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 SECURITIES EXCHANGE ACT OF
      1934




For the
quarterly period ended June 30, 2008




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 checkmark whether the registrant (1) has filed all reports required to by
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 is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition 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 checkmark 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 8, 2008,
there are 60,361,193 common shares outstanding.







PART
I.                           FINANCIAL
INFORMATION




ITEM
1.                           FINANCIAL
STATEMENTS




ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED BALANCE SHEETS





June
      30,
            
            
            December
      31,2008
            
            
            2007(unaudited)ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            1,015,709
            
            
            $
            811,403Accounts
      receivable, net of allowance for doubtful accounts of $7,843 and $21,705,
      respectively
            
            
            533,670
            
            
            
            994,446Inventories,
      net
            
            
            770,969
            
            
            
            714,864Prepaid
      expenses and other current assets
            
            
            63,657
            
            
            
            64,005Total
      current assets
            
            
            2,384,005
            
            
            
            2,584,718Property
      and equipment, net
            
            
            62,629
            
            
            
            57,751Intangible
      assets, net
            
            
            2,774,896
            
            
            
            2,977,673Other
      assets, net
            
            
            12,864
            
            
            
            12,864Total
      assets
            
            $
            5,234,394
            
            
            $
            5,633,006LIABILITIESANDSHAREHOLDERS’
      EQUITYCurrent
      liabilities:Trade
      accounts payable
            
            $
            325,368
            
            
            $
            474,346Accrued
      Series C Preferred Stock Dividends
            
            
            151,583
            
            
            
            151,583Other
      current liabilities
            
            
            125,158
            
            
            
            121,268Total
      current liabilities
            
            
            602,109
            
            
            
            747,197Series
      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: 90.7 shares; liquidation value:
      $907,015
            
            
            1
            
            
            
            1Series
      D Convertible Preferred Stock, net, $.01 par value; authorized: 2,500,000
      shares; issued and outstanding:  1,192,858 shares; liquidation
      value:  $1,192,858
            
            
            11,929
            
            
            
            11,929Common
      stock, $.01 par value; authorized:  200,000,000 shares; issued
      and outstanding: 59,861,193 shares
            
            
            598,612
            
            
            
            598,612Additional
      paid-in capital
            
            
            76,685,464
            
            
            
            76,568,825Accumulated
      deficit
            
            
            (72,663,721
            )
            
            
            (72,293,558
            )Total
      shareholders’ equity
            
            
            4,632,285
            
            
            
            4,885,809Total
      liabilities and shareholders’ equity
            
            $
            5,234,394
            
            
            $
            5,633,006




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,
                2008
            
            
            June
      30,
                2007
            
            
            June
      30,
                2008
            
            
            June
      30,
                2007RevenuesNet
      product revenues
            
            $
            817,136
            
            
            $
            862,293
            
            
            $
            1,613,558
            
            
            $
            2,167,115License
      revenues
            
            
            390,115
            
            
            
            140,171
            
            
            
            520,333
            
            
            
            407,901Revenues
            
            
            1,207,251
            
            
            
            1,002,464
            
            
            
            2,133,891
            
            
            
            2,575,016Cost
      of revenues
            
            
            474,582
            
            
            
            467,750
            
            
            
            959,717
            
            
            
            1,256,919Gross
      margin
            
            
            732,669
            
            
            
            534,714
            
            
            
            1,174,174
            
            
            
            1,318,097Research
      and development expenses
            
            
            185,341
            
            
            
            156,101
            
            
            
            378,745
            
            
            
            328,860General,
      administrative and selling expenses
            
            
            556,273
            
            
            
            491,071
            
            
            
            1,166,447
            
            
            
            1,079,832Loss
      from operations
            
            
            (8,945
            )
            
            
            (112,458
            )
            
            
            (371,018
            )
            
            
            (90,595
            )Interest
      income, net
            
            
            1,697
            
            
            
            1,576
            
            
            
            4,571
            
            
            
            404Loss
      before provision for income taxes
            
            
            (7,248
            )
            
            
            (110,882
            )
            
            
            (366,447
            )
            
            
            (90,191
            )Provision
      for income taxes
            
            
            1,643
            
            
            
            8,252
            
            
            
            3,716
            
            
            
            28,454Net
      loss
            
            $
            (8,891
            )
            
            $
            (119,134
            )
            
            $
            (370,163
            )
            
            $
            (118,645
            )Basic
      and diluted weighted average shares
            
            
            59,861,193
            
            
            
            59,611,981
            
            
            
            59,861,193
            
            
            
            59,327,389Basic
      and diluted net loss per share
            
            $
            (.00
            )
            
            $
            (.00
            )
            
            $
            (.01
            )
            
            $
            (.00
            )




See Notes
to Condensed Consolidated Financial Statements.


3


ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES




CONDENSED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY


FOR THE
SIX MONTHS ENDED JUNE 30, 2008


(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, 2008
            
            
            90.701477
            
            
            $
            1
            
            
            
            1,192,858
            
            
            $
            11,929
            
            
            
            59,861,193
            
            
            $
            598,612
            
            
            $
            76,568,825
            
            
            $
            (72,293,558
            )
            
            $
            4,885,809Stock-based
      Compensation Expense related to Stock Grants to Outside
      Directors
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            10,002
            
            
            
            -
            
            
            
            10,002Stock-based
      Compensation Expense related to Stock Option Grants
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            106,637
            
            
            
            -
            
            
            
            106,637Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (370,163
            )
            
            
            (370,163
            )Balance,
      June 30, 2008
            
            
            90.701477
            
            
            $
            1
            
            
            
            1,192,858
            
            
            $
            11,929
            
            
            
            59,861,193
            
            
            $
            598,612
            
            
            $
            76,685,464
            
            
            $
            (72,663,721
            )
            
            $
            4,632,285






4


ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)








For
      the Six Months EndedJune
      30, 2008
            
            
            June
      30, 2007Cash
      flows from operating activities:Net loss
            
            $
            (370,163
            )
            
            $
            (118,645
            )Adjustments to reconcile net loss
      to net cash provided by operating activities:Depreciation and
      amortization
            
            
            251,655
            
            
            
            243,700Stock -based compensation
      expense
            
            
            116,639
            
            
            
            128,193Provision for bad
      debt
            
            
            -
            
            
            
            (113
            )Inventory reserve
            
            
            22,979
            
            
            
            2,234Change in:Accounts
      receivable
            
            
            460,776
            
            
            
            348,250Inventories
            
            
            (79,084
            )
            
            
            323,405Prepaid expenses and other
      current assets
            
            
            348
            
            
            
            255,772Trade accounts
      payable
            
            
            (148,978
            )
            
            
            (335,655
            )Other current
      liabilities
            
            
            3,890
            
            
            
            (157,623
            )Net cash provided by operating
      activities
            
            
            258,062
            
            
            
            689,518Cash
      flows from investing activities:Purchases of property and
      equipment
            
            
            (19,042
            )
            
            
            -Purchases of patents and
      trademarks
            
            
            (34,714
            )
            
            
            (6,270
            )Net cash used in investing
      activities
            
            
            (53,756
            )
            
            
            (6,270
            )Cash
      flows from financing activities:Payments under capital
      lease
            
            
            -
            
            
            
            (3,541
            )Net cash used in financing
      activities
            
            
            -
            
            
            
            (3,541
            )Net
      increase in cash and cash equivalents
            
            
            204,306
            
            
            
            679,707Cash
      and cash equivalents, beginning of period
            
            
            811,403
            
            
            
            303,678Cash
      and cash equivalents, end of period
            
            $
            1,015,709
            
            
            $
            983,385Non-cash investing and financing
      activities:Conversion of Series C
      Convertible Preferred Stock into common stock
            
            $
            -
            
            
            $
            16,712Supplemental
      disclosures of cash flow information:Cash
      paid for:Interest
            
            $
            -
            
            
            $
            1,189Income Taxes
            
            $
            12,796
            
            
            $
            43,509





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 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 accounting principles generally accepted
in the United States of America (“GAAP”) for complete financial
statements.  In addition, the December 31, 2007 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, 2007 included in the Company's Form
10-KSB for the fiscal year ended December 31, 2007, filed on March 31,
2008.  The accounting policies used in preparing these unaudited
condensed consolidated interim financial statements are consistent with those
described in the December 31, 2007 audited consolidated financial
statements.





Management's Liquidity
Plans - As of June 30, 2008, Andrea had working capital of $1,781,896 and
cash on hand of $1,015,709.  Andrea’s loss from operations was $8,945
for the three months ended June 30, 2008.  Andrea incurred a loss from
operations of $371,018 for the six months ended June 30, 2008.  Andrea
plans to continue to improve its cash flows during 2008 by aggressively pursuing
additional licensing opportunities related to Andrea DSP Audio Software and
increasing its Andrea Anti-Noise Headset Products sales through the introduction
of refreshed product line scheduled to be introduced in the second half of 2008
as well as the increased efforts the Company is dedicating 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 8, 2008, Andrea has approximately $1,000,000 of cash. Management projects
that Andrea has sufficient liquidity available to operate through at least June
2009.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 had generated cash from
operations.  Although these steps are encouraging, 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





(Loss) Earnings Per
Share - Basic (loss) earnings per share is computed by dividing the net
(loss) income by the weighted average number of common shares outstanding during
the period.  Diluted (loss) earnings per share adjusts basic (loss)
earnings 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 (loss) 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 and Six Months EndedJune
      30, 2008
            
            
            June
      30, 2007Total
      potential common shares as of:Options
      to purchase common stock (Note 7)
            
            
            9,691,820
            
            
            
            7,440,001Series
      C Convertible Preferred Stock and related accrued dividends (Note
      3)
            
            
            4,149,736
            
            
            
            4,149,736Series
      D Convertible Preferred Stock and related warrants (Note
4)
            
            
            9,929,776
            
            
            
            9,929,776Total
      potential common shares
            
            
            23,771,332
            
            
            
            21,519,513





6


ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES


NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Cash and Cash
Equivalents - Cash and cash equivalents include cash and highly liquid
investments with original maturities of three months or less.  The
Company has cash deposits in excess of the maximum amounts insured by the
Federal Deposit Insurance Corporation at June 30, 2008 and December 31,
2007.  The Company mitigates its risk by investing in or through major
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,
                2008
            
            
            June
      30,
                2007
            
            
            June
      30,
                2008
            
            
            June
      30,
                2007Customer
      A
            
            
            *
            
            
            
            17
            %
            
            
            *
            
            
            
            14
            %Customer
      B
            
            
            *
            
            
            
            *
            
            
            
            *
            
            
            
            17
            %Customer
      C
            
            
            14
            %
            
            
            14
            %
            
            
            16
            %
            
            
            11
            %Customer
      D
            
            
            *
            
            
            
            12
            %
            
            
            11
            %
            
            
            *Customer
      E
            
            
            24
            %
            
            
            *
            
            
            
            13
            %
            
            
            *


_________________


* Amounts
are less than 10%





As of June
30, 2008, one customer accounted for approximately 29% of accounts receivable
and as of December 31, 2007, two customers account for approximately 20% and 15%
of accounts receivable.





Andrea
purchases a substantial portion of its finished goods from three
suppliers.  Purchases from these three suppliers amounted to 55%, 1%
and 26% of total purchases for the three months ended June 30, 2008 and 40%, 13%
and 47% for the three months ended June 30, 2007.  Purchases from
these three suppliers amounted to 58%, 5% and 27% of total purchases for the six
months ended June 30, 2008 and 77%, 8% and 9% for the six months ended June 30,
2007.  At June 30, 2008, the amounts due to these suppliers in
accounts payable was $4,466, $0 and $6,517, respectively. At December 31, 2007,
the amounts due to these suppliers in accounts payable were $191,411, $0 and
$104,760 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.





Inventories -
Inventories are stated at the lower of cost (on a first-in, first-out) or market
basis.  The cost elements of inventories include materials, labor and
overhead.  Andrea reviews its inventory reserve for obsolescence on a
quarterly basis and establishes reserves on inventories when the cost of the
inventory is not expected to be recovered.  Andrea’s policy is to
reserve for inventory that shows slow movement over the preceding six
consecutive quarters.  Andrea records charges in inventory reserves as
part of cost of revenues.


June
      30, 2008
            
            
            December
      31, 2007Raw
      materials
            
            $
            98,719
            
            
            $
            62,834Finished
      goods
            
            
            1,262,170
            
            
            
            1,218,9711,360,889
            
            
            
            1,281,805Less:
      reserve for slow moving and obsolescence
            
            
            (589,920
            )
            
            
            (566,941
            )$
            770,969
            
            
            $
            714,864








7


ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES


NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




Intangible and Long-Lived
Assets - Andrea accounts for its long-lived assets in accordance with
Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets” for purposes of determining and
measuring impairment of its long-lived assets (primarily intangible assets)
other than goodwill. Andrea’s policy is to periodically review the value
assigned to its long-lived assets to determine if they have been permanently
impaired by adverse conditions which may affect Andrea. If Andrea identifies a
permanent impairment such that the carrying amount of Andrea’s long lived assets
are not recoverable using the sum of an undiscounted cash flow projection (gross
margin dollars from product revenues), a new cost basis for the impaired asset
will be established. If required, an impairment charge is recorded based on an
estimate of future discounted cash flows.  This new cost basis will be
net of any recorded impairment.





At June
30, 2008, because the business segment was operating at a loss for the six
months ended June 30, 2008, management compared the sum of Andrea’s undiscounted
cash flow projections (gross margin dollars from product sales) of the Andrea
DSP Microphone and Audio Software core technology to the carrying value of that
technology.  The results of this test indicated that there was not an
impairment.  This process utilized probability weighted undiscounted
cash flow projections which include a significant amount of management’s
judgment and estimates as to future revenue.  If these probability
weighted projections do not come to fruition, the Company could be required to
record an impairment charge in the near term and such impairment could be
material.





At June
30, 2007, because the revenues from the Andrea DSP Microphone and Audio Software
Products business segment were lower than expected and this business segment was
still operating at a loss, management compared the sum of Andrea’s undiscounted
cash flow projections (gross margin dollars from product sales) of the Andrea
DSP Microphone and Audio Software core technology to the carrying value of that
technology.  The results of this test indicated that there was not an
impairment.  This process utilized probability weighted undiscounted
cash flow projections which include a significant amount of management’s
judgment and estimates as to future revenue.  If these probability
weighted projections do not come to fruition, the Company could be required to
record an impairment charge in the near term and such impairment could be
material.





Andrea
amortizes its core technology, patents and trademarks on a straight-line basis
over the estimated useful lives of its intangible assets that range from 15 to
17 years.  For the three-month periods ended June 30, 2008 and 2007,
amortization expense was $119,177 and $118,043, respectively.  For the
six-month periods ended June 30, 2008 and 2007, amortization expense was
$237,491 and $235,997, respectively.





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
Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended,
and Staff Accounting Bulletin Topic 13 “Revenue Recognition in Financial
Statements.”  License revenue is recognized based on the terms and
conditions of individual contracts (see Note 5).  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 SFAS No. 109, “Accounting for
Income Taxes” and Financial Accounting Standards Board (“FASB”) Interpretation
No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB
Statement No. 109” (“FIN 48”).  SFAS No. 109 requires an asset and
liability approach for financial accounting and reporting for income
taxes.  FIN 48 establishes for all entities a minimum threshold for
financial statement recognition of the benefit of tax positions, and requires
certain expanded disclosures.  Using both of the guidelines set forth
in these statements, 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. 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.  Since cumulative losses weigh heavily in the
overall assessment, Andrea provides a full valuation allowance on future tax
benefits until it can sustain a level of profitability that demonstrates its
ability to utilize the assets, or other significant positive evidence arises
that suggests Andrea’s ability to utilize such assets.  If it becomes
more likely than not that a tax asset will be used, the related valuation
allowance on such assets would be reversed.  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, as defined in FIN
48.  Based on the Company's evaluation, it has concluded that there
are no significant uncertain tax positions requiring recognition in the
Company's financial statements.  The Company's evaluation was
performed for tax years ended 2003 through 2007.  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, 2008, Andrea had three stock-based employee
compensation plans, which are described more fully in Note 7.  Andrea
accounts for stock based compensation in accordance with SFAS No. 123R,
“Share-Based Payment.”  SFAS No. 123R establishes accounting for
stock-based awards exchanged for employee services.  Under the
provisions of SFAS No. 123R, share-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
SFAS No. 123R, 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 option 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
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS
141R”), which replaces SFAS No. 141, “Business Combinations.” SFAS 141R
establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent consideration, and certain acquired contingencies. SFAS 141R also
requires acquisition-related transaction expenses and restructuring costs be
expensed as incurred rather than capitalized as a component of the business
combination. SFAS 141R will be applicable to the Company for fiscal 2009.. SFAS
141R would have an impact on accounting for any businesses acquired after the
effective date of this pronouncement.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – An Amendment of ARB No. 51” (“SFAS 160”).
SFAS 160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary (previously referred to as minority interests). SFAS
160 also requires that a retained noncontrolling interest upon the
deconsolidation of a subsidiary be initially measured at its fair value. Upon
adoption of SFAS 160, the Company would be required to report any noncontrolling
interests as a separate component of stockholders’ equity.  The
Company would also be required to present any net income allocable to
noncontrolling interests and net income attributable to the stockholders of the
Company separately in its consolidated statements of operations. SFAS 160 is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. SFAS 160 requires retroactive adoption
of the presentation and disclosure requirements for existing minority interests.
All other requirements of SFAS 160 shall be applied prospectively. SFAS 160
would have an impact on the presentation and disclosure of the noncontrolling
interests of any non wholly-owned businesses acquired in the
future.





On
February 12, 2008, the FASB issued FASB Staff Position (FSP) No. SFAS 157-2,
“Effective Date of FASB Statement No. 157” (FSP SFAS 157-2). FSP SFAS 157-2
amends SFAS No. 157, to delay the effective date of SFAS 157 for nonfinancial
assets and nonfinancial liabilities, except for the items that are recognized or
disclosed at fair value in the financial statements on a recurring basis. For
items within its scope, FSP SFAS 157-2 defers the effective date of SFAS 157 to
fiscal years beginning after November 15, 2008, and interim periods within those
fiscal years. The Company is currently evaluating the impact of adopting SFAS
157 and FSP SFAS 157-2 on its consolidated financial statements.





In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and
Hedging Activities an amendment of FASB Statement No. 133”, which amends and
expands the disclosure requirements of SFAS 133 to require qualitative
disclosure about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of and gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in
derivative agreements. This statement will be effective for the Company
beginning on January 1, 2009. The adoption of this statement will change the
disclosures related to derivative instruments held by the Company.





Reclassifications -
Certain prior year amounts have been reclassified to conform to the current year
presentation.





9


ANDREA
ELECTRONICS CORPORATION AND
SUBSIDIARIES


NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)




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 condensed consolidated financial
statements in the period that they are determined to be necessary. Actual
results could differ from those estimates and assumptions.





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 $671.23 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 $671.23 represents the 5% per annum from October 10, 2000
through February 17, 2004.





On April
11, 2007, 10 shares of Series C Preferred Stock, together with related accrued
dividends of $16,712, were converted into 457,516 shares of Common Stock at a
conversion price of $0.2551.





As of June
30, 2008, there were 90.701477 shares of Series C Preferred Stock outstanding,
which were convertible into 4,149,736 shares of Common Stock and remaining
accrued dividends of $151,583.





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.  The warrants are exercisable at any time after August 17, 2004
and before February 23, 2009 at an exercise price of $0.38 per
share.





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 are exercisable at any time
after December 4, 2004 and before June 4, 2009 at an exercise price of $0.17 per
share.





Knightsbridge
Capital served as a financial advisor to Andrea in connection with the
aforementioned transactions and the initial issuance of the Series D Preferred
Stock and related warrants.  In connection with these transactions,
Andrea agreed to pay Knightsbridge Capital $350,000 in cash and to issue
warrants exercisable for an aggregate of 439,594 shares of Common Stock. 377,094
of the warrants are exercisable at any time after August 17, 2004 and before
February 23, 2009 at an exercise price of $0.38 per share and 62,500 of the
warrants at any time after December 4, 2004 and before June 4, 2009 at an
exercise price of $0.17 per share.  Through June 30, 2008, 281,250
shares of common stock have been issued as a result of exercises of the Series D
Preferred Stock Warrants.





The
Company is required to maintain an effective registration statement from the
time of issuance through June 4, 2010.  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)




During
2007, 50,000 shares of Series D Preferred Stock were converted into 200,000
shares of Common Stock at a conversion price of $0.25. There were no Series D
Preferred Stock Warrant exercises during the six months ended June 30, 2008 or
the year ended December 31, 2007.





As of June
30, 2008, there are 1,192,858 shares of Series D Preferred Stock and 5,158,344
related warrants outstanding, which are convertible and exercisable into
9,929,776 shares of Common Stock.





Note
5.  Licensing
Agreements





The
Company has entered into various licensing, production and distribution
agreements with manufacturers of personal computers (“PC”) and related
components.  These agreements provide for revenues based on the terms
of each individual agreement.  The Company's three largest licensing
customers accounted for $284,288, $91,621 and $14,106 of revenues for the three
months ended June 30, 2008 and $0, $63,490 and $59,321 of revenues for the three
months ended June 30, 2007.    The Company's three largest
licensing customers accounted for $285,674, $193,997 and $34,833 of revenues for
the six months ended June 30, 2008 and $0, $131,944 and $238,629 of revenues for
the six months ended June 30, 2007.





Note
6.  Commitments
And Contingencies





Leases





In March
2005, Andrea entered into a lease for its corporate headquarters located in
Bohemia, New York, where Andrea leases space for warehousing, sales and
executive offices from an unrelated party.  The lease is for
approximately 11,000 square feet and expires in April 2010.  Rent
expense under this operating lease was $21,083 and $41,552 for the three and
six-month periods ended June 30, 2008, respectively.  Rent expense
under this operating lease was $20,469 and $40,516 for the three and six-month
periods ended June 30, 2007, respectively.





As of June
30, 2008, the future minimum annual lease payments under this lease and all
non-cancelable operating leases are as follows:





2008
      (July 1 to December 31)
            
            
            $
            51,4702009
            
            
            
            93,5412010
            
            
            
            29,171Total
            
            
            $
            174,182





Employment
Agreements





The Board
of Directors expects to enter into a new employment contract with Mr. Andrea on
substantially similar terms as the expired employment agreement described
below.  On August 8, 2008, the Board granted Mr. Andrea 3,000,000
stock options with a fair value of $120,000 (fair value was estimated using the
Black-Scholes option-pricing model).  This grant provides for a four
year vesting period (666,000 from and after August 1, 2009, 999,000 from and
after August 1, 2010, 1,001,000 from and after August 1, 2011 and 334,000 from
and after August 1, 2012) the stock options have an exercise price of $0.04 per
share, which was fair market value at the date of grant, and a term of 10
years.





In
November 2006, the Company entered into an employment agreement with the
Chairman of the Board, Douglas J Andrea.  The employment agreement
expired July 31, 2008 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 $300,000 per
annum.  In addition, upon execution of the employment agreement, Mr.
Andrea was entitled to a salary adjustment from August 1, 2006 through the date
of the employment agreement.   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 November 2,
2006, in accordance with his employment agreement, Mr. Andrea was granted
1,000,000 stock options with a fair value of $100,000. This grant provides for a
three year vesting period, an exercise price of $0.12 per share, which was fair
market value at the date of grant, and a term of 10 years.  On
November 16, 2006, in accordance with his employment agreement, Mr. Andrea was
granted an additional 1,000,000 stock options with a fair value of $100,000.
This grant provides for a three year vesting period, an exercise price of $0.12
per share, which was fair market value at the date of grant, and a term of 10
years.  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.  At June 30, 2008,
the future minimum cash commitments under this agreement aggregate
$25,000.





11


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




Legal
Proceedings





Andrea is
involved in routine litigation incidental to the normal course of business.
While it is not feasible to predict or determine the final outcome of claims,
Andrea believes the resolution of these matters will not have a material adverse
effect on Andrea’s financial position, results of operations or
liquidity.





Note
7.  Stock
Plans and Stock Based Compensation





In 1991,
the Board of Directors of Andrea (the “Board”) adopted the 1991 Performance
Equity Plan (“1991 Plan”), which was approved by the shareholders. The 1991
Plan, as amended, authorizes the granting of awards, the exercise of which would
allow up to an aggregate of 4,000,000 shares of Andrea’s Common Stock to be
acquired by the holders of those awards.  Stock options granted to
employees and directors under the 1991 Plan were granted for terms of up to 10
years at an exercise price equal to the market value at the date of
grant.  No further awards will be granted under the 1991
Plan.





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.  At June 30, 2008, there were 149,984
shares available for further issuance under the 1998 Plan.





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.  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, 2008, there were 5,436,361 shares available for further issuance under
the 2006 Plan.





During
2006, the Board granted 400,000 stock options to the Vice President and Chief
Financial Officer and 755,000 stock options to employees of the
Company.  Each option grant provides for vesting periods of up to
three years, a weighted average exercise price of $0.12 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.  The compensation expense related to these awards was
$7,641 and $20,097 for the three months ended June 30, 2008 and 2007,
respectively.  The compensation expense related to these awards was
$15,282 and $40,399 for the six months ended June 30, 2008 and 2007,
respectively.





On
November 16, 2006, the Board granted 16,667 stock options to each chairperson on
the Nominating and Compensation Committees and 41,667 stock options to the
chairperson on the Audit Committee.  The grants provide for an
eighteen-month vesting period, an exercise price of $0.12 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.  The compensation expense related to these awards
was $139 and $1,749 for the three months ended June 30, 2008 and 2007,
respectively.  The compensation expense related to these awards was
$556 and $4,498 for the six months ended June 30, 2008 and 2007,
respectively.





On
September 12, 2007, the Board granted 1,000,000 stock options to the President
and Chief Executive Officer, 350,000 stock options to the Vice President and
Chief Financial Officer, 60,000 stock options to the Board of Directors and
760,000 stock options to employees and consultants of the
Company.  Each option grant provides for vesting periods of up to
three years, an exercise price of $0.11 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.  The compensation expense related to these awards was $29,823
and $0 for the three months ended June 30, 2008 and 2007,
respectively.  The compensation expense related to these awards was
$59,646 and $0 for the six months ended June 30, 2008 and 2007,
respectively.





On
September 12, 2007, the Board granted 18,182 stock options to each chairperson
on the Nominating and Compensation Committees and 45,455 stock options to the
chairperson on the Audit Committee.  The grants provide for an
eighteen-month vesting period, an exercise price of $0.11 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.  The compensation expense related to these awards
was $1,023 and $0 for the three months ended June 30, 2008 and 2007,
respectively.  The compensation expense related to these awards was
$3,068 and $0 for the six months ended June 30, 2008 and 2007,
respectively.





12


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




In June
2008, the Board granted 200,000 stock options, 100,000 to an employee and
100,000 to an outside consultant.   The grants provide for a
three year vesting period, an exercise price of $0.05 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.  The compensation expense related to these awards was
$305 for the three and six months ended June 30, 2008.





Total
compensation expense recognized related to all stock option awards was $52,821
and $58,494 for the three months ended June 30, 2008 and 2007,
respectively.  In the accompanying consolidated statement of
operations for the three months ending June 30, 2008, $40,890 of expense is
included in general, administrative and selling expenses, $11,550 is included in
research and development expenses and $381 is included in cost of
revenues.  In the accompanying consolidated statement of operations
for the three months ending June 30, 2007, $48,108 of expense is included in
general, administrative and selling expenses, $9,927 is included in research and
development expenses and $459 is included in cost of revenues.  Total
compensation expense recognized related to all stock option awards was $106,637
and $118,193 for the six months ended June 30, 2008 and 2007,
respectively.  In the accompanying consolidated statement of
operations for the six months ending June 30, 2008, $82,775 of expense is
included in general, administrative and selling expenses, $23,100 is included in
research and development expenses and $762 is included in cost of
revenues.  In the accompanying consolidated statement of operations
for the six months ending June 30, 2007, $97,256 of expense is included in
general, administrative and selling expenses, $20,004 is included in research
and development expenses and $933 is included in cost of revenues.





The fair
values of the stock options granted were estimated on the date of grant using
the Black-Scholes option-pricing model that uses the following weighted-average
assumptions for the three and six-month periods ended June 30,
2008:





Three
      months ended June 30, 2008
            
            
            Six
      months ended June 30, 2008Expected
      life in years
            
            
            8
            
            
            
            8Risk-free
      interest rates
            
            
            4.14
            %
            
            
            4.14
            %Volatility
            
            
            138.58
            %
            
            
            138.58
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %





There were
no options granted during the three or six-month periods ended June 30,
2007.





Option
activity during 2008 and 2007 is summarized as follows:


Options
      Outstanding
            
            Options
      ExercisableOptions
      Outstanding
            
            
            Weighted
              Average
              Exercise
              Price
            
            Weighted
              Average
              Remaining
              Contractual Life
            
            Options
              Exercisable
            
            
            Weighted
              Average
              Exercise
              Price
            
            Weighted
              Average
              Remaining
              Contractual LifeAt
      January 1, 2007
            
            
            7,590,001
            
            
            $
            1.05
            
            8.01 years
            
            
            4,397,500
            
            
            $
            1.72
            
            6.26 yearsGranted
            
            
            2,251,819
            
            
            $
            0.11Cancelled
            
            
            (155,000
            )
            
            $
            5.20At
      December 31, 2007
            
            
            9,686,820
            
            
            $
            0.76
            
            7.79 years
            
            
            5,355,590
            
            
            $
            1.29
            
            6.57 yearsGranted
            
            
            200,000
            
            
            $
            0.05Cancelled
            
            
            (195,000
            )
            
            $
            14.28At
      June 30, 2008
            
            
            9,691,820
            
            
            $
            0.48
            
            7.50 years
            
            
            5,212,888
            
            
            $
            0.79
            
            6.33
  years





During the
three months ended June 30, 2008, 25,051 options vested with a weighted average
exercise price of $0.12 and a weighted average fair value of $0.10 per
option.  During the six months ended June 30, 2008, 52,298 options
vested with a weighted average exercise price of $0.11 and a weighted average
fair value of $0.10 per option.





13


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




Based on
the June 30, 2008, fair market value of the company’s common stock of $0.05, the
aggregate intrinsic value for both  the 9,691,820 options outstanding
and 5,212,888 shares exercisable is $3,100.





As of June
30, 2008, there was $161,571 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 ($71,312 in 2008, $72,498 in 2009, $17,207 in
2010 and $554 in 2011).





Pursuant
to Andrea’s compensation policy for outside directors, Andrea granted 181,820
shares of Common Stock with a fair market value of $0.11, 166,668 shares of
Common Stock with a fair market value of $0.12 and 400,000 shares of Common
Stock with a fair market value of $0.05, respectively.  These stock
grants were fully vested on the date of grant.  Compensation expense
related to these awards was $5,001 and $5,000 for the three months ended June
30, 2008 and 2007, respectively.  Compensation expense related to
these awards was $10,002 and $10,000 for the six months ended June 30, 2008 and
2007, respectively.





On August
8, 2008, pursuant to Andrea’s compensation policy for outside directors, Andrea
granted 500,000 shares of Common Stock with a fair market value of $0.04 and
granted 50,000 stock options to each chairperson on the Nominating and
Compensation Committees and 125,000 stock options to the chairperson on the
Audit Committee.  The grants provide for an eighteen-month vesting
period, an exercise price of $0.04 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.  The fair value of these 225,000 stock options was $9,000 (fair
value was estimated on the date of grant using the Black-Scholes option-pricing
model).





Also,
on August 8, 2008 the Board granted 3,000,000 stock options to the President and
Chief Executive Officer, 500,000 stock options to the Vice President and Chief
Financial Officer, 60,000 stock options to the Board of Directors and 1,200,000
stock options to employees of the Company.  Each option grant provides
for vesting periods of up to four years, an exercise price of $0.05 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.  The fair value of these 4,760,000
stock options was $190,400 (fair value was estimated on the date of grant using
the Black-Scholes option-pricing model).





Note
8.  Segment
Information





Andrea
follows the provisions of SFAS No. 131, “Disclosures about Segments of an
Enterprise and Related Information.” Reportable operating segments are
determined based on Andrea’s management approach. The management approach, as
defined by SFAS No. 131, is based on the way that the chief operating
decision-maker organizes the segments within an enterprise for making operating
decisions and assessing performance. While 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, 2008 and
2007:





2008
      Three Month Segment Data
            
            Andrea
      DSP
                Microphone
      and
                Audio
      Software
                Products
            
            
            Andrea
      Anti-
                Noise
      Products
            
            
            Total
      2008 Three
                Month
      Segment
                DataNet
      revenues from external customers
            
            $
            196,666
            
            
            $
            620,470
            
            
            $
            817,136License
      Revenues
            
            
            390,115
            
            
            
            -
            
            
            
            390,115Income
      (loss) from operations
            
            
            45,047
            
            
            
            (53,992
            )
            
            
            8,945Depreciation
      and amortization
            
            
            117,545
            
            
            
            9,086
            
            
            
            126,631Purchases
      of property and equipments
            
            
            2,531
            
            
            
            9,581
            
            
            
            12,112Purchases
      of patents and trademarks
            
            
            -
            
            
            
            23,569
            
            
            
            23,569Assets
            
            
            3,681,633
            
            
            
            1,577,761
            
            
            
            5,259,394Total
      long lived assets
            
            
            2,624,235
            
            
            
            226,154
            
            
            
            2,850,389




14


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




2007
      Three Month Segment Data
            
            Andrea
      DSP
                Microphone
      and
                Audio
      Software
                Products
            
            
            Andrea
      Anti-
                Noise
      Products
            
            
            Total
      2007 Three
                Month
      Segment
                DataNet
      revenues from external customers
            
            $
            328,601
            
            
            $
            533,692
            
            
            $
            862,293License
      Revenues
            
            
            140,171
            
            
            
            -
            
            
            
            140,171Loss
      from operations
            
            
            (108,048
            )
            
            
            (4,410
            )
            
            
            (112,458
            )Depreciation
      and amortization
            
            
            117,166
            
            
            
            4,729
            
            
            
            121,895Purchases
      of patents and trademarks
            
            
            510
            
            
            
            5,760
            
            
            
            6,270





The
following represents selected condensed consolidated financial information for
Andrea’s segments for the six-month periods ended June 30, 2008 and
2007:





2008
      Six Month Segment Data
            
            Andrea
      DSP
                Microphone
      and
                Audio
      Software
                Products
            
            
            Andrea
      Anti-
                Noise
      Products
            
            
            Total
      2008 Six
                Month
      Segment
                DataNet
      revenues from external customers
            
            $
            462,209
            
            
            $
            1,151,349
            
            
            $
            1,613,558License
      Revenues
            
            
            520,333
            
            
            
            -
            
            
            
            520,333Loss
      from operations
            
            
            (192,456
            )
            
            
            (178,562
            )
            
            
            (371,018
            )Depreciation
      and amortization
            
            
            234,888
            
            
            
            16,767
            
            
            
            251,655Purchases
      of property and equipments
            
            
            5,995
            
            
            
            13,047
            
            
            
            19,042Purchases
      of patents and trademarks
            
            
            6,155
            
            
            
            28,559
            
            
            
            34,7142007
      Six Month Segment Data
            
            Andrea
      DSP
                Microphone
      and
                Audio
      Software
                Products
            
            
            Andrea
      Anti-
                Noise
      Products
            
            
            Total
      2007 Six
                Month
      Segment
                DataNet
      revenues from external customers
            
            $
            796,085
            
            
            $
            1,371,030
            
            
            $
            2,167,115License
      Revenues
            
            
            407,901
            
            
            
            -
            
            
            
            407,901(Loss)
      income from operations
            
            
            (110,304
            )
            
            
            19,709
            
            
            
            (90,595
            )Depreciation
      and amortization
            
            
            234,325
            
            
            
            9,375
            
            
            
            243,700Purchases
      of patents and trademarks
            
            
            510
            
            
            
            5,760
            
            
            
            6,270





The
following represents selected condensed consolidated financial information for
Andrea’s segments as of December 31, 2007.





2007
      Year End Segment Data
            
            Andrea
      DSP
                Microphone
      and
                Audio
      Software
                Products
            
            
            Andrea
      Anti-
                Noise
      Products
            
            
            Total
      2007Assets
            
            
            4,021,688
            
            
            
            1,611,318
            
            
            
            5,633,006Total
      long lived assets
            
            
            2,858,713
            
            
            
            189,575
            
            
            
            3,048,288




15


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




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, 2008
and 2007, and as of each respective period-end, net revenues and accounts
receivable by geographic area are as follows:





Geographic
      Data
            
            June
      30, 2008
            
            
            June
      30, 2007Net
      revenues:United States
            
            $
            1,036,123
            
            
            $
            724,567Foreign(1)
            
            
            171,128
            
            
            
            277,897$
            1,207,251
            
            
            $
            1,002,464




(1)
            Net
      revenues to any one foreign country did not exceed 10% of total net
      revenues for the three months ended June 30, 2008.  Net revenue
      to the People’s Republic of China and Singapore represented 17% and 4%,
      respectively of total net revenues for three months ended June 30,
      2007.




For the
six-month periods ended June 30, 2008 and 2007, by geographic area, net revenues
are as follows:





Geographic
      Data
            
            June
      30, 2008
            
            
            June
      30, 2007Net
      revenues:United States
            
            $
            1,758,771
            
            
            $
            1,837,746Foreign(2)
            
            
            375,120
            
            
            
            737,270$
            2,133,891
            
            
            $
            2,575,016




(2)
            Net
      revenues to any one foreign country did not exceed 10% of total net
      revenues for the six months ended June 30, 2008.  Net revenue to
      the People’s Republic of China and Singapore represented 15% and 9%,
      respectively of total net revenues for six months ended June 30,
      2007.




As of June
30, 2008 and December 31, 2007, accounts receivable by geographic area is as
follows:





Geographic
      Data
            
            June
      30, 2008
            
            
            December
      31, 2007Accounts
      receivable:United States
            
            $
            504,792
            
            
            $
            736,122Foreign
            
            
            28,878
            
            
            
            258,324$
            533,670
            
            
            $
            994,446






16




ITEM
      2.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDIDTION 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 devises, 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-KSB for the year ended December 31, 2007.  A
discussion of our critical accounting policies and estimates are included in
Management’s Discussion and Analysis or Plan of Operation in our Annual Report
on Form 10-KSB for the year ended December 31, 2007. 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 10KSB for
the year ended December 31, 2007 as filed with the Securities and Exchange
Commission.





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 II, “Item 6. Management’s Discussion and
Analysis or Plan of Operation—Risk Factors” in the Company’s Annual
Report on Form 10-KSB for the year ended December 31, 2007.  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.





17




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;




–
            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,
2008 were $1,207,251 versus $1,002,464 for the three months ended June 30,
2007.  Net loss for the three months ended June 30, 2008 was $8,891,
or $0.00 loss per share on a basic and diluted basis, versus net loss of
$119,134, or $0.00 loss per share on a basic and diluted basis for the three
months ended June 30, 2008. Our revenues for the six months ended June 30, 2008
were $2,133,891 versus $2,575,016 for the six months ended June 30,
2007.  Net loss for the six months ended June 30, 2008 was $370,163 or
$.01 loss per share on a basic and diluted basis, versus net loss of $118,645,
or $.00 loss per share on a basic and diluted basis for the six months ended
June 30, 2007. 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 achieve profitable operations we need to
maintain/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.  We may have to
raise 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 past few years of performance, we believe
that we have sufficient liquidity to continue our operations at least through
June 2009, provided our net revenues do not continue to decline and our
operating expenses do not continue to 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, 60,361,193 were outstanding as of August 8, 2008. The number of
shares outstanding does not include an aggregate of 28,857,677 shares of common
stock that are issuable.  This number of issuable common shares is
equal to approximately 48% of the 60,361,193 outstanding
shares.  These issuable common shares are comprised
of:  a)14,676,820 shares of our common stock reserved for issuance
upon exercise of outstanding awards granted under our 1991 Performance Equity
Plan, 1998 Stock Plan and 2006 Stock Plan; b) 101,345 shares reserved for future
grants under our 2006 Stock Plan; c) 4,149,736 shares of common stock that are
issuable upon conversion of the Series C Preferred Stock; d) 4,771,432 shares of
common stock issuable upon conversion of the Series D Preferred Stock; and e)
5,158,344 of common stock issuable upon exercise of warrants relating to the
Series D Preferred stock.





18




Changes
in economic and political conditions outside the United States could adversely
affect our business, results of operations and financial condition.





We
generate revenues to regions outside the United States, particularly in Asia.
For the three months ended June 30, 2008 and 2007, net revenues to customers
outside the United States accounted for approximately 14% and 28%, respectively,
of our net sales. International sales and operations are subject to a number of
risks, including:




•           trade
restrictions in the form of license requirements;




•           restrictions
on exports and imports and other government controls;




•           changes
in tariffs and taxes;




•           difficulties
in staffing and managing international operations;




•           problems
in establishing and managing distributor relationships;




•           general
economic conditions; and




•           political
and economic instability or conflict.




To date,
we have invoiced our international revenues in U.S. dollars, and have not
engaged in any foreign exchange or hedging transactions. We may not be able to
continue to invoice all of our revenues in U.S. dollars in order to avoid
engaging in foreign exchange or hedging transactions. If we are required to
invoice any material amount of international revenues in non-U.S. currencies,
fluctuations in the value of non-U.S. currencies relative to the U.S. dollar may
adversely affect our business, results of operations and financial condition or
require us to incur hedging costs to counter such fluctuations.




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 II,
“Item 6. Management’s
Discussion and Analysis or Plan of Operation—Risk Factors” in the
Company’s Annual Report on Form 10-KSB for the year ended December 31, 2007,
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-KSB 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.





Results
Of Operations





Quarter
ended June 30, 2008 compared to Quarter ended June 30, 2007





Net
Revenues
 For
      the Three Months
                  Ended
      June 30
                
                %
                
                
                For
      the Six Months
                  Ended
      June 30
                
                %2008
                
                
                2007
                
                Change
                
                
                2008
                
                
                2007
                
                ChangeAndrea
      Anti-Noise Products net Product revenuesSales
      of products to an OEM customer for use with speech recognition
      software
                $
                98,310
                
                $
                -
                
                100
                
                $
                123,100
                
                $
                131,361
                
                (6
                )
                (a)All
      other Andrea Anti-Noise net product revenues
                
                522,160
                
                
                530,692
                
                (2
                )
                
                1,028,249
                
                
                1,239,669
                
                (5
                )Total
      Andrea Anti-Noise Products net Product revenues
                $
                620,470
                
                $
                533,692
                
                16
                
                $
                1,151,349
                
                $
                1,371,030
                
                (16
                )Andrea
      DSP Microphone and Audio Software Products revenuesSales
      of array microphone products to an OEM customer
                
                9,800
                
                
                171,140
                
                (94
                )
                
                107,800
                
                
                372,110
                
                (71
                )
                (b)All
      other Andrea DSP Microphone and Audio product revenues
                
                186,866
                
                
                157,461
                
                19
                
                
                354,409
                
                
                423,975
                
                (16
                )
                (c)License
      revenues
                
                390,115
                
                
                140,171
                
                178
                
                
                520,333
                
                
                407,901
                
                28
                
                (d)Total
      Andrea DSP Microphone and Audio Software Products revenues
                
                586,781
                
                
                468,772
                
                25
                
                
                982,542
                
                
                1,203,986
                
                (18
                )Total
      Revenues
                $
                1,207,251
                
                $
                1,002,464
                
                20
                
                $
                2,133,891
                
                $
                2,575,016
                
                (17
                )


19
 (a)
                The
      significant increase of revenues of Andrea Anti-Noise Products is directly
      related to an OEM customer for use with speech recognition software and
      was a result of the OEM’s increased demand for our products during the
      three month ended June 30, 2008 as compared to the same period in
      2007.  The slight decrease of revenues of Andrea Anti-Noise
      Products is directly related to an OEM customer for use with speech
      recognition software and was a result of the OEM’s decreased demand for
      our products during the six month ended June 30, 2008 as compared to the
      same period in 2007.  We believe that our annual revenues for
      2008 associated with this customer will be approximately
      $250,000.
  (b)
                The
      significant decrease of 94% and 71% of revenues of microphone array
      products to an OEM customer for the three month and six month period
      ending June 30, 2008, respectively, relates to the decreased demand from
      the OEM customer.  We believe that this decrease is result of
      the OEM deciding not to continue including a microphone array with all
      applicable product models.  The revenues in 2007 were a result
      of the OEM’s introduction of the OEM’s product and the OEM customer’s need
      to supply all of its customers for the initial launch.
  (c)
                The
      19% increase in all other Andrea DSP Microphone and Audio product revenues
      for the three month period ended June 30, 2008 and 16% decrease for the
      six months ended June 30, 2008 is a result of timing of shipments for both
      the three month and six month
periods.
  (d)
                The
      majority of the increase in licensing revenues for the three and six month
      periods ended June 30, 2008 is a result of licensing revenue from one
      customer in the PC Audio market.  The significant increase for
      the three month period was a result of the customer’s initial
      implementation of our technology and, as a result, we do not expect
      licensing revenue from this customer to continue to increase during the
      second half of 2008.  However, we do expect our 2008 twelve
      month licensing revenues to be slightly higher than 2007 licensing
      revenues primarily as a result of the revenues generated during the six
      months ended June 30, 2008.
 Cost of
Revenues
 
 Cost of
revenues as a percentage of net revenues for the three months ended June 30,
2008 decreased to 39% from 47% for the three months ended June 30,
2007.  The cost of revenues as a percentage of net revenues for the
three months ended June 30, 2008 for Andrea Anti-Noise Products is 63% compared
to 55% for the three months ended June 30, 2007.  The cost of revenues
as a percentage of net revenues for the three months ended June 30, 2008 for
Andrea DSP Microphone and Audio Software Products is 15% compared to 37% for the
three months ended June 30, 2007. Cost of revenues as a percentage of net
revenues for the six months ended June 30, 2008 decreased to 45% from 49% for
the six months ended June 30, 2007.  The cost of revenues as a
percentage of net revenues for the six months ended June 30, 2008 for Andrea
Anti-Noise Products is 63% compared to 59% for the six months ended June 30,
2007.  The cost of revenues as a percentage of net revenues for the
six months ended June 30, 2008 for Andrea DSP Microphone and Audio Software
Products is 24% compared to 37% for the six months ended June 30, 2007. The
changes are primarily the result of the changes in revenue as described under
“Net Revenues” above.
 
 Research and
Development
 
 Research
and development expenses for the three months ended June 30, 2008 increased 19%
to $185,341 from $156,101 for the three months ended June 30,
2007.  This increase primarily relates to increases in employee
compensation and related benefit costs.  For the three months ended
June 30, 2008, the increase in research and development expenses reflects a 10%
increase in our Andrea DSP Microphone and Audio Software Technology efforts to
$125,599, or 68% of total research and development expenses and a 41% increase
in our Andrea Anti-Noise Headset Product efforts to $59,742, or 32% of total
research and development expenses. Research and development expenses for
the six months ended June 30, 2008 increased 15% to $378,745 from $328,860 for
the six months ended June 30, 2007.  This increase primarily relates
to increases in employee compensation and related benefit
costs.  For the six months ended June 30, 2008, the increase in
research and development expenses reflects a 9% increase in our Andrea DSP
Microphone and Audio Software Technology efforts to $258,570, or 68% of total
research and development expenses and a 30% increase in our Andrea Anti-Noise
Headset Product efforts to $120,175, or 32% 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 increased approximately 13% to $556,273 for
the three months ended June 30, 2008 from $491,071 for the three months
ended June 30, 2007.  For the three months ended June 30, 2008, the
increase reflects a 15% increase in our Andrea DSP Microphone and Audio Software
Technology efforts to $330,892, or 60% of total general, administrative and
selling expenses and an 11% increase in our Andrea Anti-Noise Headset
Product efforts to $225,381, or 40% of total general, administrative and selling
expenses. General, administrative and selling expenses increased
approximately 8% to $1,166,447 for the six months ended June 30, 2008 from
$1,079,832 for the six months ended June 30, 2007.  For the six months
ended June 30, 2008, the increase reflects a 9% increase in our Andrea DSP
Microphone and Audio Software Technology efforts to $681,450, or 58% of total
general, administrative and selling expenses and a 7% increase in our Andrea
Anti-Noise Headset Product efforts to $484,997, or 42% of total general,
administrative and selling expenses. These increases relate to
increases in employee compensation and related benefit costs as well as
increases in sales and marketing efforts.
 
 20
  Interest income,
net
 
 Interest
income, net for the three months ended June 30, 2008 was $1,697 compared to
$1,576 for the three months ended June 30, 2007. Interest income, net for the
six months ended June 30, 2008 was $4,571 compared to $404 for the six months
ended June 30, 2007.  The year to date increase in other income
is the result of interest earned on higher cash balances in 2008.
 
 Provision for 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.  Amounts are based on net revenues and
are therefore subject to change.
 
 Net loss
 
 Net loss
for the three months ended June 30, 2008 was $8,891 compared to a net loss of
$119,134 for the three months ended June 30, 2007. Net loss for the six
months ended June 30, 2008 was $370,163 compared to a net loss of $118,645 for
the six months ended June 30, 2007.  The net loss for the three and
six month periods ended June 30, 2008 and the net loss for the three months and
six months ended June 30, 2007 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.
 
 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, 2008, we had cash and cash
equivalents of $1,015,709 compared with $811,403 at December 31,
2007.  The balance of cash and cash equivalents at June 30, 2008 is
primarily a result of our cash provided from operations during the six months
ended June 30, 2008.
 
 Working
capital balance at June 30, 2008 was $1,781,896 compared to a working capital
balance of $1,837,521 at December 31, 2007.  The decrease in working
capital reflects a decrease in total current assets of $200,713 coupled with a
decrease in total current liabilities of $145,088. The decrease in total current
assets reflects an increase in cash and cash equivalents of $204,306, a decrease
in accounts receivable of $460,776, an increase in inventory of $56,105, and a
decrease in prepaid expenses and other current assets of $348.  The
decrease in total current liabilities reflects a decrease in trade accounts
payable of $148,978, and an increase of $3,890 in other current liabilities. The
increase in cash and cash equivalents of $204,306 reflects $258,062 of net cash
provided by operating activities, and $53,756 of net cash used in investing
activities.
 
 The cash
provided by operating activities of $258,062, excluding non-cash charges for the
quarter ended June 30, 2008, is attributable to a $460,776 decrease in accounts
receivable, a $79,084 increase in inventory, a $348 decrease in prepaid expenses
and other current assets, a $148,978 decrease in accounts payable, and a $3,890
increase in other current liabilities.  The changes in receivables,
inventory 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 by investing activities of $53,756 reflects an increase in property and
equipment of $19,042 and an increase in patents and trademarks of
$34,714.  The increase in property and equipment reflects capital
expenditures associated with computer purchases and tooling for some of new
products.  The increase in patents and trademarks reflects capital
expenditures associated with our intellectual property.
 
 We plan to
continue to improve our cash flows during 2008 by aggressively pursuing
additional licensing opportunities related to our Andrea DSP Audio Software and
increasing our Andrea Anti-Noise Headset Products through the introduction of
refreshed product line scheduled to be introduced in the second half of 2008 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  8, 2008, Andrea has approximately $1,000,000 of cash and cash
equivalents.  We believe that we have sufficient liquidity available
to continue in operation through at least June 2009.  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.
  21
 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 DISCLOSURE 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.
  Limitations on the
Effectiveness of Controls
  A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that all control issues and instance 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
during the period covered by this Quarterly Report that have materially
affected, or are reasonable likely to materially affect the Company’s internal
controls over financial reporting.
  PART
II                      OTHER
INFORMATION
  ITEM
1.                      LEGAL
PROCEEDINGS
  None.
  ITEM
1A.                    RISK
FACTORS
 
 Not
Applicable.
 
 ITEM
2.                      UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  None.
  ITEM
3.                      DEFAULTS
UPON SENIOR SECURITIES
  None.
  ITEM
4.                      SUBMISSION
OF MATTERS TO A VOTE OF SECURITIES HOLDERS
  None
  .ITEM
5.                      OTHER INFORMATION
  None.
  ITEM
6.                      EXHIBITS
  a)
              
              Exhibits
  Exhibit 31
– Rule 13a-14(a)/15d-14(a) Certifications*
  Exhibit 32
– Section 1350 Certifications*
 
 * Filed
herewith
 
 22
  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
                Executive Officer and Corporate
      Secretary
 
  Date:
      August 14, 2008
 /s/    DOUGLAS
      J. ANDREA
              Chairman
      of the Board, President, Chief
              August
      14, 2008Douglas
      J. Andrea
              Executive
      Officer and Corporate Secretary/s/    CORISA
      L. GUIFFRE
              Vice
      President, Chief Financial Officer and
              August
      14, 2008Corisa
      L. Guiffre
              Assistant
      Corporate Secretary
   23