##### 



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 September 25, 2004 OR  o
    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 001-11655 HearUSA, Inc. 
 (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    22-2748248(State of Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)1250 Northpoint Parkway, West Palm Beach, Florida
    
    33407(Address of Principal Executive Offices)
    
    (Zip Code)
 Registrants Telephone Number, Including Area Code   (561) 478-8770   Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report
 Indicate
by check ü whether the registrant (1) has filed all reports
required to be filed by Section 13 or15(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   Yesþ  No  o Indicate
by check ü whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).  Yeso Noþ On October 29, 2004 29,516,483 shares of the Registrants Common Stock and
913,419 exchangeable shares of HEARx Canada, Inc. were outstanding.




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##### 



INDEX PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements:Consolidated Balance Sheets
September 25, 2004 and December 27, 2003
    
    
    3Consolidated Statements of Operations
Nine months ended September 25, 2004 and September 27, 2003
    
    
    4Consolidated Statements of Operations
Three months ended September 25, 2004 and September 27, 2003
    
    
    5Consolidated Statements of Cash Flows
Nine months ended September 25, 2004 and September 27, 2003
    
    
    6-7Notes to Consolidated Financial Statements
    
    
    8-13Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    14-21Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    22PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    23-24Signatures
    
    
    25
 2




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##### 



Part I  Financial Information Item 1. Financial Statements HearUSA, Inc.
Consolidated Balance Sheets September 25,
    
    December 27,2004
    
    2003(unaudited)
    
    (audited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    2,498,247
    
    
    $
    6,714,881Restricted Cash
    
    
    285,000
    
    
    
    Investment securities
    
    
    150,000
    
    
    
    435,000Accounts and notes receivable, less allowance for
doubtful accounts of $386,544 and $490,881
    
    
    6,791,231
    
    
    
    6,539,149Inventories
    
    
    925,755
    
    
    
    979,092Prepaid expenses and other
    
    
    611,982
    
    
    
    1,115,393Total current assets
    
    
    11,262,215
    
    
    
    15,783,515Property and equipment, net
    
    
    3,923,851
    
    
    
    4,969,265Goodwill
    
    
    33,410,903
    
    
    
    33,222,779Intangible assets, net
    
    
    11,276,580
    
    
    
    11,577,097Deposits and other
    
    
    375,733
    
    
    
    630,694$
    60,249,282
    
    
    $
    66,183,350LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    7,160,003
    
    
    $
    6,750,234Accrued expenses
    
    
    2,062,064
    
    
    
    2,492,094Accrued salaries and other compensation
    
    
    1,972,280
    
    
    
    1,706,252Current maturities of long-term debt
    
    
    4,105,704
    
    
    
    6,436,271Dividends payable
    
    
    253,970
    
    
    
    728,699Total current liabilities
    
    
    15,554,021
    
    
    
    18,113,550Long-term debt
    
    
    18,318,802
    
    
    
    20,579,977Commitments and contingencies
    
    
    
    
    
    
    Convertible subordinated notes, net of debt discount of
$5,938,723 and $7,423,596 (Note 4)
    
    
    1,561,277
    
    
    
    76,404Mandatorily redeemable convertible preferred stock (Series E)
    
    
    4,682,468
    
    
    
    4,600,107Stockholders equityPreferred stock (Aggregate liquidation preference
$2,330,000; $1 par, 7,500,000 shares authorized)Series H Junior Participating (none outstanding)
    
    
    
    
    
    
    Series J (233 shares outstanding)
    
    
    233
    
    
    
    233Total preferred stock
    
    
    233
    
    
    
    233Common stock: $.10 par; 75,000,000 shares authorized
30,040,010 and 29,528,432 shares issued
    
    
    3,004,014
    
    
    
    2,952,845Stock subscription
    
    
    (412,500
    )
    
    
    (412,500
    )Additional paid-in capital
    
    
    120,091,819
    
    
    
    120,226,050Accumulated deficit
    
    
    (101,283,036
    )
    
    
    (98,501,791
    )Accumulated other comprehensive income
    
    
    1,217,325
    
    
    
    1,033,616Treasury stock, at cost: 523,662 and 523,662 common shares
    
    
    (2,485,141
    )
    
    
    (2,485,141
    )Total stockholders equity
    
    
    20,132,714
    
    
    
    22,813,312$
    60,249,282
    
    
    $
    66,183,350
 See accompanying notes to the consolidated financial statements 3




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##### 



HearUSA, Inc.
Consolidated Statements of Operations
Nine Months Ended September 25, 2004 and September 27, 2003 September 25,
    
    September 27,2004
    
    2003(unaudited)
    
    (unaudited)Net revenues
    
    $
    53,515,329
    
    
    $
    53,664,664Operating costs and expensesCost of products sold
    
    
    15,064,687
    
    
    
    15,202,201Center operating expenses
    
    
    27,971,230
    
    
    
    26,062,405General and administrative expenses
    
    
    7,534,233
    
    
    
    7,529,998Depreciation and amortization
    
    
    1,755,384
    
    
    
    2,334,585Total operating costs and expenses
    
    
    52,325,534
    
    
    
    51,129,189Income from operations
    
    
    1,189,795
    
    
    
    2,535,475Non-operating income (expense):Interest income
    
    
    11,045
    
    
    
    16,701Interest expense (including approximately $1,595,000
of non-cash debt discount amortization in 2004)
    
    
    (3,467,304
    )
    
    
    (1,608,717
    )Income (loss) from continuing operations
    
    
    (2,266,464
    )
    
    
    943,459Discontinued operationsLoss from discontinued operations
    
    
    
    
    
    
    (201,536

    )Net income (loss) before dividends on preferred stock
    
    
    (2,266,464
    )
    
    
    741,923Dividends on preferred stock
    
    
    (530,828
    )
    
    
    (439,972
    )Net income (loss) applicable to common stockholders
    
    $
    (2,797,292
    )
    
    $
    301,951Net income (loss) from continuing operations,
including dividends on preferred stock, per common
share - basic
    
    $
    (0.09
    )
    
    $
    0.02Net income (loss) from continuing operations,
including dividends on preferred stock, per common
share - diluted
    
    $
    (0.09
    )
    
    $
    0.01Net income (loss) applicable to common stockholders
per common share - basic
    
    $
    (0.09
    )
    
    $
    0.01Net income (loss) applicable to common stockholders
per common share - diluted
    
    $
    (0.09
    )
    
    $
    0.01Weighted average number of shares of common stock
outstanding - basic
    
    
    30,425,804
    
    
    
    30,424,466Weighted average number of shares of common stock
outstanding - diluted
    
    
    30,425,804
    
    
    
    48,191,168
 See accompanying notes to the consolidated financial statements 4




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##### 



HearUSA, Inc.
Consolidated Statements of Operations
Three Months Ended September 25, 2004 and September 27, 2003 September 25,
    
    September 27,2004
    
    2003(unaudited)
    
    (unaudited)Net revenues
    
    $
    18,430,846
    
    
    $
    17,276,558Operating costs and expensesCost of products sold
    
    
    5,084,418
    
    
    
    4,745,705Center operating expenses
    
    
    9,118,614
    
    
    
    8,927,598General and administrative expenses
    
    
    2,585,408
    
    
    
    2,657,870Depreciation and amortization
    
    
    563,816
    
    
    
    700,011Total operating costs and expenses
    
    
    17,352,256
    
    
    
    17,031,184Income from operations
    
    
    1,078,590
    
    
    
    245,374Non-operating income (expense):Interest income
    
    
    3,601
    
    
    
    4,740Interest expense (including approximately
$532,000 of non-cash debt discount
amortization in 2004)
    
    
    (1,138,273
    )
    
    
    (493,179
    )Loss from continuing operations
    
    
    (56,082
    )
    
    
    (243,065
    )Discontinued operationsLoss from discontinued operations
    
    
    
    
    
    
    (3,830
    )Net loss before dividends on preferred stock
    
    
    (56,082
    )
    
    
    (246,895
    )Dividends on preferred stock
    
    
    (177,331
    )
    
    
    (142,547
    )Net loss applicable to common stockholders
    
    $
    (233,413
    )
    
    $
    (389,442
    )Net loss from continuing operations,
including dividends on preferred stock, per
common share - basic
    
    $
    (0.01
    )
    
    $
    (0.01
    )Net loss from continuing operations,
including dividends on preferred stock, per
common share - diluted
    
    $
    (0.01
    )
    
    $
    (0.01
    )Net loss applicable to common stockholders
per common share - basic
    
    $
    (0.01
    )
    
    $
    (0.01
    )Net loss applicable to common stockholders
per common share - diluted
    
    $
    (0.01
    )
    
    $
    (0.01
    )Weighted average number of shares of common
stock outstanding - basic
    
    
    30,429,902
    
    
    
    30,423,652Weighted average number of shares of common
stock outstanding - diluted
    
    
    30,429,902
    
    
    
    30,423,652
 See accompanying notes to the consolidated financial statements 5




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##### 



HearUSA, Inc.
Consolidated Statements of Cash Flows
Nine Months Ended September 25, 2004 and September 27, 2003 September 25,
    
    September 27,2004
    
    2003(unaudited)
    
    (unaudited)Cash flows from operating activitiesNet income (loss)
    
    $
    (2,266,464
    )
    
    $
    741,923Loss from discontinued operations
    
    
    
    
    
    
    201,536Net income (loss) from continuing operations
    
    
    (2,266,464
    )
    
    
    943,459Adjustments to reconcile net (loss) gain to net cash
(used in) provided by operating activities:Depreciation and amortization
    
    
    1,755,384
    
    
    
    2,335,085Provision for doubtful accounts
    
    
    313,443
    
    
    
    591,663Debt discount amortization
    
    
    1,595,300
    
    
    
    Principal payments on long-term debt made through
preferred pricing reductions
    
    
    (2,190,603
    )
    
    
    (2,189,836
    )Interest on Siemens Tranche D
    
    
    480,215
    
    
    
    576,643Executive compensation expense
    
    
    19,750
    
    
    
    Equipment purchases through vendor credit
    
    
    (158,800
    )
    
    
    Consulting expense through issuance of warrants
    
    
    6,881
    
    
    
    Cash flows provided by (used in) operations before
changes in non-cash current assets and liabilities
    
    
    (444,894
    )
    
    
    2,257,014(Increase) decrease in:Accounts and notes receivable
    
    
    (1,202,220
    )
    
    
    (1,261,040
    )Inventories
    
    
    54,764
    
    
    
    (135,218
    )Prepaid expenses and other
    
    
    759,068
    
    
    
    526,216Increase (decrease) in:Accounts payable and accrued expenses
    
    
    (146,817
    )
    
    
    (1,122,961
    )Accrued salaries and other compensation
    
    
    248,304
    
    
    
    (1,699,867
    )Net cash used in continuing operations
    
    
    (731,795
    )
    
    
    (1,435,856
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (372,098
    )Net cash used in operations
    
    
    (731,795
    )
    
    
    (1,807,954
    )Cash flows from investing activitiesPurchase of property and equipment
    
    
    (176,656
    )
    
    
    (213,516
    )Capital expenditures of discontinued operations
    
    
    
    
    
    
    (8,196
    )Proceeds from sales of discontinued operations
    
    
    102,539
    
    
    
    1,164,667Net cash (used in) provided by investing activities
    
    
    (74,117
    )
    
    
    942,955Cash flows from financing activitiesProceeds from issuance of long-term debt
    
    
    500,000
    
    
    
    3,500,000Payments on long-term debt from discontinued operations
    
    
    
    
    
    
    (29,822
    )Principal payments on long-term debt
    
    
    (2,894,616
    )
    
    
    (962,210
    )Purchase of treasury stock
    
    
    
    
    
    
    (1,700
    )Cost of exchange & redemption of capital stock
    
    
    (102,382
    )
    
    
    (153,757
    )Proceeds from Board of Director sale of stock
    
    
    
    
    
    
    40,250Proceeds from exercise of employee stock options
    
    
    4,189
    
    
    
    15Dividends on preferred stock
    
    
    (923,196
    )
    
    
    (339,800
    )Net cash provided by (used in) financing activities
    
    
    (3,416,005
    )
    
    
    2,052,976Effects of exchange rate changes on cash
    
    
    5,283
    
    
    
    17,305Net increase (decrease) in cash and cash equivalents
    
    
    (4,216,634
    )
    
    
    1,205,282Cash and cash equivalents at beginning of period
    
    
    6,714,881
    
    
    
    2,410,023Cash and cash equivalents at end of period
    
    $
    2,498,247
    
    
    $
    3,615,305
 See accompanying notes to consolidated financial statements 6




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HearUSA, Inc.
Consolidated Statements of Cash Flows
Nine Months Ended September 25, 2004 and September 27, 2003 September 25,
    
    September 27,2004
    
    2004(unaudited)
    
    (unaudited)Supplemental disclosure of cash flows information:Cash paid for interest
    
    $
    934,777
    
    
    $
    309,112Supplemental schedule of non-cash investing and
financing activities:Capital lease of property and equipment
    
    
    
    
    
    
    409,910
 See accompanying notes to consolidated financial statements 7




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HearUSA, Inc.
Notes to Consolidated Financial Statements The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included. Operating results for the nine month period ended September 25,
2004 are not necessarily indicative of the results that may be expected for the
year ending December 25, 2004. For further information, refer to the audited
consolidated financial statements and footnotes thereto included in the
Companys annual report on Form 10-K for the year ended December 27, 2003. 1. Description of the Company and Summary of Significant Accounting Policies The Company HearUSA, Inc. (HearUSA or the Company), a Delaware corporation, was
organized for the purpose of creating a nationwide chain of centers to serve
the needs of the hearing impaired. The Company now has a network of 156
company-owned hearing care centers in 11 states and the Province of Ontario,
Canada. The Company also sponsors a network of approximately 1,400 credentialed
audiology providers that participate in selected hearing benefit programs
contracted by the company with employer groups, health insurers and benefit
sponsors in 49 states. The centers and the network providers provide
audiological products and services for the hearing impaired. Basis of consolidation The consolidated financial statements include the accounts of the Company and
its wholly owned and majority controlled subsidiaries. Intercompany accounts
and transactions have been eliminated in consolidation. Income (loss) per common share Net income (loss) per common share is calculated in accordance with Statement
of Financial Accounting Standards (SFAS) No. 128 Earnings Per Share which
requires companies to present basic and diluted earnings per share. Net income
(loss) per common share  basic is based on the weighted average number of
common shares outstanding during the year. Net income (loss) per common share
 diluted is based on the weighted average number of common shares and dilutive
potential common shares outstanding during the year. Convertible subordinated
notes, mandatorily redeemable convertible preferred stock, convertible
preferred stock, stock options and stock warrants are excluded from the
computations of net loss per common share because the effect of their inclusion
would be anti-dilutive. Due to the Companys net loss for the first nine months of 2004, the following
common stock equivalents for convertible subordinated notes, mandatorily
redeemable convertible preferred stock, outstanding options and warrants to
purchase common stock of 9,505,864 were excluded from the computation of net
loss per common share  diluted at September 25, 2004 because they were
anti-dilutive. For computing net income per share-diluted for the nine months
ended September 27, 2003, 16,997,723 shares were included which represents the
common stock equivalent for the outstanding convertible preferred stock of the
Company. For purposes of computing net income (loss) per common share  basic
and diluted, for the nine and three months ended September 25, 2004 and
September 27, 2003, the weighted average number of shares of common stock
outstanding includes the effect of the 913,419 and 2,055,943, respectively,
exchangeable shares of HEARx Canada, Inc., as if they were outstanding common
stock of the Company on June 30, 2002, the effective date of the combination
with Helix for financial reporting purposes. 8




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HearUSA, Inc.
Notes to Consolidated Financial Statements Comprehensive income Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. The
Companys other comprehensive income represents a foreign
currency translation adjustment. Comprehensive income (loss) and the components of other comprehensive income
are as follows: Nine Months Ended
    
    Three Months EndedSeptember 25,
    
    September 27,
    
    September 25,
    
    September 27,2004
    
    2003
    
    2004
    
    2003Net income (loss) for the period
    
    $
    (2,266,464
    )
    
    $
    741,923
    
    
    $
    (56,082
    )
    
    $
    (246,895
    )Other comprehensive income:Foreign currency translation
adjustments
    
    
    183,709
    
    
    
    (249,737
    )
    
    
    486,339
    
    
    
    (248,465
    )Comprehensive income (loss) for
the period
    
    $
    (2,082,755
    )
    
    $
    492,186
    
    
    $
    430,257
    
    
    $
    (495,360
    )
 Stock-based compensation The Company has granted stock options to employees and directors under stock
option plans. The Company accounts for those plans using the intrinsic value
method under Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees. Stock-based employee compensation cost reflected in net
income (loss) is not significant, as all options granted under those plans had
an exercise price greater than or equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the effect
on net income (loss) and income (loss) per share if the Company had applied the
fair value recognition provisions of SFAS No. 123, (SFAS 123) Accounting for
Stock-Based Compensation, to stock-based employee compensation: Nine Months Ended
    
    Three Months EndedSeptember
    
    September
    
    September
    
    September25, 2004
    
    27, 2003
    
    25, 2004
    
    27, 2003Net income (loss) applicable
to common stockholders as
reported
    
    $
    (2,797,292
    )
    
    $
    301,951
    
    
    $
    (233,413
    )
    
    $
    (389,442
    )Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards
    
    
    (536,000
    )
    
    
    (312,000
    )
    
    
    (350,000
    )
    
    
    (134,000
    )Pro forma
    
    $
    (3,333,292
    )
    
    $
    (10,049
    )
    
    $
    (583,413
    )
    
    $
    (523,442
    )Income (loss) per share-basicAs reported
    
    $
    (0.09
    )
    
    $
    0.01
    
    
    $
    (0.01
    )
    
    $
    (0.01
    )Pro forma
    
    $
    (0.11
    )
    
    $
    0.00
    
    
    $
    (0.02
    )
    
    $
    (0.02
    )Income (loss) per share dilutedAs reported
    
    $
    (0.09
    )
    
    $
    0.01
    
    
    $
    (0.01
    )
    
    $
    (0.01
    )Pro forma
    
    $
    (0.11
    )
    
    $
    0.00
    
    
    $
    (0.02
    )
    
    $
    (0.02
    )
 For purposes of the above disclosure, the determination of the fair value of
stock options granted in 2004 and 2003 was based on the following: (i) a risk
free interest rate of 3.46%, and 2.15% respectively; (ii) expected option lives
ranging from 5 to 10 years; (iii) expected volatility in the market price of
the Companys common stock of 97% and 93%, respectively; and (iv) no dividends
on the underlying common stock. 9




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##### 



HearUSA, Inc.
Notes to Consolidated Financial Statements Reclassifications Certain amounts in the 2003 consolidated financial statements have been
reclassified in order to conform to the 2004 presentation. 2. Cash and Cash Equivalents Restricted Cash During the nine months ended September 25, 2004 a certificate of deposit for
$285,000 matured. The bank currently requires that the Company maintain this
balance in its operating account. 3. Stockholders Equity Common stock During the nine months ended September 25, 2004, 2,425,000 employee stock
options were issued at exercise prices ranging from $1.33 to $2.31, no warrants
were exercised and employee stock options for 6,250 shares of common stock were
exercised. 4. Convertible Subordinated Notes On December 19, 2003, the Company completed a private placement of $7.5 million
five-year convertible subordinated notes with five-year warrants to purchase
2,642,750 shares of the Companys common stock. The notes may not be converted
and warrants to purchase 2,142,750 shares may not be exercised for a two-year
period. The remaining warrants to purchase 500,000 shares are exercisable
beginning in June 2005 at $1.75 per share. Beginning in December 2005 the notes
may be converted at $1.75 per share and the warrants may be exercised for up to
2,142,750 shares at $1.75 per share. The quoted closing market price of the
Companys common stock on the commitment date was $2.37 per share. The notes
bear interest at 11 percent per annum for the first two years and then at 8
percent per annum through the remainder of their term. Proceeds from this financing were used to repay the $2 million notes that were
issued on October 3, 2003. In addition, approximately $1.8 million of the net
proceeds were used to make payments to Siemens in early fiscal 2004 under the
Credit Agreement, including 50% against the Tranche D Loan and 50% against the
Tranche E Loan. The balance of the net proceeds was used for working capital.
As of December 27, 2003, $500,000 of the financing proceeds was recorded as a
subscription receivable under the caption accounts and notes receivable in the
accompanying consolidated balance sheet, and was received in January 2004. Beginning March 25, 2004, the Company is required to make quarterly payments of
interest only. Beginning March 25, 2006, the Company is required to make twelve
equal quarterly payments of principal plus interest. Payments of interest and
principal may be made, at the Companys option, in cash or with the Companys
common stock. If payments are made using the Companys common stock the shares
to be issued would be computed at 90% of the average closing price for the 20
day trading period immediately preceding the payment date. Approximate
aggregate amount of maturities of the convertible subordinated notes maturing
in future years as of September 25, 2004, is $2,500,000 in each of 2006, 2007
and 2008. 10




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##### 



HearUSA, Inc.
Notes to Consolidated Financial Statements In addition to the 2,642,750 common stock purchase warrants issued to the
investors in the $7.5 million financing, the Company also issued 117,143 common
stock purchase warrants with the same terms as the lender warrants and paid
cash of approximately $206,000 to third parties as finder fees and financing
costs. These warrants were valued at approximately $220,000 using a
Black-Scholes option pricing model. The total of such costs of approximately
$426,000 are being amortized as interest expense using the effective interest
method over the five year term of the notes. The Company recorded a debt discount of approximately $7,488,000 consisting of
the intrinsic value of the beneficial conversion of approximately $4,519,000
and the portion of the proceeds allocated to the warrants issued to the lenders
of approximately $2,969,000, using the Black-Scholes option pricing model,
based on the relative fair values of the warrants and the notes. The debt
discount is being amortized as interest expense over the five-year term of the
notes using the interest method. During the first nine months of 2004, approximately $2,170,000 of prepaid
financing fees and debt discount was amortized as interest expense, including a
non-cash portion of approximately $1,595,000. The future non-cash debt discount
and prepaid finder fees to be amortized as interest expense over the next five
years are approximately $532,000 for the remainder of 2004, $2,151,000 in 2005,
$1,763,000 in 2006, $1,145,000 in 2007 and $434,000 in 2008. In the event the
investors convert or exercise the debt or warrants, the Company will be
required to amortize the remaining debt discount in the period in which the
exercise or conversion occurs. 5. Discontinued Operations On July 15, 2003, the Company sold 100% of the shares of the Companys three
subsidiaries and selected assets associated with the management of the centers
located in the Canadian Province of Quebec, to Forget & Sauve,
Audioprothesistes, S.E.N.C. (Forget & Sauve) and 6068065 Canada Inc.,
private entities owned and controlled by Steve Forget, a former Helix officer
and director. Mr. Forget served as an officer of the Company until October 2002
and as a director until May 2003. The sale agreement provided for total
payments to the Company of approximately $1.7 million, which included in part
payment of pre-existing debt, owed the Company by Forget & Sauve of
approximately $1.6 million. The Company received an initial cash payment of
$700,000 at closing and $1 million over the five following months, including an
amount of approximately $103,000 received in January 2004. The three Quebec subsidiaries and selected assets have been presented as a
discontinued operation and the consolidated financial statements have been
reclassified to segregate the assets, liabilities and operating results of
these subsidiaries for all periods presented. The sale resulted in a loss on
disposal of approximately $105,000 recorded in the second quarter of 2003. Net
revenues of the discontinued operations for the nine and three months ended
September 27, 2003 were approximately $2,559,000 and $1,391,000 respectively
and net loss of the discontinued operations was approximately $93,000 and
$136,000 respectively. 11




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##### 



HearUSA, Inc.
Notes to Consolidated Financial Statements 6. Segments The Company operates in three business segments, which include the operation
and management of centers, the establishment, maintenance and support of an
affiliated network and the operation of an e-commerce business. The Companys
business units are located in the United States and Canada. Centers
    
    E-commerce
    
    Network
    
    Corporate
    
    TotalNet revenues9 months ended 9/25/04
    
    $
    52,686,000
    
    
    $
    46,000
    
    
    $
    783,000
    
    
    
    
    
    
    $
    53,515,0009 months ended 9/27/03
    
    
    52,826,000
    
    
    
    53,000
    
    
    
    786,000
    
    
    
    
    
    
    
    53,665,000Income (loss) from operations9 months ended 9/25/04
    
    
    8,635,000
    
    
    
    (12,000
    )
    
    
    312,000
    
    
    
    (7,745,000
    )
    
    
    1,190,0009 months ended 9/27/03
    
    
    10,693,000
    
    
    
    (38,000
    )
    
    
    390,000
    
    
    
    (8,509,000
    )
    
    
    2,536,0009 months ended 9/25/04Depreciation and
amortization
    
    
    1,540,000
    
    
    
    
    
    
    
    4,000
    
    
    
    211,000
    
    
    
    1,755,000Identifiable assets
    
    
    47,324,000
    
    
    
    
    
    
    
    1,481,000
    
    
    
    11,444,000
    
    
    
    60,249,000Capital expenditures
    
    
    149,000
    
    
    
    
    
    
    
    2,000
    
    
    
    26,000
    
    
    
    177,0009 months ended 9/27/03Depreciation and
amortization
    
    
    1,623,000
    
    
    
    
    
    
    
    3,000
    
    
    
    709,000
    
    
    
    2,335,000Identifiable assets
    
    
    43,977,000
    
    
    
    
    
    
    
    1,702,000
    
    
    
    16,788,000
    
    
    
    62,467,000Capital expenditures
    
    
    134,000
    
    
    
    
    
    
    
    
    
    
    
    79,000
    
    
    
    213,000
 Income from operations at the segment level are computed before general and
administrative expenses. Information concerning geographic areas as of and for the nine months ended
September 25, 2004 and September 27, 2003 are as follows: United States
    
    Canada
    
    United States
    
    Canada2004
    
    2004
    
    2003
    
    2003$
    
    $
    
    $
    
    $Net revenues
    
    
    48,579,000
    
    
    
    4,936,000
    
    
    
    49,919,000
    
    
    
    3,746,000Long-lived assets
    
    
    39,179,000
    
    
    
    9,432,000
    
    
    
    39,925,000
    
    
    
    9,350,000
 Net revenues by geographic area are allocated based on the location of the
subsidiary operations. 7. Recent Accounting Pronouncements On September 30, 2004, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board (FASB) reached a final consensus on EITF 04-8,
Accounting Issues Related to Certain Features of Contingently Convertible Debt
and the Effect on Diluted Earnings per Share,which requires all shares
contingently issuable under our convertible debt instruments to be included in
our calculation of diluted earnings per share. The Companys adoption of EITF
04-8 had no effect on its consolidated financial statements. 12




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##### 



HearUSA, Inc.
Notes to Consolidated Financial Statements Effective July 1, 2003, the Company adopted EITF Issue No. 00-21 (EITF
00-21), Accounting For
Revenue Arrangements with Multiple Deliverables,which establishes criteria
for whether revenue on a deliverable can be recognized separately from other
deliverables in a multiple deliverable arrangement. The criteria considers
whether the delivered item has stand-alone value to the customer, whether the
fair value of each of the deliverable items can be reliably determined and the
customers right of return for the delivered items. The Companys adoption of
EITF 00-21 had no effect on its consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.It is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. This Statement establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). Many of those instruments were previously
classified as equity. This Statement did not have a material effect on the
Companys consolidated results of operations or financial position. 8. Liquidity Working capital decreased $2.0 million to a working capital deficit of $4.3
million as of September 25, 2004 from a working capital deficit of $2.3 million
as of December 27, 2003. The working capital deficit of $4.3 million includes
approximately $2.9 million representing the current portion of the long-term
debt to Siemens for Tranches A, B and C, which may be repaid through preferred
pricing reductions related to product purchases. Cash and cash equivalents as
of September 25, 2004 was approximately $2.5 million. In July of 2004, the Company implemented a cost reduction program to reduce its
salary, marketing and other expenses by approximately $2.5 million annually,
based on the second quarter of 2004 expense level. This cost reduction,
combined with an improvement in gross margin for the third quarter of 2004
enabled the Company to increase income from operations from $380,000 in the
second quarter of 2004 to $1,079,000 in the third quarter of 2004. The Company
believes that current cash and cash equivalents, expected cash flows from
operations and the impact of the cost reduction program implemented in July
2004 will be sufficient to support the Companys operational needs through the
remainder of the year. There can be no assurance, however, that the Company
will achieve its expected cash from operations or that net revenue levels will
increase above the current level and that unexpected cash needs will not arise
for which the cash, cash equivalents and cash flows from operations will be
sufficient. In the event of a shortfall in cash, the Company would consider
short-term debt, or additional equity or debt offerings. There can be no
assurance however, that such financing will be available to the Company on
favorable terms or at all. The Company also is continuing its aggressive cost
controls and sales and gross margin improvements. 13




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##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations GENERAL In the third quarter of 2004, the Company generated a net loss of approximately
$233,000, compared to a net loss of approximately $389,000 in the third quarter
of 2003. The third quarter of 2004 loss includes non-cash interest expense of
approximately $532,000, representing the amortization of the debt discount
related to the $7.5 million convertible subordinated notes financing completed
in December 2003. In the first nine months of 2004, the Company generated a net of loss of
approximately $2.8 million, compared to net income of approximately $302,000
for the comparable period in 2003. The first nine months of 2004 loss includes
non-cash interest expense of approximately $1,595,000 representing the
amortization of the debt discount mentioned in the preceding paragraph. The overall decrease in the net loss in the third quarter of 2004 compared to
the same period of last year, is mainly attributable to an increase in net
revenues and a decrease in general and administrative expenses and depreciation
and amortization expense, offset in part by an increase in center operating
expenses and in interest expense. To improve its profitability, the Company
implemented a cost reduction program in July of 2004 in order to reduce its
wages (both at the center and the corporate level), marketing and other
expenses by approximately $2.5 million, on an annualized basis, based on the
second quarter of 2004 expense level. Benefits of this program impacted the
third quarter of 2004. The Company expects to benefit more from the cost
reduction program in the fourth quarter of 2004. RESULTS OF OPERATIONS For the three months ended September 25, 2004 compared to the three months
ended September 27, 2003 Net revenues in the third quarter of 2004 increased approximately $1,154,000,
or 6.7%, compared to the third quarter of 2003. This increase includes an
increase of approximately $95,000 related to a favorable change in the average
Canadian exchange rate from 2003 to 2004. The balance of approximately
$1,059,000 is mainly due to a increase of approximately 7.1% in the average
selling price during the quarter representing approximately $1.0 million in
increased revenues, as patients selected a higher percentage of high end
technology hearing aids, and an increase in non-hearing aid revenues of
approximately $452,000. These increases were offset by a decrease of 1.8% in
the number of units sold. Cost of products sold in the third quarter of 2004 increased approximately
$339,000 or 7.1%, compared to the third quarter of 2003. Included in the cost
of products sold are Siemens preferred pricing reductions of approximately
$901,000 and $982,000 for the third quarter of 2004 and the third quarter of
2003, respectively. Such pricing reductions from Siemens are accounted for as
reductions of cost of products sold for financial reporting purposes and
applied, pursuant to the Siemens credit agreement, against the principal and
interest payments due to Siemens on Tranches A, B and C of the Siemens loan.
The cost of products sold, as a percent of net revenues, was essentially flat
at 27.6% and 27.5% for the third quarter of 2004 and the third quarter of 2003,
respectively. Center operating expenses increased approximately $191,000, or 2.1%, in the
third quarter of 2004 compared to the third quarter of 2003. This increase is
mainly attributable to an increase in compensation and marketing in 2004
compared to 2003 of approximately $300,000 and $95,000, respectively, offset by
a decrease in bad debt expense of approximately $240,000. The increase in
compensation is mainly attributable to annual increases to employees at the
center level and increases in commissions. The increase in commissions is due
to changes to some of the compensation programs at the end of the third quarter
of 2003 and increases in revenues in regions and/or sectors with higher
commission rates as well as additional commission on additional revenues. The
increase in marketing is attributable to increase in the frequency in the
Companys advertising to the private pay sector and additional mailers to
members of managed care companies compared to the third quarter of the prior
year. 14




---



##### 



General and administrative expenses decreased approximately $72,000, or 2.7%,
in the third quarter of 2004 compared to the third quarter of 2003. This
decrease is mainly attributable to a decrease of approximately $256,000 in
professional fees, offset by an increase of $40,000 in wages and fringe
benefits, $130,000 in Canadian employer health tax and other state and local
taxes, and $26,000 in public relations and shareholder expenses. Depreciation and amortization expense decreased $136,000 or 19.5% in the third
quarter of 2004. This decrease is due to certain property and equipment being
fully depreciated. Interest expense increased $645,000 or 130.8% in the third quarter of 2004
compared to the third quarter of 2003. This increase is attributable to
approximately $726,000 of interest (including the non-cash portion of
approximately $532,000) on the $7.5 million financing that was completed in
December 2003. These increases were offset by a decrease in interest on
existing balances due to repayments of principal during 2003 and the beginning
of 2004. The non-cash charge of $532,000 included in the interest expense is the
amortization of the debt discount resulting from the intrinsic value of the
beneficial conversion option, and the proceeds allocated to the warrants to
purchase 2,642,750 shares of the Companys common stock based on relative fair
values of the $7.5 million financing in December 2003. This non-cash charge
does not have an impact on the liquidity or working capital of the Company. For the nine months ended September 25, 2004 compared to the nine months
ended September 27, 2003 Net revenues in the first nine months of 2004 decreased approximately $149,000
or 0.3%, compared to the first nine months in 2003. The decrease is due to a
decrease of approximately 7.2% in the number of hearing aids sold during the
first nine months, offset by an increase in the average selling price of
approximately 4.3%, representing approximately a $1.9 million increase in
revenues, as patients selected a higher percentage of high end technology
hearing aids, and an increase in non-hearing aid revenues of approximately $1.3
million. Approximately $350,000 related to a favorable change in the average
Canadian exchange rate from 2003 to 2004. Unlike the first six months of 2003,
the first six months of 2004 did not benefit from an aggregate of approximately
$2.8 million in revenues from a special contract and an excess of undelivered
hearing aids from the prior quarter. Cost of products sold in the first nine months of 2004 decreased approximately
$138,000 or 0.9%, compared to the first nine months in 2003. Included in the
cost of products sold are Siemens preferred pricing reductions of approximately
$2,759,000 and $2,989,000 for the first nine months of 2004 and the first nine
months of 2003, respectively. Such pricing reductions from Siemens are
accounted for as reductions of cost of products sold for financial reporting
purposes and applied, pursuant to the Siemens credit agreement, against the
principal and interest payments due to Siemens on Tranches A, B and C of the
Siemens loan. As of September 25, 2004 the cumulative amount of preferred
pricing reductions received from Siemens is approximately $8,211,000, reducing
the original debt (Tranches A, B and C) from approximately $14,104,000 to
$5,893,000. The cost of products sold, as a percent of net revenues, was
essentially flat at 28.2% and 28.3% for the first nine months of 2004 and the
first nine months of 2003, respectively. Center operating expenses increased approximately $1.9 million, or 7.3%, in the
first nine months of 2004 compared to the first nine months of 2003. This
increase is mainly attributable to an increase in compensation and marketing in
2004 compared to 2003 of approximately $1.1 million and $842,000, respectively.
The increase in compensation is attributable in part to annual increases to
employees and new employees at the center level and in part to increases in
commissions. The increase in commissions is due to changes to some of the
compensation programs at the end of the second quarter of 2003 and increase in
revenues in regions and/or sectors with higher commission rates. The increase
in marketing is attributable to increase in the frequency in the Companys
advertising to the private pay sector and additional mailers to members of
managed care companies compared to the first nine months of the prior
year. 15




---



##### 



General and administrative expenses for the nine months remained constant as
compared to the year ago period at approximately $7.5 million. Although no
global increase of the general and administrative expenses occurred, wages and
fringe benefits increased approximately $125,000, due to increase in salaries
and additional employees, taxes increased approximately $177,000 and public and
shareholder relations expense increased approximately $135,000. These
increases were offset by a reduction of expenses of approximately $159,000,
resulting from a vendor credit in order to purchase computer equipment and a
reduction of professional fees of approximately $235,000. Depreciation and amortization expense decreased $579,000 or 24.8% in the first
nine months of 2004. This decrease is due to certain property and equipment
being fully depreciated. Interest expense increased $1.9 million or 116% in the first nine months of
2004 compared to the first nine months of 2003 This increase is attributable
to approximately $2,170,000 of interest (including the non-cash portion of
approximately $1,595,000) on the $7.5 million financing that was completed in
December 2003. These increases were offset by a decrease of interest on
existing balances due to repayments of principal during 2003 and the beginning
of 2004. The non-cash charge of $1,595,000 included in the interest expense is the
amortization of the debt discount resulting from the intrinsic value of the
beneficial conversion option, and the proceeds allocated to the warrants to
purchase 2,642,750 shares of the Companys common stock based on relative fair
values of the $7.5 million financing in December 2003. This non-cash charge
does not have an impact on the liquidity or working capital of the Company. LIQUIDITY AND CAPITAL RESOURCES The Company has a secured credit facility from Siemens comprised of (a) a
$10,875,000 five-year term loan credit facility (the Tranche A Loan); (b) a
$25,000,000 five-year revolving loan credit facility (the Tranche B Loan); (c)
a $3,000,000 five-year term loan facility (the Tranche C Loan); (d) a
$13,000,000 five-year term loan credit facility (the Tranche D Loan); and (e) a
$3,500,000 five-year term loan (the Tranche E loan). At September 25, 2004,
$4,174,990, $67,600, $1,650,000, $12,090,250 and $2,311,035, respectively,
representing principal on the Tranche A, Tranche B, Tranche C, Tranche D, and
Tranche E Loans, were outstanding. As of September 25, 2004, approximately
$24,932,000 is available to the Company for acquisitions under Tranche B of the
credit facility. The Tranche A, B and C Loans are payable quarterly over five years with the
outstanding principal and interest at 10%, due and payable on the final
maturity date. Principal and interest, at prime (as defined) plus 1%, on the
Tranche D Loan is payable on the final maturity date. The Company is required
to make monthly payments of interest only, at a rate of 10% per annum, on the
Tranche E Loan in the first year. In years two through five, the Company must
make monthly principal and interest payments. Quarterly principal and interest
payments on the Tranche A, B and C Loans may be paid through preferred pricing
reductions received from Siemens by HearUSA as long as the Company purchases
certain minimum percentages of its requirements of hearing aids from Siemens.
During the first nine months of 2004 and 2003, approximately $2,759,000 and
$2,989,000, respectively, of earned preferred pricing reductions, were recorded
as a reduction of cost of products sold, and $568,000 and $799,000 of interest,
respectively, and $2,191,000 and $2,190,000 of principal, respectively, has
been repaid through such preferred pricing reductions. The Company is also
required to make additional payments on the Tranche D Loan under the following
conditions: The Company must make a payment equal to 25% of net proceeds it
receives from the issuance of stock or stock equivalents. In addition, within
120 days of any fiscal year end, the Company must make a payment equal to 20%
of Excess Cash Flow (as defined in the credit agreement) for such fiscal year
end. As a result of the December 2003 financing, the Company paid Siemens
approximately $1.8 million in January of 2004, of which approximately $910,000
was applied against Tranche D and approximately $910,000 to Tranche E, based on
approval by Siemens of the application of these payments. Also, the Company
paid Siemens an amount of approximately $314,000
on April 30, 2004 representing the payment of 20% of the Companys 2003 Excess
Cash Flow as defined. 16




---



##### 



The Siemens credit facility includes certain financial and other covenants of
the Company which are customary for loans of this size and nature, including
restrictions on the conduct of the Companys business, the occurrence of
indebtedness, merger or sale of assets, the modification of material
agreements, changes in capital structure, making certain payments and paying
dividends. If the Company cannot maintain compliance with these covenants,
Siemens may terminate future funding under the credit facility and declare all
then outstanding amounts under the facility immediately due and payable. Also,
the Companys supply agreement with Siemens requires full payment for hearing
aids purchased from Siemens within 60 days from statement date. As of
September 25, 2004, the Company was in compliance with those payment
provisions. In the event of non-compliance, Siemens may declare the Company to
be in default of the supply agreement by written notification, which, if not
cured within 60 days of the date of written notification, would be an event of
default under the Companys credit facility with Siemens and Siemens would have
the right to declare all amounts outstanding under the credit facility
immediately due and payable. Any non-compliance with the supply agreement could
have a material adverse effect on the Companys financial condition and
continued operations. As of September 25, 2004, working capital decreased $2.0 million to a working
capital deficit of $4.3 million as of September 25, 2004 from a working capital
deficit of $2.3 million as of December 27, 2003. The working capital deficit
of $4.3 million includes approximately $2.9 million representing the current
portion of the long-term debt to Siemens for Tranches A, B and C, which may be
repaid through preferred pricing reductions related to product purchases. Cash
and cash equivalents as of September 25, 2004 was approximately $2.5 million. In July of 2004, the Company implemented a cost reduction program to reduce its
salary, marketing and other expenses by approximately $2.5 million annually,
based on the second quarter of 2004 expense level. This cost reduction,
combined with an improvement in gross margin from the third quarter of 2004
enabled the Company to increase income from operations from $380,000 in the
second quarter of 2004 to $1,079,000 in the third quarter of 2004. The Company
believes that current cash and cash equivalents, expected cash flows from
operations and the impact of the cost reduction program implemented in July
2004 will be sufficient to support the Companys operational needs through the
remainder of the year. There can be no assurance, however, that the Company
will achieve its expected cash from operations or that net revenue levels will
increase above the current level and that unexpected cash needs will not arise
for which the cash, cash equivalents and cash flows from operations will be
sufficient. In the event of a shortfall in cash, the Company would consider
short-term debt, or additional equity or debt offerings. There can be no
assurance however, that such financing will be available to the Company on
favorable terms or at all. The Company also is continuing its aggressive cost
controls and sales and gross margin improvements. 17




---



##### 



Below is a chart setting forth the Companys contractual cash payment
obligations which have been aggregated to facilitate a basic understanding of
the Companys liquidity as of September 25, 2004: Payments due by periodLess
    
    
    
    
    
    
    
    
    
    Morethan 1
    
    1  3
    
    4  5
    
    than 5Total
    
    year
    
    years
    
    years
    
    yearsContractual obligationsLong-term debt (1)
    
    $
    22,425,000
    
    
    $
    4,106,000
    
    
    $
    4,600,000
    
    
    $
    13,719,000
    
    
    $
    Interest to be paid on long-term debt (2)
    
    
    3,383,000
    
    
    
    731,000
    
    
    
    463,000
    
    
    
    2,189,000
    
    
    
    Operating leases
    
    
    13,708,000
    
    
    
    5,572,000
    
    
    
    7,390,000
    
    
    
    716,000
    
    
    
    30,000Convertible subordinated notes (3)
    
    
    7,500,000
    
    
    
    
    
    
    
    2,500,000
    
    
    
    5,000,000
    
    
    
    Interest to be paid on convertible
subordinated notes
    
    
    1,974,000
    
    
    
    834,000
    
    
    
    975,000
    
    
    
    165,000
    
    
    
    Manditorily redeemable convertible
preferred stock and redemption premiums
(4)
    
    
    4,928,000
    
    
    
    
    
    
    
    4,928,000
    
    
    
    
    
    
    
    Premiums to be paid on manditorily
redeemable convertible preferred stock
    
    
    1,242,000
    
    
    
    646,000
    
    
    
    596,000
    
    
    
    
    
    
    
    Employment agreements
    
    
    1,980,000
    
    
    
    135,000
    
    
    
    1,620,000
    
    
    
    225,000
    
    

    
    Purchase obligations
    
    
    1,350,000
    
    
    
    651,000
    
    
    
    699,000
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    58,490,000
    
    
    $
    12,675,000
    
    
    $
    23,771,000
    
    
    $
    22,014,000
    
    
    $
    30,000
  (1)
    
    Approximately $5.8 million (Tranches A, B and C) can be repaid through
preferred pricing reductions from Siemens, including $2.9 million in less
than 1 year, $2.9 million in years 1-3.(2)
    
    Interest on long-term debt excludes $1,641,000 of accrued but unpaid
interest on Tranche D presented with long-term debt on the balance sheet.(3)
    
    These notes and corresponding interest can be repaid at the option of the
Company in common stock at the time payment becomes due.(4)
    
    Includes approximately $365,000 of the 8% premium payable upon redemption
in December 2006, of which $119,000 has been accreted as of September 25,
2004. Net cash used in operating activities improved from approximately $1.8 million
in the first nine months of 2003 to net cash used in operating activities of
approximately $732,000 in the first nine months of 2004. The reduction in net
cash used in operating activities was primarily the result of a net increase in
accounts receivable, inventories and prepaid expenses of approximately $388,000
in 2004, compared to a net increase of approximately $870,000 in 2003, and a
net increase in accounts payable, accrued expenses, accrued salaries and other
compensation of approximately $101,000 in 2004, compared to a net decrease of
approximately $2.8 million in 2003. This improvement in net cash used in
operating activities due to changes in non-cash current assets and liabilities
was however offset by a decrease in the Companys cash flow from operations
before changes in non-cash current assets and liabilities of approximately $2.5
million from 2004 to 2003. Accounts receivable increased approximately $1.2 million from December 27, 2003
to September 25, 2004 due to the increase in net revenues of approximately $1.5
million from the fourth quarter of 2003 to the third quarter of 2004. Prepaid
expenses decreased approximately $759,000 from December 27, 2003 to September
25, 2004 due to the amortization of the prepaid finders fees and warrants
related to the $7.5 million convertible subordinated notes of December 2003 as
well as the amortization of other prepaid expenses. Accounts payable and
accrued expenses decreased approximately $147,000 and accrued salaries and
other compensation increased approximately $248,000 from December 27, 2003 to
September 25, 2004 due to timing in payments. 18




---



##### 



Net cash provided by investing activities decreased from approximately $943,000
in the first nine months of 2003 to net cash used in investing activities of
$74,000 in the first nine months of 2004 due to the collection of approximately
$1.2 million in 2003 related to the discontinued operations compared to only
$103,000 in 2004. (See Note 4 of the Consolidated Financial Statements
herein.) Net cash provided by financing activities decreased from approximately $2.0
million in the first nine months of 2003 to net cash used by financing
activities of approximately $3.4 million in the first nine months of 2004.
This decrease is primarily the result of the net proceeds of $3,500,000 from
the Siemens Tranche E Loan in 2003, and the payments on long-term debt of $2.9
million and the payment of dividends on preferred stock of $923,000 in 2004
compared to 2003. The increase in the payment of dividends is due to the new
manditorily redeemable convertible preferred stock on which the Company paid
accrued but unpaid dividends on an accelerated payment schedule. The expected
dividend payments for the remainder of the year are $114,075. CRITICAL ACCOUNTING POLICIES Management believes the following critical accounting policies affect the
significant judgments and estimates used in the preparation of the financial
statements: Goodwill The majority of the Companys goodwill resulted from the combination with
Helix. On an annual basis, the Company is required to assess whether its
goodwill is impaired. The Company elected to perform this analysis on the
first day of its fourth quarter. In order to do this, management applied
judgment in determining its reporting units, which represent distinct parts
of the Companys business. The reporting units determined by management are
the centers, the network and e-commerce. The definition of the reporting units
affects the Companys goodwill impairment assessments. The annual goodwill
impairment assessment involves estimating the fair value of a reporting unit
and comparing it with its carrying amount. If the carrying value of the
reporting unit exceeds its fair value, additional steps are required to
calculate a potential impairment charge. Calculating the fair value of the
reporting units requires significant estimates and long-term assumptions. The
Company utilized an independent appraisal firm to test goodwill for impairment
as of the first day of the Companys fourth quarter of 2002 and 2003, and each
of these tests indicated no impairment. The Company estimates the fair value
of its reporting units by applying a weighted average of three methods: quoted
market price, external transactions, and discounted cash flow. Significant
changes in key assumptions about the business and its prospects, or changes in
market conditions, stock price, interest rates or other externalities, could
result in an impairment charge. Revenue recognition HearUSA recognizes revenues from the sale of audiological products at the time
of delivery and revenues from hearing care services at the time those services
are performed. The Company has capitation contracts with certain health care organizations
under which the Company is paid an amount for each enrollee of the health
maintenance organization to provide to the enrollee a once every three years
discount on certain hearing products and services. The amount paid to the
Company by the healthcare organization is calculated on a per-capita basis and
is referred to as capitation revenue. The Company defers recognition of
capitation revenue until the earlier of the actual utilization by the member
populations of the benefit, or the end of the contract term. When the actual utilization of the benefit by the member population exceeds the
amount received on a per-capita basis (over utilization), the excess is
recorded as accounts receivable on the balance sheet. Usually, the hearing
benefit is structured in a way that the member can use it only once every three
years. In these circumstances, historical data shows that the benefit will
generally be overutilized the first year, appropriately utilized the second
year and underutilized the third year. The Company estimates an allowance to
reduce the accounts receivable from overutilization to a level equivalent to
the estimated future underutilization during the remaining term of the benefit. 19




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Allowance for doubtful accounts Certain of the accounts receivable of the Company are from health insurance and
managed care organizations and government agencies. These organizations could
take up to nine months before paying a claim made by the Company and also
impose a limit on the time the claim can be billed. The Company provides an
allowance for doubtful accounts equal to the estimated uncollectible amounts.
That estimate is based on historical collection experience, current economic
and market conditions, and a review of the current status of each
organizations trade accounts receivable. In order to calculate that allowance, the Company first identifies any known
uncollectible amounts in its accounts receivable listing and charges them
against the existing allowance for doubtful accounts. Then a specific percent
per plan and per aging categories is applied against the remaining receivables
to estimate the new allowance. Any changes in the percent assumptions per plan
and aging categories could result in a change in the allowance for doubtful
accounts. For example, an increase of 10% in the percent used would increase
the allowance for doubtful accounts by approximately $23,000. Sales returns The Company provides to all patients purchasing hearing aids a specific return
period of at least 30 days if the patient is dissatisfied with the product.
The Company provides an allowance in accrued expenses for returns. The return
period can be extended to 60 days if the patient attends the Companys H.E.L.P.
program. The Company calculates its allowance for returns using estimates
based upon actual historical returns. The cost of the hearing aid is reimbursed
to the Company by the manufacturer if the return is made within 90 days from
the time of delivery to the hearing center. RECENT ACCOUNTING PRONOUNCEMENTS On September 30, 2004, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board (FASB) reached a final consensus on EITF 04-8,
Accounting Issues Related to Certain Features of Contingently Convertible Debt
and the Effect on Diluted Earnings per Share,which requires all shares
contingently issuable under our convertible debt instruments to be included in
our calculation of diluted earnings per share. The Companys adoption of EITF
04-8 had no effect on its consolidated financial statements. Effective July 1, 2003, the Company adopted EITF Issue No. 00-21 (EITF
00-21), Accounting For Revenue Arrangements with Multiple Deliverables,
which establishes criteria for whether revenue on a deliverable can be
recognized separately from other deliverables in a multiple deliverable
arrangement.
The criteria considers whether the delivered item has stand-alone value to the
customer, whether the fair value of each of the deliverable items can be
reliably determined and the customers right of return for the delivered items.
The Companys adoption of EITF 00-21 had no effect on its consolidated
financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.It is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. This Statement establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). Many of those instruments were previously
classified as equity. This Statement did not have a material effect on the
Companys consolidated results of operations or financial position. 20




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Cautionary Statement Regarding Forward-Looking Statements This Form 10-Q contains forward-looking statements within the meaning of the
Securities Litigation Reform Act of 1995, including those concerning the
Companys expectation of the effect of its recently implemented cost reduction
program; its belief that current cash and cash equivalents, expected cash flows
from operations and the impact of the cost reduction program will be sufficient
to support the Companys operational needs through the remainder of the year;
and the Companys statement that it will consider short-term debt, or
additional equity or debt offerings in the event of a shortfall in cash. Such
statements involve certain risks and uncertainties that could cause actual
results to differ materially from those in the forward-looking statements.
Potential risks and uncertainties include such factors as unexpected cash
needs, market demand for the Companys goods and services; changes in the
pricing environment; general economic conditions in those geographic regions
where the Companys centers are located; the impact of competitive products;
and other risks and uncertainties described herein and in the Companys filings
with the Securities and Exchange Commission, including the Companys annual
report on Form 10-K for the 2003 fiscal year. 21




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Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company does not engage in derivative transactions. The Company is exposed
to Canadian currency exchange rates and the Company is not hedging that
exposure. Differences in the fair value of investment securities are not
material; therefore the related market risk is not significant. The Companys
exposure to market risk for changes in interest rates relates primarily to the
Companys long-term debt. The following table presents the Companys financial
instruments for which fair value is subject to changing market interest rates: Long-Term Debt and Convertible Subordinated Notes Fixed RateVariable
    
    Yr 1  2Rate
    
    11%Prime Rate
    
    Yr 3  5 8%+ 1% note
    
    due
    
    
    
    
    
    
    
    
    
    10 % notedue April
    
    November
    
    10 % notes
    
    10 % notes
    
    due Dec 1,2007
    
    2008
    
    due 2008
    
    due 2007
    
    2006
    
    Other notes
    
    TotalAs of September 25,
2004:Estimated cash
inflow (outflow) by
fiscal year of
principal maturity
    
    
    $
    

    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $2004
    
    
    (107,000
    )
    
    
    
    
    
    
    (140,000
    )
    
    
    (156,000
    )
    
    
    (575,000
    )
    
    
    (269,000
    )
    
    
    (1,247,000
    )2005
    
    
    
    
    
    
    
    
    
    
    (595,000
    )
    
    
    (621,000
    )
    
    
    (2,300,000
    )
    
    
    (428,000
    )
    
    
    (3,944,000
    )2006
    
    
    
    
    
    
    (2,500,000
    )
    
    
    (657,000
    )
    
    
    (621,000
    )
    
    
    (1,300,000
    )
    
    
    (53,000
    )
    
    
    (5,131,000
    )2007
    
    
    (13,308,000
    )
    
    
    (2,500,000
    )
    
    
    (726,000
    )
    
    
    (320,000
    )
    
    
    
    
    
    
    (56,000
    )
    
    
    (16,910,000
    )2008
    
    
    
    
    
    
    (2,500,000
    )
    
    
    (193,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,693,000
    )Total
    
    
    (13,415,000
    )
    
    
    (7,500,000
    )
    
    
    (2,311,000
    )
    
    
    (1,718,000
    )
    
    
    (4,175,000
    )
    
    
    (806,000
    )
    
    
    (29,925,000
    )Estimated fair value
    
    
    (13,415,000
    )
    
    
    (7,500,000
    )
    
    
    (2,311,000
    )
    
    
    (1,718,000
    )
    
    
    (4,175,000
    )
    
    
    (806,000
    )
    
    
    (29,925,000
    )Carrying Value
    
    
    (13,415,000
    )
    
    
    (7,500,000
    )
    
    
    (2,311,000
    )
    
    
    (1,718,000
    )
    
    
    (4,175,000
    )
    
    
    (806,000
    )
    
    
    (29,925,000
    )
 Item 4. Controls and Procedures  a.
    
    As of the end of the period covered by this report, the Company evaluated
the effectiveness of its disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14(c). Based upon that evaluation, the Companys
Chief Executive Officer and Chief Financial Officer concluded that the
Companys disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company required to
be included in its periodic SEC filings.b.
    
    There have been no significant changes in the Companys internal control
over financial reporting or in other factors during the last fiscal
quarter that have materially affected or are reasonably likely to
materially affect the Companys internal control over financial reporting
subsequent to the date of the evaluation referenced above. 22




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Part II Other Information Item 6. Exhibits  2.1
    
    The Amended and Restated Merger Agreement, dated November 6, 2001, between HEARx
and Helix Hearing Care of America Corp. (incorporated herein by reference as
Exhibit 2.1 to the Companys Joint Proxy Statement/Prospectus on Form S-4 (Reg.
No. 333-73022)).2.2
    
    Interim Order issued by the Superior Court of Quebec and Notice of Application
(incorporated herein by reference as Exhibit 2.2 to the Companys Joint Proxy
Statement/Prospectus Form S-4 (Reg. No. 333-73022)).2.3
    
    Plan of Arrangement, including exchangeable share provisions (incorporated herein
by reference as Exhibit 2.3 to the Companys Joint Proxy Statement/Prospectus on
Form S-4 (Reg. No. 333-73022)).3.1
    
    Restated Certificate of Incorporation of HEARx Ltd., including certain
certificates of designations, preferences and rights of certain preferred stock of
the Company (incorporated herein by reference as Exhibit 3 to the Companys
Current Report on Form 8-K, filed May 17, 1996 (File No. 001-11655)).3.2
    
    Amendment to the Restated Certificate of Incorporation (incorporated herein by
reference as Exhibit 3.1A to the Companys Quarterly Report on Form 10-Q for the
period ended June 28, 1996 (File No. 001-11655)).3.3
    
    Amendment to Restated Certificate of Incorporation including one for ten reverse
stock split and reduction of authorized shares (incorporated herein as Exhibit 3.5
to the Companys Quarterly Report on Form 10-Q for the period ending July 2, 1999
(File No. 001-11655)).3.4
    
    Amendment to Restated Certificate of Incorporation including an increase in
authorized shares and change of name (incorporated herein by reference as Exhibit
3.1 to the Companys Current Report on Form 8-K, filed July 17, 2002 (File No.
001-11655)).3.5
    
    Certificate of Designations, Preferences and Rights of the Companys 1999 Series H
Junior Participating Preferred Stock (incorporated herein by reference as Exhibit
4 to the Companys Current Report on Form 8-K, filed December 17, 1999 (File No.
001-11655)).3.6
    
    Certificate of Designations, Preferences and Rights of the Companys Special
Voting Preferred Stock (incorporated herein by reference as Exhibit 3.2 to the
Companys Current Report on Form 8-K, filed July 19, 2002 (File No. 001-11655)).3.7
    
    Amendment to Certificate of Designations, Preferences and Rights of the Companys
1999 Series H Junior Participating Preferred Stock (incorporated herein by
reference as Exhibit 4 to the Companys Current Report on Form 8-K, filed July 17,
2002 (File No. 001-11655)).3.8
    
    Certificate of Designations, Preferences and Rights of the Companys 1998-E
Convertible Preferred Stock (incorporated herein by reference as Exhibit 4.1 to
the Companys Current Report on Form 8-K, filed August 28, 2003 (File No.
001-11655)).3.9
    
    Certificate of Amendment of Restated Certificate of Incorporation increasing
authorized capital effective June 18, 2004 (incorporated herein by reference as
Exhibit 3.9 to the Companys Quarterly Report on Form 10-Q for the period ended
June 26, 2004 (File No. 001-11655)).3.10
    
    Amended and Restated By-Laws of HearUSA, Inc. (incorporated by reference to
Exhibit 3.9 to the Companys Annual Report on Form 10-K for the fiscal year ended
December 27, 2003 (File No. 001-11655)).4.1
    
    Specimen of Certificate representing Common Stock (incorporated herein by
reference as Exhibit 4.1 to the Companys Registration Statement on Form S-18,
filed September 4, 1987 (Registration No. 33-17041-NY)).4.2
    
    Amended and Restated Rights Agreement, dated July 11, 2002 between HEARx and the
Rights Agent, which includes an amendment to the Certificate of Designations,
Preferences and Rights of the Companys 1999 Series H Junior Participating
Preferred 23




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##### 



Stock (incorporated herein by reference as Exhibit 4.9.1 to the
Companys Joint Proxy/Prospectus on Form S-4 (Reg. No. 333-73022)).4.3
    
    Form of Support Agreement among HEARx Ltd., HEARx Canada, Inc. and HEARx
Acquisition ULC (incorporated herein by reference as Exhibit 99.3 to the Companys
Joint Proxy Statement/Prospectus on Form S-4 (Reg No. 333-73022)).4.4
    
    Form of 2003 Convertible Subordinated Note due November 30, 2008 (incorporated
herein by reference as Exhibit 4.1 to the Companys Current Report on Form 8-K,
filed December 31, 2003).10.1
    
    Form of option grant agreement under 2002 Flexible Stock Plan.**31.1
    
    CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    CEO and CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ** This exhibit is a management contract, compensatory plan or arrangement. 24




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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. HearUSA Inc.(Registrant)November 9, 2004/s/Stephen J. HansbroughStephen J. HansbroughChief Executive OfficerHearUSA, Inc./s/Gino ChouinardGino ChouinardChief Financial OfficerHearUSA, Inc.
 25