##### 



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 26, 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 0-11655 HearUSA, Inc. 
 (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    22-2748248(State of Other Jurisdiction of
Incorporation or Organization)
    
    I.R.S. Employer
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 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 YesþNoo Indicate by check whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YesoNoþ On July 28, 2004 29,492,798 shares of the Registrants Common Stock and 937,108
exchangeable shares of HEARx Canada, Inc. were outstanding.




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##### 



INDEX PagePART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements:Consolidated Balance Sheets June 26, 2004 and December 27, 2003
    
    
    3Consolidated Statements of
Operations Six months ended June 26, 2004 and June 28, 2003
    
    
    4Consolidated Statements of
Operations Three months ended June 26, 2004 and June 28, 2003
    
    
    5Consolidated Statements of Cash
Flows Six months ended June 26, 2004 and June 28, 2003
    
    
    6-7Notes to Consolidated Financial Statements
    
    
    8-12Item 2.
    
    Managements Discussion and
Analysis of Financial Condition and Results of Operations
    
    
    13-20Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    21PART II.
    
    OTHER INFORMATIONItem 2.
    
    Changes in Securities
    
    
    22Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    22Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    23-24Signatures
    
    
    25
 2




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##### 



Part I  Financial Information Item 1. Financial Statements HearUSA, Inc.
Consolidated Balance Sheets June 26,
    
    December 27,2004
    
    2003(unaudited)
    
    (audited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    2,207,800
    
    
    $
    6,714,881Investment securities
    
    
    435,000
    
    
    
    435,000Accounts and notes receivable, less allowance for
doubtful accounts of $478,206 and $490,881
    
    
    6,407,044
    
    
    
    6,539,149Inventories
    
    
    916,234
    
    
    
    979,092Prepaid expenses and other
    
    
    725,802
    
    
    
    1,115,393Total current assets
    
    
    10,691,880
    
    
    
    15,783,515Property and equipment, net
    
    
    4,331,091
    
    
    
    4,969,265Goodwill
    
    
    33,062,872
    
    
    
    33,222,779Intangible assets, net
    
    
    11,266,657
    
    
    
    11,577,097Deposits and other
    
    
    462,529
    
    
    
    630,694$
    59,815,029
    
    
    $
    66,183,350LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    6,584,187
    
    
    $
    6,750,234Accrued expenses
    
    
    2,052,108
    
    
    
    2,492,094Accrued salaries and other compensation
    
    
    1,941,650
    
    
    
    1,706,252Current maturities of long-term debt
    
    
    4,038,204
    
    
    
    6,436,271Dividends payable
    
    
    354,283
    
    
    
    728,699Total current liabilities
    
    
    14,970,432
    
    
    
    18,113,550Long-term debt
    
    
    19,198,840
    
    
    
    20,579,977Commitments and contingencies
    
    
    
    
    
    
    Convertible subordinated notes, net of debt discount of
$6,433,567 and $7,423,596 (Note 3)
    
    
    1,066,433
    
    
    
    76,404Mandatorily redeemable convertible preferred stock
    
    
    4,655,014
    
    
    
    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
30,009,380 and 29,528,432 shares issued
    
    
    3,000,938
    
    
    
    2,952,845Stock subscription
    
    
    (412,500
    )
    
    
    (412,500
    )Additional paid-in capital
    
    
    120,192,441
    
    
    
    120,226,050Accumulated deficit
    
    
    (101,102,647
    )
    
    
    (98,501,791
    )Accumulated other comprehensive income
    
    
    730,986
    
    
    
    1,033,616Treasury stock, at cost: 523,662 and 523,662 common shares
    
    
    (2,485,141
    )
    
    
    (2,485,141
    )Total stockholders equity
    
    
    19,924,310
    
    
    
    22,813,312$
    59,815,029
    
    
    $
    66,183,350
 See accompanying notes to the consolidated financial statements 3




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##### 



HearUSA, Inc.
Consolidated Statements of Operations
Six Months Ended June 26, 2004 and June 28, 2003 June 26,
    
    June 28,2004
    
    2003(unaudited)
    
    (unaudited)Net revenues
    
    $
    35,084,483
    
    
    $
    36,388,106Operating costs and expensesCost of products sold
    
    
    9,980,269
    
    
    
    10,456,496Center operating expenses
    
    
    18,852,616
    
    
    
    17,134,807General and administrative expenses
    
    
    4,948,825
    
    
    
    4,872,128Depreciation and amortization
    
    
    1,191,568
    
    
    
    1,634,574Total operating costs and expenses
    
    
    34,973,278
    
    
    
    34,098,005Income from operations
    
    
    111,205
    
    
    
    2,290,101Non-operating income (expense):Interest income
    
    
    7,444
    
    
    
    11,961Interest expense (including approximately
$1,064,000 and $0 of non-cash debt discount
amortization)
    
    
    (2,329,031
    )
    
    
    (1,115,538
    )Income (loss) from continuing operations
    
    
    (2,210,382
    )
    
    
    1,186,524Discontinued operationsLoss from discontinued operations
    
    
    
    
    
    
    (197,706
    )Net income (loss)
    
    
    (2,210,382
    )
    
    
    988,818Dividends on preferred stock
    
    
    (353,497
    )
    
    
    (297,425
    )Net income (loss) applicable to common stockholders
    
    $
    (2,563,879
    )
    
    $
    691,393Net income (loss) from continuing operations,
including dividends on preferred stock, per common
share  basic
    
    $
    (0.08
    )
    
    $
    0.03Net income (loss) from continuing operations,
including dividends on preferred stock, per common
share  diluted
    
    $
    (0.08
    )
    
    $
    0.02Net income (loss) applicable to common
stockholders per common share  basic
    
    $
    (0.08
    )
    
    $
    0.02Net income (loss) applicable to common
stockholders per common share  diluted
    
    $
    (0.08
    )
    
    $
    0.01Weighted average number of shares of common stock
outstanding  basic
    
    
    30,423,755
    
    
    
    30,424,872Weighted average number of shares of common stock
outstanding  diluted
    
    
    30,423,755
    
    
    
    53,323,137
 See accompanying notes to the consolidated financial statements 4




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##### 



HearUSA, Inc.
Consolidated Statements of Cash Flows
Three Months Ended June 26, 2004 and June 28, 2003 June 26,
    
    June 28,2004
    
    2003(unaudited)
    
    (unaudited)Net revenues
    
    $
    18,149,883
    
    
    $
    18,976,378Operating costs and expensesCost of products sold
    
    
    4,989,787
    
    
    
    5,640,257Center operating expenses
    
    
    9,709,801
    
    
    
    8,719,105General and administrative expenses
    
    
    2,493,576
    
    
    
    2,426,000Depreciation and amortization
    
    
    576,778
    
    
    
    725,656Total operating costs and expenses
    
    
    17,769,942
    
    
    
    17,511,018Income from operations
    
    
    379,941
    
    
    
    1,465,360Non-operating income (expense):Interest income
    
    
    3,587
    
    
    
    7,743Interest expense (including approximately $532,000
and $0 of non-cash debt discount amortization)
    
    
    (1,155,758
    )
    
    
    (592,653
    )Income (loss) from continuing operations
    
    
    (772,230
    )
    
    
    880,450Discontinued operationsLoss from discontinued operations
    
    
    
    
    
    
    (241,184
    )Net income (loss)
    
    
    (772,230
    )
    
    
    639,266Dividends on preferred stock
    
    
    (175,778
    )
    
    
    (149,101
    )Net income (loss) applicable to common stockholders
    
    $
    (948,008
    )
    
    $
    490,165Net income (loss) from continuing operations,
including dividends on preferred stock, per common
share  basic
    
    $
    (0.03
    )
    
    $
    0.02Net income (loss) from continuing operations,
including dividends on preferred stock, per common
share  diluted
    
    $
    (0.03
    )
    

    $
    0.02Net income (loss) applicable to common
stockholders per common share  basic
    
    $
    (0.03
    )
    
    $
    0.02Net income (loss) applicable to common
stockholders per common share  diluted
    
    $
    (0.03
    )
    
    $
    0.01Weighted average number of shares of common stock
outstanding  basic
    
    
    30,423,705
    
    
    
    30,423,639Weighted average number of shares of common stock
outstanding  diluted
    
    
    30,423,705
    
    
    
    48,619,906
 See accompanying notes to the consolidated financial statements 5




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##### 



HearUSA, Inc.
Consolidated Statements of Cash Flows
Six Months Ended June 26, 2004 and June 28, 2003 June 26,
    
    June 28,2004
    
    2003(unaudited)
    
    (unaudited)Cash flows from operating activitiesNet income (loss)
    
    $
    (2,210,279
    )
    
    $
    988,818Loss from discontinued operations
    
    
    
    
    
    
    197,706Net income (loss) from continuing operations
    
    
    (2,210,279
    )
    
    
    1,186,524Adjustments to reconcile net (loss) gain to net cash
(used in) provided by operating activities:Depreciation and amortization
    
    
    1,191,569
    
    
    
    1,634,574Provision for doubtful accounts
    
    
    197,504
    
    
    
    171,437Debt discount amortization
    
    
    1,063,533
    
    
    
    Principal payments on long-term debt made through
preferred pricing reductions
    
    
    (1,460,402
    )
    
    
    (1,450,002
    )Interest on Siemens Tranche D
    
    
    311,366
    
    
    
    375,397Executive compensation expense
    
    
    19,750
    
    
    
    Equipment purchases through vendor credit
    
    
    (158,800
    )
    
    
    Consulting expense through issuance of warrants
    
    
    2,044
    
    
    
    (Increase) decrease in:Accounts and notes receivable
    
    
    (799,958
    )
    
    
    (614,568
    )Inventories
    
    
    61,295
    
    
    
    (78,734
    )Prepaid expenses and other
    
    
    557,071
    
    
    
    132,662Increase (decrease) in:Accounts payable and accrued expenses
    
    
    (667,571
    )
    
    
    1,137,742Accrued salaries and other compensation
    
    
    228,010
    
    
    
    (1,716,281
    )Net cash (used in) provided by continuing operations
    
    
    (1,664,868
    )
    
    
    778,751Net cash (used in) discontinued operations
    
    
    
    
    
    
    (398,544
    )Net cash (used in) provided by operations
    
    
    (1,664,868
    )
    
    
    380,207Cash flows from investing activitiesPurchase of property and equipment
    
    
    (152,940
    )
    
    
    (119,758
    )Capital expenditures of discontinued operations
    
    
    
    
    
    
    (8,196
    )Proceeds from sales of discontinued operations
    
    
    101,746Net cash (used in) investing activities
    
    
    (51,194
    )
    
    
    (127,954
    )Cash 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
    
    
    (2,632,182
    )
    
    
    (816,535
    )Purchase of treasury stock
    
    
    
    
    
    
    (1,700
    )Redemption of preferred stock, net of costs
    
    
    
    
    
    
    (90,847
    )Proceeds from Board of Director sale of stock
    
    
    
    
    
    
    40,250Proceeds from exercise of employee stock options
    
    
    4,189
    
    
    
    13Dividends on preferred stock
    
    
    (673,007
    )
    
    
    (269,512
    )Net cash provided by (used in) financing activities
    
    
    (2,801,000
    )
    
    
    2,331,847Effects of exchange rate changes on cash
    
    
    9,981
    
    
    
    153,079Net increase (decrease) in cash and cash equivalents
    
    
    (4,507,081
    )
    
    
    2,737,179Cash and cash equivalents at beginning of period
    
    
    6,714,881
    
    
    
    2,410,023Cash and cash equivalents at end of period
    
    $
    2,207,800
    
    
    $
    5,147,202
 See accompanying notes to consolidated financial statements 6




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HearUSA, Inc.
Consolidated Statements of Cash Flows
Six Months Ended June 26, 2004 and June 28, 2003 June 26,
    
    June 28,2004
    
    2003(unaudited)
    
    (unaudited)Supplemental
disclosure of cash flow information:Cash paid for interest
    
    $
    666,753
    
    
    $
    218,221Supplemental schedule of non-cash investing and
financing activities:Capital lease on property and equipment
    
    
    
    
    
    
    395,204
 See accompanying notes to consolidated financial statements 7




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Hear USA, 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 six month period ended June 26, 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. As of June 26, 2004, the Company 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 six 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 9,031,699 were excluded from the computation of net
loss per common share  diluted at June 26, 2004 because they were
anti-dilutive. For purposes of computing net income (loss) per common share 
basic and diluted, for the six and three months ended June 26, 2004 and June
28, 2003, the weighted average number of shares of common stock outstanding
includes the effect of the 944,182 and 2,839,846, 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. 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. 8




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Hear USA, Inc.Notes to Consolidated Financial Statements Comprehensive income (loss) and the components of other comprehensive income
are as follows: Six Months Ended
    
    Three Months EndedJune 26, 2004
    
    June 28, 2003
    
    June 26, 2004
    
    June 28, 2003Net income (loss) for the period
    
    $
    (2,210,382
    )
    
    $
    988,818
    
    
    $
    (772,232
    )
    
    $
    639,266Other comprehensive income:Foreign currency translation
adjustments
    
    
    (302,629
    )
    
    
    (1,272
    )
    
    
    (232,146
    )
    
    
    (218,014
    )Comprehensive income (loss) for
the period
    
    $
    (2,513,011
    )
    
    $
    987,546
    
    
    $
    (1,145,345
    )
    
    $
    421,252
 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: Six Months Ended
    
    Three Months EndedJune 26,
    
    June 28,
    
    June 26,
    
    June 28,2004
    
    2003
    
    2004
    
    2003Net income (loss) applicable
to common stockholders as
reported
    
    $
    (2,563,879
    )
    
    $
    691,393
    
    
    $
    (948,008
    )
    
    $
    490,165Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards
    
    
    (186,000
    )
    
    
    (178,000
    )
    
    
    (93,000
    )
    
    
    (134,000
    )Pro forma
    
    $
    (2,749,879
    )
    
    $
    513,393
    
    
    $
    (1,041,008
    )
    
    $
    356,165Income (loss) per share-basicAs reported
    
    $
    (0.08
    )
    
    $
    0.02
    
    
    $
    (0.03
    )
    
    $
    0.02Pro forma
    
    $
    (0.09
    )
    
    $
    0.01
    
    
    $
    (0.03
    )
    
    $
    0.01Income (loss) per share dilutedAs reported
    
    $
    (0.08
    )
    
    $
    0.02
    
    
    $
    (0.03
    )
    
    $
    0.01Pro forma
    
    $
    (0.09
    )
    
    $
    0.02
    
    
    $
    (0.03
    )
    
    $
    0.01
 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 2.23%, and 3.42% respectively; (ii) expected option lives
ranging from 5 to 7 years; (iii) expected volatility in the market price of the
Companys common stock of 94% and 95%, respectively; and (iv) no dividends on
the underlying common stock. Reclassifications Certain amounts in the 2003 consolidated financial statements have been
reclassified in order to conform to the 2004 presentation. 9




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##### 



Hear USA, Inc.Notes to Consolidated Financial Statements 2. Stockholders Equity Common stock During the six months ended June 26, 2004, 75,000 employee stock options were
issued at an exercise price of $2.31, no warrants were exercised and employee
stock options for 6,250 shares of common stock were exercised. 3. 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 have been used to repay the $2 million notes that
was 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 on March 25, 2004, the Company is required to make quarterly
payments of interest only. On 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 June 26, 2004, is $2,500,000 in each of
2006, 2007 and 2008. 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 six months of 2004, approximately $1,446,000 of prepaid
financing fees and debt discount was amortized as interest expense, including a
non-cash portion of approximately $1,064,000.
The future non-cash debt discount and prepaid finder fees to be amortized as
interest expense over the next five years are approximately $1,064,000 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. 10




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##### 



Hear USA, Inc.Notes to Consolidated Financial Statements 4. 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 HearUSA 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 six and three months ended June
28, 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. 5. 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 revenues6 months ended 6/26/04
    
    $
    35,574,000
    
    
    $
    31,000
    
    
    $
    479,000
    
    
    
    
    
    
    $
    35,084,0006 months ended 6/28/03
    
    
    35,803,000
    
    
    
    33,000
    
    
    
    552,000
    
    
    
    
    
    
    
    36,388,000Income (loss) from operations6 months ended 6/26/04
    
    
    4,849,000
    
    
    
    (8,000
    )
    
    
    159,000
    
    
    
    (5,111,000
    )
    
    
    111,0006 months ended 6/28/03
    
    
    7,669,000
    
    
    
    (32,000
    )
    
    
    273,000
    
    
    
    (5,620,000
    )
    
    
    2,290,0006 months ended 6/26/04Depreciation and
amortization
    
    
    1,028,000
    
    
    
    
    
    
    
    2,000
    
    
    
    162,000
    
    
    
    1,192,000Identifiable assets
    
    
    47,309,000
    
    
    
    
    
    
    
    1,111,000
    
    
    
    11,395,000
    
    
    
    59,815,000Capital expenditures
    
    
    128,000
    
    
    
    
    
    
    
    
    
    
    
    25,000
    
    
    
    153,0006 months ended 6/28/03Depreciation and
amortization
    
    
    1,047,000
    
    
    
    
    
    
    
    2,000
    
    
    
    586,000
    
    
    
    1,635,000Identifiable assets
    
    
    48,237,000
    
    
    
    
    
    
    
    1,202,000
    
    
    
    17,978,000
    
    
    
    67,417,000Capital expenditures
    
    
    58,000
    
    
    
    
    
    
    
    
    
    
    
    62,000
    
    
    
    120,000
 Incomes from operations at the segment level are computed before general and
administrative expenses. 11




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##### 



Hear USA, Inc.Notes to Consolidated Financial Statements Information concerning geographic areas as of and for the six months ended June
26, 2004 and June 28, 2003 are as follows: United States
    
    Canada
    
    United States
    
    Canada2004
    
    2004
    
    2003
    
    2003$
    
    $
    
    $
    
    $Net revenues
    
    
    31,949,000
    
    
    
    3,137,000
    
    
    
    34,033,000
    
    
    
    2,355,000Long-lived assets
    
    
    39,649,000
    
    
    
    9,012,000
    
    
    
    40,833,000
    
    
    
    9,062,000
 Net revenues by geographic area are allocated based on the location of the
subsidiary operations. 6. Recent Accounting Pronouncements 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 did not have an 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. 7. Liquidity Working capital decreased $2.0 million to a working capital deficit of $4.3
million as of June 26, 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. In the first six months of
2004, the Company generated income from operations of approximately $111,000
compared to income generated from operations of $2,290,000 in 2003. Cash and
cash equivalents as of June 26, 2004 was approximately $2.2 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. The Company believes that
current cash and cash equivalents, expected cash flow 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 flow 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. 12




---



##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations GENERAL In the second quarter of 2004, the Company generated a net loss of
approximately $948,000, compared to a net income of approximately $490,000 in
the second quarter of 2003. The second quarter 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 six months of 2004, the Company generated a net of loss of
approximately $2.6 million, compared to a net income of approximately $691,000
in 2003. The first six months of 2004 loss includes non-cash interest expense
of approximately $1,064,000 representing the amortization of the debt discount
mentioned in the preceding paragraph. The overall reduction in profitability of the Company in the second quarter and
the first six months of 2004, compared to the same period of last year, is
mainly attributable to a reduction in net revenues, an increase in wages at the
center level, an increase in marketing expense and an increase in interest
expense. The impact of the decrease in net revenue and the increase in
expenses were offset in part by a reduction of the cost of products sold, as a
percent of revenues, and a reduction in depreciation and amortization, during
both the second quarter and the first six months of 2004 compared to the same
periods of 2003. 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. The Company expects this program to have a partial impact in
the third quarter of 2004 and a full impact in the fourth quarter of 2004. RESULTS OF OPERATIONS For the three months ended June 26, 2004 compared to the three months ended
June 28, 2003 Net revenues in the second quarter of 2004 decreased approximately $826,000, or
4.4%, compared to the second quarter of 2003. This decrease was net of an
increase of approximately $46,000 related to a favorable change in the average
Canadian exchange rate from 2003 to 2004. The gross decrease of approximately
$872,000 is mainly due to a decrease of approximately 11.4% in the number of
hearing aids sold during the quarter representing approximately $1.9 million in
decreased revenues, offset by an increase in the average selling price of
approximately 1.8% representing approximately a $271,000 increase in revenues
and an increase in non-hearing aid revenues of approximately $812,000 due to
the additional revenue of approximately $745,000 generated by the new contract
with the Department of Veteran Affairs. Unlike the second quarter of 2003, the
second quarter of 2004 did not benefit from an aggregate of approximately $1.3
million in revenues from income of a special contract and an excess of
undelivered hearing aids from the prior quarter. The Company expects in the
third and fourth quarter of 2004 that the effect of undelivered hearing aids
from prior quarters will be minimal and the effect of the 2003 special contract
will be offset in part by the additional revenues to be generated from the
contract with the Department of Veteran Affairs and other managed care
contracts. Cost of products sold in the second quarter of 2004 decreased approximately
$650,000 or 11.5%, compared to the second quarter of 2003. Included in the
cost of products sold are Siemens preferred pricing reductions of approximately
$920,000 and $1,001,000 for the second quarter of 2004 and the
second 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
27.5% and 29.7% for the second quarter of 2004 and the second quarter of 2003,
respectively. The decrease in cost of products sold, as a percent of net
revenues, is attributable to the additional revenues generated from the
contract with the Department of Veteran Affairs which bear no cost of products
sold as they represent testing and dispensing fees only. Excluding these
revenues, the cost of products sold, as a percent of net revenues, 13




---



##### 



would have
been 28.7% in the second quarter of 2004 compared to the 29.7% of 2003. This
reduction is mainly attributable to the impact of the increase in the average
selling price and a change in the mix of products, which more than offset the
increase in pricing from our vendors experienced at the beginning of 2004. Center operating expenses increased approximately $990,000, or 11.4%, in the
second quarter of 2004 compared to the second quarter of 2003. This increase
is mainly attributable to an increase in compensation and marketing in 2004
compared to 2003 of approximately $462,000 and $445,000, 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 increases 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 second quarter of the prior year. General and administrative expenses increased approximately $68,000, or 2.8%,
in the second quarter of 2004 compared to the second quarter of 2003. This
increase is mainly attributable to an increase of approximately $133,000 in
wages and fringe benefits due to the increases in salaries and additional
employees, $65,000 in taxes, and $50,000 in public relations and shareholder
expenses. These increases were offset by a reduction in expense of
approximately $159,000, resulting from a vendor credit in order to purchase
computer equipment, and a reduction in professional fees of approximately
$31,000. The vendor credit of $159,000 is a non-recurring item. Also the
Company had annual meeting expenses of approximately $124,000 in the second
quarter of 2004 which will not occur in the third and fourth quarters of 2004. Depreciation and amortization expense decreased $149,000 or 20.5% in the second
quarter of 2004. This decrease is due to certain property and equipment being
fully depreciated. Interest expense increased $563,000 or 95.0% in the second quarter of 2004
compared to the second quarter of 2003, of which approximately $532,000 is
non-cash as explained below. This increase is attributable to approximately
$726,000 of interest (including the non-cash portion) 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 and working capital of the Company. For the six months ended June 26, 2004 compared to the six months ended June
28, 2003 Net revenues in the first six months of 2004 decreased approximately $1.3
million, or 3.6%, compared to the first six months in 2003. This decrease was
net of an increase of approximately $250,000 related to a favorable change in
the average Canadian exchange rate from 2003 to 2004. The gross decrease of
approximately $1.6 million is mainly due to a decrease of approximately 9.8% in
the number of hearing aids sold during the first six months representing
approximately $3.1 million in decreased revenues,
offset by an increase in the average selling price of approximately 3.0%
representing approximately a $877,000 increase in revenues and an increase in
non hearing aid revenues of approximately $964,000 mainly due to additional
revenues of approximately $745,000 generated by the new contract with the
Department of Veteran Affairs. 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 income of a special contract and an excess of
undelivered hearing aids from the prior six months. 14




---



##### 



Cost of products sold in the first six months of 2004 decreased approximately
$476,000 or 4.6%, compared to the first six months in 2003. Included in the
cost of products sold are Siemens preferred pricing reductions of approximately
$1,858,000 and $2,007,000 for the first six months of 2004 and the first six
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 June 26, 2004 the cumulative amount of preferred pricing
reductions received from Siemens is approximately $7,481,000, reducing the
original debt (Tranches A, B and C) from approximately $14,104,000 to $
6,623,000. The cost of products sold, as a percent of net revenues, was 28.4%
and 28.7% for the first six months of 2004 and the first six months of 2003,
respectively. The decrease in cost of products sold, as a percent of net
revenues, is mainly attributable to the additional revenues generated from the
contract with the Department of Veteran Affairs which bears no cost of products
sold as they represent testing and dispensing fees only. Excluding these
revenues, the cost of products sold, as a percent of revenues, would have been
29.1% in the first six months of 2004 compared to 28.7% in the first six months
of 2003. This increase is attributable to increases in prices from our vendors
and change in mix of product, which were offset in part by the impact of the
increase in average selling price. Center operating expenses increased approximately $1.7 million, or 10.0%, in
the first six months of 2004 compared to the first six months of 2003. This
increase is mainly attributable to an increase in compensation and marketing in
2004 compared to 2003 of approximately $806,000 and $748,000, 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 six months of the prior year. General and administrative expenses for the six months remained constant as
compared to the year ago period at approximately $4.9 million. Although no
global increase of the general and administrative expenses occurred, wages and
fringe benefits increased approximately $86,000, due to increase in salaries
and additional employees, taxes increased approximately $61,000 and public and
shareholder relations expense increased approximately $108,000. 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 $13,000. Depreciation and amortization expense decreased $443,000 or 27.1% in 2003. This
decrease is due to certain property and equipment being fully depreciated. Interest expense increased $1.2 million or 109% in the first six months of 2004
compared to the first six months of 2003, of which approximately $1,064,000 is
non-cash as explained below. This increase is attributable to approximately
$1,450,000 of interest (including the non-cash portion) 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 $1,064,000 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 and working capital of the Company. 15




---



##### 



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 June 26, 2004,
$4,749,990, $72,800, $1,800,000, $12,090,250 and $2,447,305, respectively,
representing principal on the Tranche A, Tranche B, Tranche C, Tranche D, and
Tranche E Loans, were outstanding. As of June 26, 2004, approximately
$24,905,000 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 six months of 2004 and 2003, approximately $1,858,000 and
$2,007,000, respectively, of earned preferred pricing reductions, were recorded
as a reduction of cost of products sold, and $398,000 and $547,000 of interest,
respectively, and $1,460,000 and $1,460,000 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
million 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. 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 June 26,
2004, the Company was in compliance with those payment
provisions. In the event of noncompliance, 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 June 26, 2004, working capital decreased $2.0 million to a working
capital deficit of $4.3 million, 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. In the first six months of 2004, the Company generated income from
operations of approximately $111,000 compared to income generated from
operations of $2,290,000 in the first six months of 2003. Cash and cash
equivalents as of June 26, 2004 was approximately $2.2 million. In July of 2004, the Company implemented a cost reduction program in order to
reduce its wages, marketing and other expenses by approximately $2.5 million on
an annualized basis, based on the second quarter of 2004 expense level. The
Company believes that current cash and cash equivalents, expected cash flow
from operations and the impact of the cost reduction program implemented in
July of 2004 will be sufficient to support the Companys operational needs
through the remainder of the year. There can be 16




---



##### 



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 flow 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. 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 June 26, 2004: Payments due by periodLess
    
    
    
    
    
    
    
    
    
    Morethan 1
    
    1  3
    
    4  5
    
    than 5Contractual obligations
    
    Total
    
    year
    
    years
    
    years
    
    yearsLong-term debt (1)
    
    $
    23,237,000
    
    
    $
    4,026,000
    
    
    $
    5,341,000
    
    
    $
    13,870,000
    
    
    $
    Interest to be paid on long-term debt (2)
    
    
    3,763,000
    
    
    
    864,000
    
    
    
    696,000
    
    
    
    2,203,000
    
    
    
    Operating leases
    
    
    15,121,000
    
    
    
    5,676,000
    
    
    
    8,402,000
    
    
    
    984,000
    
    
    
    59,000Convertible subordinated notes (3)
    
    
    7,500,000
    
    
    
    
    
    
    
    2,500,000
    
    
    
    5,000,000
    
    
    
    Interest to be paid on convertible
subordinated notes
    
    
    2,183,000
    
    
    
    834,000
    
    
    
    1,113,000
    
    
    
    236,000
    
    
    
    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
    
    
    1,456,000
    
    
    
    746,000
    
    
    
    710,000
    
    
    
    
    
    
    
    Purchase obligations
    
    
    1,543,000
    
    
    
    691,000
    
    
    
    852,000
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    59,731,000
    
    
    $
    12,837,000
    
    
    $
    24,542,000
    
    
    $
    22,293,000
    
    
    $
    59,000
  (1)
    
    Approximately $6.6 million (Tranches A, B and C) can be repaid through
preferred pricing reductions from Siemens, including $2.9 million in less
than 1 year, $3.7 million in years 1-3.(2)
    
    Interest on long-term debt excludes $1,472,000 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 $92,000 has been accreted as of June 26, 2004. Net cash provided by operating activities decreased from $778,751 in the first
six months of 2003 to net cash used in operating activities of $1.7 million in
the first six months of 2004. The decrease in net cash provided by operating
activities was primarily the result of a change from net income of
approximately $691,000 to a net loss of approximately $2.6 million between
periods, a net increase in accounts receivable, inventories and prepaid
expenses of approximately $182,000 in 2004, compared to a net increase of
approximately $561,000 in 2003, and a net decrease in accounts payable, accrued
expenses,
accrued salaries and other compensation of approximately $440,000 in 2004,
compared to a net decrease of approximately $579,000 in 2003. Accounts receivable, increased approximately $800,000 from December 27, 2003 to
June 26, 2004. This increase is mainly attributable to the increase in revenues
of approximately $745,000 generated from the new contract with the Department
of Veteran Affairs which began in the month of April 2004. Prepaid expenses
decreased approximately $557,000 from December 27, 2003 to June 26, 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 $668,000 from December 27, 2003 to June 26, 2004 due to
a question of timing in payment of vendors. 17




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Net cash used in investing activities increased from approximately $128,000 in
the first six months of 2003 to net cash provided by investing activities of
$51,000 in the first six months of 2004 as a result of the collection of
approximately $102,000 related to the discontinued operations. (See Note 4 of
the Consolidated Financial Statements herein.) Net cash provided by financing activities decreased from approximately $2.3
million in the first six months of 2003 to net cash used by financing
activities of approximately $2.8 million in the first six 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, offset by an increase in the payments on
long-term debt of $1.8 million and the payment of dividends on preferred stock
of $404,000 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
$214,000 in the third quarter of 2004 and $190,125 in the fourth quarter of
2004. 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. 18




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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 $29,000. 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 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 did not have an 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. 19




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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 flow
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;
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; and the Companys
expectation that in the third and fourth quarters of 2004 the effect of
undelivered hearing aids from prior quarters will be minimal and the effect of
the 2003 special contract will be offset in part by the additional revenues to
be generated from the contract with the Department of Veteran Affairs and other
managed care contracts. 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 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. 20




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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 NotesFixed RateVariable RatePrime Rate
    
    Yr 1 
 2  11%+ 1% note
    
    Yr 3 
5   8%
    
    
    
    
    
    
    
    10 % notedue April
    
    due November
    
    10 % notes
    
    10 % notes
    
    due Dec 1,2007
    
    2008
    
    due 2008
    
    due 2007
    
    2006
    
    Other notes
    
    TotalAs of March 27, 2004:Estimated cash
inflow (outflow) by
fiscal year of
principal maturity
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $2004
    
    
    
    
    
    
    
    
    
    
    (276,000
    )
    
    
    (311,000
    )
    
    
    (1,150,000
    )
    
    
    (395,000
    )
    
    
    (2,132,000
    )2005
    
    
    
    
    
    
    
    
    
    
    (595,000
    )
    
    
    (621,000
    )
    
    
    (2,300,000
    )
    
    
    (417,000
    )
    
    
    (3,933,000
    )2006
    
    
    
    
    
    
    (2,500,000
    )
    
    
    (657,000
    )
    
    
    (621,000
    )
    
    
    (1,300,000
    )
    
    
    (53,000
    )
    
    
    (5,131,000
    )2007
    
    
    (13,246,000
    )
    
    
    (2,500,000
    )
    
    
    (726,000
    )
    
    
    (320,000
    )
    
    
    
    
    
    
    (56,000
    )
    
    
    (16,848,000
    )2008
    
    
    
    
    
    
    (2,500,000
    )
    
    
    (193,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,693,000
    )Total
    
    
    (13,246,000
    )
    
    
    (7,500,000
    )
    
    
    (2,447,000
    )
    
    
    (1,873,000
    )
    
    
    (4,750,000
    )
    
    
    (921,000
    )
    
    
    (30,737,000
    )Estimated fair value
    
    
    (13,246,000
    )
    
    
    (7,500,000
    )
    
    
    (2,447,000
    )
    
    
    (1,873,000
    )
    
    
    (4,750,000
    )
    
    
    (921,000
    )
    
    
    (30,737,000
    )Carrying Value
    
    
    (13,246,000
    )
    
    
    (7,500,000
    )
    
    
    (2,447,000
    )
    
    
    (1,873,000
    )
    
    
    (4,750,000
    )
    
    
    (921,000
    )
    
    
    (30,737,000
    )
 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 controls
or in other factors that could significantly affect internal controls
subsequent to the date of the evaluation referenced above. 21




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##### 



Part II Other Information Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities Subsequent to the approval by the Companys shareholders of the increase in
capital stock of the Company (see Item 4, below), the Company filed a
certificate of amendment to the Companys Amended and Restated Certificate of
Incorporation with the Delaware Secretary of State. The amendment was
effective June 18, 2004. The sole purpose and effect of the amendment was to
increase the authorized capital of the Company to 75,000,000 shares of common
stock and 7,500,000 shares of preferred stock. The amendment had no effect
upon the rights of the existing holders of the Companys outstanding common
stock or preferred stock. Item 4. Submission of Matters to a Vote of Security Holders The Company held its annual meeting of stockholders on June 11, 2004. At that
meeting, the stockholders were asked to consider and act on the election of
directors and an increase in the number of authorized shares of the Companys
capital stock from 50,000,000 shares of common stock, par value of $0.10 per
share to 75,000,000 shares of common stock, par value $0.10 and from 5,000,000
shares of preferred stock, par value $1.00 per share to 7,500,000 shares of
preferred stock, par value $1.00. The following persons were elected as directors for terms expiring in 2005 and
received the number of votes set forth opposite their respective names: Against/
    
    BrokerNominee
    
    For
    
    Withheld
    
    Non-votes
    
    AbstentionsPaul A. Brown, M. D.
    
    
    26,297,205
    
    

    
    642,309
    
    
    
    0
    
    
    
    8,635,097Stephen J. Hansbrough
    
    
    26,929,735
    
    
    
    639,779
    
    
    
    0
    
    
    
    8,635,097Thomas W. Archibald
    
    
    26,929,895
    
    
    
    639,619
    
    
    
    0
    
    
    
    8,635,097David J. McLachlan
    
    
    26,929,445
    
    
    
    640,069
    
    
    
    0
    
    
    
    8,635,097Joseph L. Gitterman III
    
    
    26,929,815
    
    
    
    639,699
    
    
    
    0
    
    
    
    8,635,097Michel Labadie
    
    
    24,956,066
    
    
    
    2,613,448
    
    
    
    0
    
    
    
    8,635,097
 The following numbers of votes were received for the approval of the increase
in the Companys capital and preferred stock: For
    
    Against/Withheld
    
    Abstentions16,675,413
    
    
    2,042,828
    
    
    
    8,851,273
 22




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##### 



Item 6. Exhibits and Reports on Form 8-K (a) 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
    
    Amendment to Restate Certificate of Incorporation increasing authorized capital
effective June 18, 2004.3.10
    
    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 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)).
 23




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##### 



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).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
 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)August 10, 2004/s/ Stephen J. HansbroughStephen J. HansbroughChief Executive OfficerHearUSA, Inc./s/ Gino ChouinardGino ChouinardChief Financial OfficerHearUSA, Inc.
 25