an increase in the current portion in long-term debt of $694, a decrease in short-term deferred revenue of $13,536 and an increase of $21,470 in other current liabilities.
 
 The increase in cash of $250,530 reflects $311,604 of net cash provided by operating activities, $50,526 of net cash used in investing activities and $10,548 of cash used in financing activities.
 
 The cash provided by operating activities of $311,604, excluding non-cash charges for the six months ended June 30, 2010, is attributable to a $43,859 increase in accounts receivable, a $61,850 decrease in inventories, a $13,536 decrease in short term customer deposits, a $17,162 decrease in prepaid expenses and other current assets, a $166,740 decrease in accounts payable, a $13,536 decrease in short-term deferred revenue and a $21,470 increase 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 $50,526 reflects purchases of property and equipment of $50,076 and an increase in patents and trademarks of $450.  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 $10,548, reflects repayments to finance a significant upgrade to our information technologies systems.
 
 We plan to continue to improve our cash flows in 2010 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 6, 2010, 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 2011.  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.
 
 Recently Issued Accounting Pronouncements
 
 For a discussion of the impact of recent accounting pronouncements, see Note 2 of the accompanying condensed consolidated financial statements.
  ITEM 3.                      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Not applicable.
  ITEM 4.                      CONTROLS AND PROCEDURES
  Andrea’s management, including its principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, Andrea’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that it files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to Andrea’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that all control issues and instances of fraud, if any, within a company have been detected.  Andrea’s disclosure controls and procedures are designed to provide reasonable assurance of achieving its objectives.
  There have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonable likely to materially affect the Company’s internal controls over financial reporting during the period covered by this Quarterly Report.
  20
  PART II                      OTHER INFORMATION
  ITEM 1.                      LEGAL PROCEEDINGS
  None.
  ITEM 1A.                      RISK FACTORS
  Not applicable.
  ITEM 2.                      UNREGISTERED SALES OF EQUITY SECURITY AND USE OF PROCEEDS
  None.
  ITEM 3.                      DEFAULTS UPON SENIOR SECURITIES
  None.
  ITEM 4.                      (REMOVED AND RESERVED)
  ITEM 5.                      OTHER INFORMATION
  The Company’s 2010 annual meeting of shareholders will be held on September 22, 2010.
  ITEM 6.                      EXHIBITS
  a)
Exhibits
  Exhibit 10.1
Employment Agreement dated August 1, 2010 by and between Andrea Electronics Corporation andDouglas J. Andrea*Exhibit 31
– Rule 13a-14(a)/15d-14(a) CertificationsExhibit 32
– Section 1350 Certifications*Management contract or compensatory plan or arrangement
 
  21
 
 SIGNATURES
  Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  ANDREA ELECTRONICS CORPORATIONBy:
/s/    DOUGLAS J. ANDREAName:Douglas J. AndreaTitle:Chairman of the Board, President, Chief

ExecutiveOfficer and Corporate Secretary
 
  Date: August 10, 2010/s/    DOUGLAS J. ANDREA
Chairman of the Board, President, Chief
August 10, 2010Douglas J. Andrea
Executive Officer and Corporate Secretary/s/    CORISA L. GUIFFRE
Vice President, Chief Financial Officer and
August 10, 2010Corisa L. Guiffre
Assistant Corporate Secretary