UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-KSB




x
            ANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the Fiscal Year Ended December 31, 2007





 ̈
            TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
      the transition period from    to




Commission
      file number 1-4324







ANDREA
ELECTRONICS CORPORATION


(Name
of small business issuer in its charter)





New
      York
            11-0482020(State
      or other jurisdiction
              of
      incorporation or organization)
            (I.R.S.
      employer
              identification
      no.)65
      Orville Drive, Bohemia, New York
            11716(Address
      of principal executive offices)
            (Zip
      Code)





Issuer’s
telephone number, including area code: 631-719-1800


Securities
registered pursuant to Section 12(b) of the
Act:  None




Securities
registered under Section 12(g) of the Exchange Act:




Common
Stock, par value $.01 per share


Title
of class





Check
whether the issuer is not required to file reports Section 13 or 15(d) of the
Exchange Act.    ̈





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





Check if there is no disclosure of
delinquent filers in response to Item 405 of Regulation S-B contained in this
form, and no disclosure will be contained, to the best of registrant’s
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-KSB or any amendment to this Form
10-KSB. ̈





Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).   Yes     ̈    No     x





The
issuer’s revenues for the fiscal year ended December 31, 2007 were
$5,046,213.





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates was $4,700,683 based upon the closing price of $0.08 as quoted on
the Over the Counter Market on March 24, 2008.





The number
of shares outstanding of the registrant’s Common Stock as of March 24, 2008, was
59,861,193.





DOCUMENTS
INCORPORATED BY REFERENCE




None





Transitional
Small Business Disclosure
Format.    Yes     ̈    No    x












TABLE
OF CONTENTS





TITLE
            
            PAGEPART
      IITEM 1.
            DESCRIPTION OF BUSINESS
            1ITEM 2.
            DESCRIPTION OF PROPERTY
            6ITEM 3.
            LEGAL PROCEEDINGS
            6ITEM 4.
            SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
            6PART
      IIITEM 5.
            MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND
      SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
            7ITEM 6.
            MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATION
            7ITEM 7.
            FINANCIAL STATEMENTS
            15ITEM 8.
            CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
      AND FINANCIAL DISCLOSURE
            15ITEM 8A(T).
            CONTROLS AND PROCEDURES
            15ITEM 8B.
            OTHER INFORMATION
            16PART
      IIIITEM 9.
            DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS
      AND CORPORATE GOVERANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
      ACT
            16ITEM 10.
            EXECUTIVE COMPENSATION
            17ITEM 11.
            SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
      MANAGEMENT AND RELATED STOCKHOLDER MATTERS
            20ITEM 12.
            CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
      DIRECTOR INDEPENDENCE
            21ITEM 13.
            EXHIBITS
            21ITEM 14
            PRINCIPAL ACCOUNTANT FEES AND SERVICES
            23









PART
I





ITEM 1. DESCRIPTION OF BUSINESS





Overview





Andrea
Electronics Corporation (“Andrea”) designs, develops and manufactures
state-of-the-art microphone technologies and products for enhancing speech-based
applications software and communications that require high quality, clear voice
signals. Our technologies eliminate unwanted background noise to enable the
optimum performance of various speech-based and audio applications. We are
incorporated under the laws of the State of New York and have been engaged in
the electronic communications industry since 1934.





Andrea’s
products and technologies optimize the performance of speech-based applications
and audio applications in primarily the following markets:





•
            personal
      computing (primarily for speech recognition applications and voice
      communication over the internet);





•
            audio
      and video conferencing; and





•
            in-vehicle
      communications (to enable untethered, hands-free
      communication).





Andrea Digital Signal Processing
(“DSP”) Microphone and Audio Software business – Our patented and
patent-pending digital noise canceling technologies enable a speaker to be
several feet from the microphone, and free the speaker from having to hold the
microphone (we refer to this capability as “far-field” microphone use). Our
Digital Super Directional Array (“DSDA”) and Pure Audio microphone products
convert sound received by an array of microphones into digital signals that are
then processed to cancel background noise from the signal to be transmitted.
These two adaptive technologies represent the core technologies within our
portfolio of far-field technologies. In addition to DSDA and Pure Audio, Andrea
has developed and commercialized several other digital, far-field noise
canceling technologies, including, among others, Andrea EchoStop, a high-quality
acoustic echo canceller which enables speaker phone functionality with
technology for canceling unwanted stationary noises.





All of our
digital, far-field microphone technologies are software-based and operate using
either a dedicated DSP or a general purpose processor (for example, the Intel
Pentium).  The software, which may encompass one or all of our
far-field noise canceling technologies, can be applied to improve the
performance of a single microphone or multiple microphones. In addition, our
digital, far-field, noise canceling technologies can be tailored and implemented
into various form factors, for example, into the monitor of a PC, a personal
digital assistant, a rear view mirror or, and can be used individually or
combined depending on particular customer requirements.





We are
currently targeting our far-field technologies at 1) the desktop computing
market (primarily through our relationship with Analog Devices, Inc. (“Analog
Devices”), 2) the video and audio conferencing market and 3) the market for
personal hands free communication designed for use in automobiles, trucks and
buses to control PCs and cellular communication and other devices within
vehicles.  Our far-field, digital noise canceling technologies and
related products, together with implementations of other high-end audio
technologies (for example, our Active Noise Cancellation technology) comprise
our Andrea DSP Microphone and Audio Software line of business.  Net
revenues of such technologies and products during the years ended December 31,
2007 and 2006 approximated 48% and 55%, respectively, of our total net revenues.
We dedicate the majority of our marketing and research and development resources
to this business segment, as we believe that communication products will
increasingly require high performance, untethered (hands-free and headset-free)
microphone technology.





Andrea Anti-Noise Headset Product
business – Our headset microphone products help to ensure clear speech in
personal computer and telephone headset applications. Our Active Noise
Cancellation microphone technology uses electronic circuits that distinguish a
speaker’s voice from background noise in the speaker’s environment and then
cancels the noise from the signal to be transmitted by the microphone. Our
Active Noise Reduction headphone products use electronic circuits that
distinguish the signal coming through an earphone from background noise in the
listener’s environment and then reduces the noise heard by the listener.
Together with our standard noise canceling headset products, these products
comprise our Andrea Anti-Noise Headset Product segment.  During the
years ended December 31, 2007 and 2006, our Andrea Anti-Noise Headset Product
segment approximated 52% and 45%, respectively, of our total net
revenues.





For more
financial information regarding our operating segments, see Note 14 of the
audited consolidated financial statements.





Industry
Background





Our
primary mission is to provide the emerging “voice interface” markets with
state-of-the-art microphone and communication products. The idea underlying
these markets is that natural language spoken by the human voice will become an
important means by which to communicate and control many types of computing
devices and other appliances and equipment that contain microprocessors. We are
designing and marketing our products and technologies to be used for these
“natural language, human/machine” interfaces with:




1




•
            desktop,
      laptop and hand-held computers and mobile personal computing
      devices;





•
            video
      and audio conferencing systems; and





•
            automotive
      communication systems.





We believe
that end users of these applications and interfaces will require high quality
microphone and earphone products that enhance voice transmission, particularly
in noisy office and mobile environments. We also believe that these applications
will increasingly require microphones that are located several feet from the
person speaking, or far-field microphone technology. Applications in this area
include:





•
            continuous
      speech dictation to personal
computers;





•
            multiparty
      video teleconferencing and software that allows participants to see and
      jointly communicate; and





•
            cellular
      hands free interfaces for automobiles, home and office
      automation.





We believe
that an increasing number of these devices will be introduced into the
marketplace during the next several years.





Our
Strategy





Our
strategy is to:





•
            maintain
      and extend our market position with our Andrea DSP Microphone and Audio
      Software technologies and products and our higher margin Andrea Anti-Noise
      products;





•
            develop
      relationships with companies that have significant distribution
      capabilities for our Andrea DSP Microphone and Audio Software technologies
      and products and Andrea Anti-Noise
products;





•
            broaden
      our Andrea DSP Microphone and Audio Software product lines and Andrea
      Anti-Noise product lines through a more modest but still a healthy level
      of internal research and
development;





•
            design
      our products to satisfy specific end-user requirements identified by our
      collaborative partners; and





•
            outsource
      manufacturing of our products in order to reduce fixed overhead and
      achieve economies of scale.





An
important element of our strategy for expanding the channels of distribution and
broadening the base of users for our products is our collaborative arrangements
with manufacturers of computing and communications equipment and software
publishers that are actively engaged in the various markets in which our
products have application. In addition, we have been increasing our own direct
marketing efforts.





The
success of our strategy will depend on our ability to, among other
things:





•
            increase
      net revenues of Andrea DSP Microphone and Audio Software products and our
      line of existing Andrea Anti-Noise
products;





•
            continue
      to contain costs;





•
            introduce
      additional Andrea DSP Microphone and Audio Software products and Andrea
      Anti-Noise products;





•
            maintain
      the competitiveness of our technologies through focused and targeted
      research and development; and





•
            achieve
      widespread adoption of our products and
  technologies.





Our
Technologies





We design
our Andrea DSP Microphone and Audio Software and Andrea Anti-Noise products to
transmit voice signals with the high level of quality, intelligibility and
reliability required by the broad range of voice-based applications in computing
and telecommunications. We achieve this through the use of several audio
technologies that employ software processes that are proprietary to us. Software
processes of this type are commonly referred to as algorithms.





2




Andrea
DSP Microphone and Audio Software Technology





This set
of technologies is generally based on the use of an array of microphones from
which the analog signals are converted to digital form and then processed using
digital electronic circuitry to eliminate unwanted noise in the speaker’s
environment. Our Andrea DSP Microphone and Audio Software Products provide clear
acoustic and audio input performance where the desired audio signal is at a
distance from the microphone. An example of this is a person driving an
automobile who wants to control various systems in the car or communicate
through a wireless telephone. We have also engineered our Andrea DSP Microphone
and Audio Software Products to be compatible with Universal Serial Bus, or USB,
computer architecture. USB is an industry standard for connecting peripherals,
such as microphones, earphones, headsets, keyboards, mice, joysticks, scanners
and printers, to personal computers. We believe that our Andrea DSP Microphone
and Audio Software technology achieve far-field microphone performance
previously unattainable through microphones based on mechanical acoustic designs
and microphones based on analog signal processing.





Our Andrea
DSP Microphone and Audio Software Products include the use of the following
technologies, among other technologies and techniques:





Digital Super Directional Array
(DSDA®).  Our patented
DSDA microphone technology enables high quality far-field communications by
centering microphone sensitivity on a user’s voice and canceling noise outside
of that signal. DSDA continuously samples the ever changing acoustic properties
within an environment and adaptively identifies interfering noises that are
extraneous to the voice signal, resulting in increased intelligibility of
communications.





PureAudio®. Our
patented PureAudio is a noise canceling algorithm that enhances applications
that are controlled by speech by sampling the ambient noise in an environment
and attenuating the noise from sources near or around the desired speech
signals, thus delivering a clear audio signal. Designed specifically to improve
the signal-to-noise ratio, PureAudio is effective in canceling stationary noises
such as computer and ventilation fans, tires and engines.





EchoStop®. Our patented EchoStop is an
advanced acoustic echo canceller (stereo version available) developed for use
with conferencing systems such as group audio and videoconferencing systems and
cellular car phone kits. EchoStop allows true two-way communication (often
referred to as full duplex) over a conferencing system, even when the system is
used in large spatial environments that may be vulnerable to extensive
reverberation. EchoStop incorporates noise reduction algorithms to reduce the
background noise of both the microphone input and the loudspeaker output, thus
preventing the accumulation of interfering noise over conferencing systems that
facilitate communication among multiple sites.





SuperBeamTM.  SuperBeam
is a highly accurate digital algorithm that forms an acoustic beam that extends
from the microphone to the speech source in an environment. We believe SuperBeam
provides a fixed noise reduction microphone solution for the typical acoustic
environment found in room environments in which speech is used, such as in
offices and homes. The microphone beam is generated by processing multiple
microphone samples through pre-established digital filters and adding the
outputs. The result is an optimum speech enhancement and noise reduction
solution to a predefined setting. Because the beam is able to adapt to changes
in the acoustic environment, this technology is called adaptive
beamforming.





Direction Finding and Tracking Array
(DFTA®). Our patented DFTA
technology utilizes an array of microphones, unique software algorithms and
digital signal processing to detect the presence of a user’s
voice.  DFTA determines the direction of the voice which then tracks
the speaker when he or she moves.





Andrea
Anti-Noise Technologies





Noise Cancellation (“NC”) Microphone
Technology. This technology is based on the use of pressure gradient
microphones to reduce the transmission of noise from the speaker’s location.
Instead of using electronic circuitry to reduce noise, pressure gradient
microphones rely on their mechanical and acoustic design to do so. Our NC
microphones are well-suited for applications in which there is less background
noise in the speaker’s environment.





Active Noise Cancellation (“ANC”)
Microphone Technology. This technology is based on analog signal
processing circuits that electronically cancel the transmission of noise from
the speaker’s location. ANC is particularly well-suited for those environments
in which the speaker is surrounded by high levels of ambient background
noise.





Our ANC
and NC microphones are most effectively used in “near-field” applications where
the microphone is next to the speaker’s mouth such as a headset
environment.





Active Noise Reduction (“ANR”)
Earphone Technology. This technology is based on analog signal processing
circuits that electronically reduce the amount of noise in the environment that
the listener would otherwise hear in the earphone. Our ANR earphones improve the
quality of speech and audio heard by a listener in extremely noisy environments,
particularly those characterized by low frequency sounds, such as those in
aircraft, machine rooms, factories, automobiles, trucks and other ground
transportation equipment.





3


Our Products and their Markets and
Applications




Our Andrea
DSP Microphone and Audio Software Products and Andrea Anti-Noise Products have
been designed for applications that are controlled by or depend on speech across
a broad range of hardware and software platforms. These products incorporate our
DSP, NC, ANC and ANR microphone technologies, and are designed to cancel
background noise in a range of noisy environments, such as homes, offices,
factories and automobiles. We also manufacture a line of accessories for these
products. For the consumer and commercial markets, we have designed our Andrea
DSP Microphone and Audio Software Products and Andrea Anti-Noise Products for
the following applications:





–
            Speech
      recognition for word processing, database, and similar
      applications;





–
            Distance
      Learning (education through the use of Internet-base lessons and training
      information);




–
              Audio/videoconferencing;


–
            Internet
      telephony and Voice Chat;





–
            Professional
      audio systems;





–
            Voice-activated
      interactive games;




–
              Cellular
      and other wireless telecommunications;
and


–
              Telematics,
      or in-vehicle computing (the use of computer-controlled systems in
      automobiles and trucks)


We market
and sell our products directly to end users through our website, computer
product distributors, through value-added resellers, to original equipment
manufacturers and to software publishers. For more information about these
collaborative arrangements, please refer to the information under the caption
“Our Collaborative Arrangements”.





Andrea
DSP Microphone and Audio Software Products





We develop
our Andrea DSP Microphone and Audio Software Products primarily through
customer-specific integration efforts, and we either license our related
algorithms, sell a product incorporating our related algorithms, or both. For
example, we have developed technologies that can be, or are, embedded into a PC,
PC monitors, high-end videoconferencing units, IP telephony applications,
automotive interiors and hand-held devices, among others. In addition, we have
developed stand-alone products for specific customers who then sell such
products to end users. As a result, such products are not available from us
directly. However, as part of our strategy to increase sales to prospective
customers desiring high-quality microphone performance for certain
customer-specific environments, we have developed the following products that
may be purchased directly from Andrea:





Andrea Superbeam Array
Microphone. The Superbeam Array Microphone is a two-microphone device
that attaches to the top of any laptop or PC equipped with Analog Devices’
SoundMax® Digital
Audio System. The SoundMax Cadenza software is integrated with Andrea
Electronics’ PureAudio and DSDA noise-cancellation software, thereby removing
the high costs associated with required memory and processing power from
previous, DSP-based microphone devices (now powered by Intel’s host
processor).





Andrea USB Stereo Full Duplex
Adapter (“USBD2A”).The USBD2A was designed for users who desire to
utilize Andrea Electronics’ award winning Superbeam Array Microphone, and who
operate PCs which do not have integrated stereo microphone input capability. In
addition to providing users with high quality voice input to enable,
headset-free, speech-based PC applications such as VoIP, voice command and
control, and online-gaming, the USBD2A also provides high fidelity, amplified
stereo output for multimedia audio playback.





Andrea AudioCommanderTM.Offering an audio interface for controlling PC multimedia applications,
AudioCommander includes controls to operate noise cancellation features, thereby
enhancing microphone performance. The software also includes an audio wizard
that sets microphone levels to optimize PC audio for speech-enabled applications
including speech recognition, Internet telephony and command and speech control
functions.





Andrea AutoArrayTM Microphone
(“AutoArray”).The AutoArray is a digital, high performance microphone
system designed for computing applications in vehicles such as automobiles and
trucks. It is the first super-directional audio input device designed
specifically for in-vehicle computing. The AutoArray incorporates our DSDA and
PureAudio technologies, among others.





Andrea VoiceCenterTM
(“VoiceCenter”). The VoiceCenter is a multi-functional, digital voice
recorder software application that enables recorded speech files to be applied
for productivity as well as expressing personality. The digital WAV recorded
files are automatically labeled and can be compressed with WMA for attachment to
e-mail, used as voice memos, voice alarms (with a calendar reminder function)
and even add your voice annotation to documents. The VoiceCenter also includes
Andrea PureAudio noise reduction/speech enhancement technology for increasing
the recording sound quality of any microphone.





4




Andrea
Anti-Noise Products





Our Andrea
Anti-Noise Products include a line of headsets, handsets and related accessories
that incorporate our NC, ANC and ANR technologies. Our headsets are mostly
differentiated by the various designs of their headband, microphone boom and
earphone components and are available in both single earphone monaural and dual
earphone stereo models.





NC Products. Our NC products
are sold through our internal contact center, as well as to original equipment
manufacturers for incorporation into, or for use with their products. With some
of our headsets, customers have the unique ability to mix and match microphone
boom and headband components to meet their specific application and user comfort
preferences. The speaker-housing unit in these models can be used for digital,
CD-quality sound. By removing the speaker-housing unit, we can offer this
headset for simple speech applications at a lower price.





ANC Products. All of our ANC
products are sold through our internal contact center. Two of our higher end ANC
headset products incorporate a dual microphone housing design that optimizes the
acoustic performance of the sound output with tenor and base attributes that are
set, or pre-equalized, at the time of manufacture.





We have
developed and manufactured a line of accessories for our Andrea Anti-Noise
Products:





Andrea Personal Computer Telephone
Interface (“PCTI”). The PCTI is a comprehensive desktop device that
integrates computer applications controlled by speech and traditional telephony
applications by connecting headset users to the telephone, to the computer, or
to both simultaneously. Users can alternately or simultaneously conduct
telephone conversations and use speech recognition to enter data or dictate into
the PC, without having to pause or toggle between connectivity
devices.





Andrea MC-100 Multimedia Audio
Controller. The Andrea MC-100 Multimedia Audio Controller connects a PC
headset or handset with a PC multimedia speaker system thereby allowing a user
to conveniently switch between the headset/handset and the speaker
system.





Our
Collaborative Arrangements





An
important element of our strategy is to promote widespread adoption of our
products and technologies by collaborating with large enterprises and market and
technology leaders in telecommunications, computer manufacturing, and software
publishing. For example, we have arrangements and/or relationships with Analog
Devices, Ericsson Inc. and Creative Labs.  We are currently discussing
additional arrangements with other companies, but we cannot assure that any of
these discussions will result in any definitive agreements.





Patents,
Trademarks, and Other Intellectual Property Rights





We rely on
a combination of patents, patent applications, trade secrets, copyrights,
trademarks, nondisclosure agreements, and contractual restrictions to protect
our intellectual property and proprietary rights. We cannot assure, however,
that these measures will protect our intellectual property or prevent
misappropriation or circumvention of our intellectual property.





Andrea
maintains a number of patents in the United States covering claims to certain of
its products and technology, which expire at various dates ranging from 2012 to
2024.  We also have other patent applications currently pending;
however, we cannot assure that patents will be issued with respect to these
currently pending or future applications which we may file, nor can we assure
that the strength or scope of our existing patents, or any new patents, will be
of sufficient scope or strength or provide meaningful protection or commercial
advantage to us.





Research
and Development





We
consider our technology to be of substantial importance to our competitiveness.
To maintain this competitiveness, we have organized our research and development
efforts using a “market and applications” approach for meeting the requirements
of new and existing customers. Consistent with this approach, our engineering
staff interacts closely with our sales and marketing personnel and directly with
customers. The engineering staff is responsible for the research and development
of new products and the improvement and support of existing
products.  For the years ended December 31, 2007 and 2006, total
research and development expenses were $676,977 and $571,288, respectively.
During 2008, we expect research and development expenses to remain at the same
level when compared to 2007.  We expect this will occur as a result of
our overall plan to improve cash flows by containing our
expenses.  Additionally, most of Andrea’s core technology is already
developed, therefore, heightened emphasis will be placed on application
engineering, sales and marketing activity and less emphasis on research and
development.  No assurance can be given that our research and
development efforts will succeed. See “Part II – Item 6 – Management’s
Discussion and Analysis or Plan of Operation.”




5




Sales
and Marketing




We employ
a sales staff as well as outside sales representative organizations to market
our Andrea DSP Microphone and Audio Software Products and our Andrea Anti-Noise
Products.  Andrea DSP Microphone and Audio Software Products and
Andrea Anti-Noise Products are marketed to computer OEMs, distributors of
personal computers and telecommunications equipment, software publishers, and
end-users in both business and household environments. These products are sold
to end-users through distributors and value-added resellers, software
publishers, Internet Service Providers and Internet Content Developers. Under
our existing collaborative agreements, our collaborators have various marketing
and sales rights to our Andrea DSP Microphone and Audio Software and Andrea
Anti-Noise Products.  We are seeking to enter into additional
collaborative arrangements for marketing and selling our Andrea DSP Microphone
and Audio Software Products and Andrea Anti-Noise Products, but we cannot assure
that we will be successful in these efforts. Market acceptance of the Andrea DSP
Microphone and Audio Software Products and Andrea Anti-Noise Products is
critical to our success.





Production
Operations





In 2007
and 2006, all of our assembly operations were done with subcontractors in Asia
or in the United States.  Most of the components for the Andrea DSP
Microphone and Audio Software Products and Andrea Anti-Noise Products are
available from several sources and are not characteristically in short
supply.  However, certain specialized components, such as microphones
and DSP boards, are available from a limited number of suppliers and subject to
long lead times. To date we have been able to obtain sufficient supplies of
these more specialized components, but we cannot assure that we will continue to
be able to do so. Shortages of, or interruptions in, the supply of these more
specialized components could have a material adverse effect on our sales of
Andrea DSP Microphone and Audio Software Products and Andrea Anti-Noise
Products.





Competition





The
markets for our Andrea DSP Microphone and Audio Software Products and Andrea
Anti-Noise Products are highly competitive. Competition in these markets is
based on varying combinations of product features, quality and reliability of
performance, price, sales, marketing and technical support, ease of use,
compatibility with evolving industry standards and other systems and equipment,
name recognition, and development of new products and enhancements. Most of our
current and potential competitors in these markets have significantly greater
financial, marketing, technical, and other resources than us. Consequently,
these competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, marketing, and sale of their products than we
can.  We cannot assure that one or more of these competitors will not
independently develop technologies that are substantially equivalent or superior
to our technology.





We believe
that our ability to compete successfully will depend upon our ability to develop
and maintain advanced technology, develop proprietary products, attract and
retain qualified personnel, obtain patent or other proprietary protection for
our products and technologies and manufacture, assemble and market products,
either alone or through third parties, in a profitable manner.





Employees





At
December 31, 2007, we had 16 employees, of whom 3 were engaged in production and
related operations, 4 were engaged in research and development, and 9 were
engaged in management, administration, sales and customer support duties. None
of our employees are unionized or covered by a collective bargaining agreement.
We believe that we generally enjoy good relations with our
employees.  In addition to our regular employees, we utilize 6
independent consultants (3 are sales representatives and 3 engaged in research
and development activities).





ITEM 2. DESCRIPTION OF PROPERTY





In March
2005 Andrea entered into a lease for its corporate headquarters, which is
located in Bohemia, New York.  The lease is for approximately 11,000
square feet of leased space, which houses our production operations, research
and development activities, sales, administration and executive
offices.  We believe that we maintain our machinery, equipment and
tooling in good operating condition and that these assets are adequate for our
current business and are adequately insured. See Notes 5 and 12 to the
accompanying Consolidated Financial Statements for further information
concerning our property and equipment and leased facilities.





ITEM 3.LEGAL PROCEEDINGS





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





ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS





None.





6








PART
II





ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES





The table
below sets forth the high and low sales prices for Andrea’s Common Stock as
reported by the Over the Counter Bulletin Board for the eight fiscal quarters
ended December 31, 2007. On March 24, 2008, there were approximately 452 holders
of record of Andrea’s Common Stock.





Quarter
      Ended
            
            High
            
            
            LowMarch
      31, 2006
            
            $
            0.09
            
            
            $
            0.03June
      30, 2006
            
            $
            0.17
            
            
            $
            0.06September
      30, 2006
            
            $
            0.13
            
            
            $
            0.06December
      31, 2006
            
            $
            0.16
            
            
            $
            0.09March
      31, 2007
            
            $
            0.16
            
            
            $
            0.06June
      30, 2007
            
            $
            0.22
            
            
            $
            0.12September
      30, 2007
            
            $
            0.14
            
            
            $
            0.07December
      31, 2007
            
            $
            0.10
            
            
            $
            0.05





No cash
dividends were paid on Andrea’s Common Stock in 2007 or 2006.





During the
three months ended December 31, 2007, the Company did not repurchase any of its
common stock.





ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION





Overview





Our
mission is to provide the emerging “voice interface” markets with
state-of-the-art communications products that facilitate natural language,
human/machine interfaces.





Examples
of the applications and interfaces for which Andrea DSP Microphone and Audio
Software Products and Andrea Anti-Noise Products provide benefits include:
Internet and other computer-based speech; telephony communications; multi-point
conferencing; speech recognition; multimedia; multi-player Internet and CD ROM
interactive games; and other applications and interfaces that incorporate
natural language processing. We believe that end users of these applications and
interfaces will require high quality microphone and earphone products that
enhance voice transmission, particularly in noisy environments, for use with
personal computers, mobile personal computing devices, cellular and other
wireless communication devices and automotive communication systems. Our Andrea
DSP Microphone and Audio Software Products use “far-field” digital signal
processing technology to provide high quality transmission of voice where the
user is at a distance from the microphone. High quality audio communication
technologies will be required for emerging far-field voice applications, ranging
from continuous speech dictation, to Internet telephony and multiparty video
teleconferencing and collaboration, to natural language-driven interfaces for
automobiles, home and office automation and other machines and devices into
which voice-controlled microprocessors are expected to be introduced during the
next several years.





We
outsource to Asia high volume assembly for most of our products from purchased
components.  We assemble some low volume Andrea DSP Microphone and
Audio Software Products from purchased components. As sales of any particular
Andrea DSP Microphone and Audio Software Product increases, assembly operations
are transferred to a subcontractor in Asia.





Our
Critical Accounting Policies





Our
consolidated financial statements and the notes to our consolidated financial
statements contain information that is pertinent to management's discussion and
analysis.  The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosures of contingent assets and liabilities and
determination of revenues and expenses in the reporting
period.  Management bases its estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources.  On a continual basis, management reviews its estimates
utilizing currently available information, changes in facts and circumstances,
historical experience and reasonable assumptions.  After such reviews,
and if deemed appropriate, those estimates are adjusted
accordingly.  Actual results may vary from these estimates and
assumptions under different and/or future circumstances.  Management
considers an accounting estimate to be critical if: 1) it requires assumptions
to be made that were uncertain at the time the estimate was made; and 2) changes
in the estimate, or the use of different estimating methods that could have been
selected, could have a material impact on the Company’s consolidated results of
operations or financial condition.





7




The
following critical accounting policies that affect the more significant
judgments and estimates used in the preparation of the consolidated financial
statements have been identified.  In addition to the recording and
presentation of our convertible preferred stock, we believe that the following
are some of the more critical judgment areas in the application of our
accounting policies that affect our financial condition and results of
operations.  We have discussed the application of these critical
accounting policies with our Audit Committee.  The following critical
accounting policies are not intended to be a comprehensive list of all the
Company’s accounting policies or estimates.





Revenue
Recognition – Non software-related revenue, which is generally comprised of
microphones and microphone connectivity product revenues, is recognized when
title and risk of loss pass to the customer, which is generally upon
shipment.  With respect to licensing revenues, Andrea recognizes
revenue in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue
Recognition,” as amended, and Staff Accounting Bulletin Topic 13 “Revenue
Recognition.”  License revenue is recognized based on the terms and
conditions of individual contracts (for example, see Note 9 of our consolidated
financial statements).  In addition, fee based services, which are
short-term in nature, are generally performed on a time-and-material basis under
separate service arrangements and the corresponding revenue is generally
recognized as the services are performed.





Accounts
Receivable – We are required to estimate the collectibility of our trade
receivables. Judgment is required in assessing the realization of these
receivables, including the current creditworthiness of each customer and related
aging of the past due balances. We evaluate specific accounts when we become
aware of a situation where a customer may not be able to meet its financial
obligations due to a deterioration of its financial viability, credit ratings or
bankruptcy. The reserve requirements are based on the best facts available to us
and are reevaluated and adjusted as additional information is received. Our
reserves are also determined by using percentages applied to certain aged
receivable categories. At December 31, 2007 and 2006, our allowance for doubtful
accounts were $21,705 and $16,704 respectively.





Inventory
– We are required to state our inventories at the lower of cost or market. In
assessing the ultimate realization of inventories, we are required to make
considerable judgments as to future demand requirements and compare that with
our current inventory levels. Our reserve requirements generally increase as our
projected demand requirements decrease due to market conditions, technological
and product life cycle changes as well as longer than previously expected usage
periods.  We have evaluated the current levels of inventories,
considering historical net revenues and other factors and, based on this
evaluation, recorded adjustments to cost of revenues to adjust inventories to
net realizable value.  Inventories of $714,864 and $1,088,778 at
December 31, 2007 and 2006 are net of reserves of $566,941 and $591,980,
respectively. It is possible that additional charges to inventory may occur in
the future if there are further declines in market conditions, or if additional
restructuring actions are taken.





Long Lived
Assets – Statement of Financial Accounting Standards (“SFAS”), No. 144
“Accounting for the Impairment or Disposal of Long-Lived Assets” (“FAS 144”)
requires management judgments regarding the future operating and disposition
plans for marginally performing assets, and estimates of expected realizable
values for assets to be sold.  Andrea accounts for its long-lived
assets in accordance with FAS 144 for purposes of determining and measuring
impairment of its other intangible assets. Andrea’s policy is to periodically
review the value assigned to its long lived assets to determine if they have
been permanently impaired by adverse conditions which may affect
Andrea.  If required, an impairment charge would be recorded based on
an estimate of future discounted cash flows.  In order to test for
recoverability, Andrea compared the sum of an undiscounted cash flow projections
(gross margin dollars from product sales) of the Andrea DSP Microphone and Audio
Software core technology to the carrying value of that
technology.  Considerable management judgment is necessary to estimate
undiscounted future operating cash flows and fair values and, accordingly,
actual results could vary significantly from such estimates.  No
impairment charges were recognized during the years ended December 31, 2007 and
2006, respectively.





Deferred
Tax Assets – We currently have significant deferred tax assets. SFAS No. 109,
“Accounting for Income Taxes”(“FAS 109”), requires a valuation allowance be
established when it is more likely than not that all or a portion of deferred
tax assets will not be realized. Furthermore, FAS 109 provides that it is
difficult to conclude that a valuation allowance is not needed when there is
negative evidence such as cumulative losses in recent years. Therefore,
cumulative losses weigh heavily in the overall assessment. Accordingly, and
after considering changes in previously existing positive evidence, we recorded
a full valuation allowance.  In addition, we expect to provide a full
valuation allowance on future tax benefits until we can sustain a level of
profitability that demonstrates our ability to utilize the assets, or other
significant positive evidence arises that suggests our ability to utilize such
assets. The future realization of a portion of our reserved deferred tax assets
related to tax benefits associated with the exercise of stock options, if and
when realized, will not result in a tax benefit in the consolidated statement of
operations, but rather will result in an increase in additional paid in capital.
We will continue to re-assess our reserves on deferred income tax assets in
future periods on a quarterly basis.





Contingencies
- We are subject to proceedings, lawsuits and other claims, including
proceedings under laws and government regulations related to securities,
environmental, labor, product and other matters. We are required to assess the
likelihood of any adverse judgments or outcomes to these matters, as well as
potential ranges of probable losses. A determination of the amount of reserves
required, if any, for these contingencies is based on an analysis of each
individual issue with the assistance of legal counsel. The amount of any
reserves may change in the future due to new developments in each
matter.




The impact
of changes in the estimates and judgments pertaining to revenue recognition,
receivables and inventories is directly reflected in our segments’ loss from
operations. Although any charges related to our deferred tax provision are not
reflected in our segment results, the long-term forecasts supporting the
realization of those assets and changes in them are significantly affected by
the actual and expected results of each segment.





8




Cautionary
Statement Regarding Forward-Looking Statements





Certain
information contained in this Management’s Discussion and Analysis or Plan of
Operation for the year ended December 31, 2007 and other items set forth in this
Report on Form 10-KSB are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The words “anticipates,”
“believes,” “estimates,” “expects,” “intends,” “plans,” “seeks,” variations of
such words, and similar expressions are intended to identify forward-looking
statements. We have based these forward-looking statements on our current
expectations, estimates and projections about our business and industry, our
beliefs and certain assumptions made by our management. Investors are cautioned
that matters subject to forward-looking statements involve risks and
uncertainties including economic, competitive, governmental, technological and
other factors that may affect our business and prospects. These statements are
not guarantees of future performance and are subject to certain risks,
uncertainties and assumptions that are difficult to predict. In order to obtain
the benefits of these “safe harbor” provisions for any such forward-looking
statements, we wish to caution investors and prospective investors about the
following significant factors, which, among others, have in some cases affected
our actual results and are in the future likely to affect our actual results and
could cause them to differ materially from those expressed in any such
forward-looking statements. These factors include:





Risk
Factors





Our
operating results are subject to significant fluctuation; period-to-period
comparisons of our operating results may not necessarily be meaningful and you
should not rely on them as indications of our future performance.





Our
results of operations have historically been and are subject to continued
substantial annual and quarterly fluctuations. The causes of these fluctuations
include, among other things:





–
            the
      volume of sales of our products under our collaborative marketing
      arrangements;





–
            the
      cost of development of our
products;





–
            the
      mix of products we sell;





–
            the
      mix of distribution channels we
use;





–
            the
      timing of our new product releases and those of our
      competitors;





–
            fluctuations
      in the computer and communications hardware and software
      marketplace;





–
            general
      economic conditions.





We cannot
assure that the level of revenues and gross profit, if any, that we achieve in
any particular fiscal period will not be significantly lower than in other
fiscal periods. Our net revenues for the year ended December 31, 2007 were
approximately $5 million versus $5.7 million in the year ended December 31,
2006. Net loss for the year ended December 31, 2007 was approximately $390,000,
or $0.01 per share on a basic and diluted basis, versus net income of
approximately $19,000, or $0.00 per share on a basic and diluted basis for the
year ended December 31, 2006.  We continue to explore opportunities to
grow sales in other business areas; we are also examining additional
opportunities for cost reduction, production efficiencies and further
diversification of our business.  Although we have improved cash flows
by reducing overall expenses, if our revenues continue to decline we may not
continue to generate positive cash flows and our net income or loss may be
affected.


If
we fail to maintain access to funds sufficient to meet our operating needs, we
may be required to significantly reduce, sell, or refocus our operations and our
business, results of operations and financial condition could be materially and
adversely effected.





In order
to be a viable entity we need to maintain and increase profitable
operations.  To continue to achieve profitable operations we need to
maintain/increase current net revenues and continue to look for ways to control
expenses.  We might also need to sell additional assets or raise
capital as a means of funding continued operations.  In recent years,
we have sustained significant operating losses.  Since 1997, we have
been unable to generate sufficient cash flow from operations to meet our
operating needs and, correspondingly, from time to time during the past several
years, we have raised additional capital from external sources.  We
may have to continue to raise additional capital from external
sources.  These sources may include private or public financings
through the issuance of debt, convertible debt or equity, or collaborative
arrangements.  Such additional capital and funding may not be
available on favorable terms, if at all.  Additionally, we may only be
able to obtain additional capital or funds through arrangements that require us
to relinquish rights to our products, technologies or potential markets, in
whole or in part, or result in our sale.  As a result of past few
years of performance, we believe that we have sufficient liquidity to continue
our operations at least through December 2008, provided our net revenues do not
decline and our operating expenses do not increase.  Although we have
revised our business strategies to reduce our expenses and capital expenditures,
we cannot assure you that we will be successful in generating positive cash
flows or obtaining access to additional sources of funding in amounts necessary
to continue our operations.  Failure to maintain sufficient access to
funding may also result in our inability to continue operations.





9




Shares
Eligible For Future Sale May Have An Adverse Effect On Market Price; Andrea
Stockholders May Experience Substantial Dilution.





Sales of a
substantial number of shares of our common stock in the public market could have
the effect of depressing the prevailing market price of our common
stock.  Of the 200,000,000 shares of common stock presently
authorized, 59,861,193 were outstanding as of March 24, 2008. The number of
shares outstanding does not include an aggregate of 29,357,677 shares of common
stock that are issuable.  This number of issuable common shares is
equal to approximately 49% of the 59, 861,193 outstanding
shares.  These issuable common shares are comprised of:  a)
9,626,820 shares of our common stock reserved for issuance upon exercise of
outstanding awards granted under our 1991 Performance Equity Plan, 1998 Stock
Plan and 2006 Stock Plan; b) 14,984 shares reserved for future grants under our
1998 Stock Plan; c) 5,636,361 shares reserved for future grants under our 2006
Stock Plan; d) 4,149,736 shares of common stock that are issuable upon
conversion of the Series C Preferred Stock; e) 4,771,432 shares of common stock
issuable upon conversion of the Series D Preferred Stock; and f) 5,158,344 of
common stock issuable upon exercise of warrants relating to the Series D
Preferred stock.





Conversions
of our Series C Preferred Stock, Series D Preferred Stock and related warrants
may result in substantial dilution to other holders of our common
stock.





As of
March 24, 2008, we had 90.701477 shares of Series C Preferred Stock, 1,192,858
shares of Series D Preferred Stock and 5,158,344 Common Stock warrants
outstanding.  The issuance of shares of common stock upon conversion
of the Series C Preferred Stock is limited to that amount which, after given
effect to the conversion, would cause the holder not to beneficially own in
excess of 4.99% or, together with other shares beneficially owned during the 60
day period prior to such conversion, not to beneficially own in excess of 9.99%
of the outstanding shares of common stock.  The issuance of common
stock upon conversion of the Series D Preferred Stock and the related warrants
also is limited to that amount which, after given effect to the conversion,
would cause the holder not to beneficially own an excess of 4.99% of then
outstanding shares of our common stock, except that each holder has a right to
terminate such limitation upon 61 days notice to us.  Beneficial
ownership for purposes of calculation of such percentage limitations does not
include shares whose acquisition is subject to similar
limitations.  If all shares of the Series C and Series D Preferred
Stock and warrants, which are outstanding to be issued, are assumed to be
converted into or exercised for shares of common stock, the number of new shares
of common stock required to be issued as a result would aggregate 14,079,512
shares, which would represent 24% of the then outstanding shares of common
stock.





Short
sales of our common stock may be attracted by or accompany conversions of Series
C Preferred Stock and Series D Preferred Stock, which sales may cause downward
pressure upon the price of our common stock.





Short
sales of our common stock may be attracted by or accompany the sale of converted
common stock, which in the aggregate could cause downward pressure upon the
price of the common stock, regardless of our operating results, thereby
attracting additional short sales of the common stock.




If we fail to commercialize and fully
market our Andrea DSP Microphone and Audio Software products, or continue to
develop, and not fully market, Andrea Anti-Noise Headset products, our net
revenues may not increase at a high enough rate to improve our results of
operations or may not increase at all.





Our
business, results of operations and financial condition depend on the successful
commercialization of our Andrea DSP Microphone and Audio Software products and
technologies.  We introduced our first Andrea DSP Microphone products
in 1998 and we continued to introduce complementary products and technologies
over the last several years.  We are primarily targeting these
products at the desktop computer market, the audio and video conferencing
markets and the market for in-vehicle computing, among others.  The
success of these products is subject to the risks frequently encountered by
companies in an early stage of product commercialization, particularly companies
in the computing and communications industries.





If
we are unable to obtain market acceptance of Andrea DSP Microphone and Audio
Software products and technologies or if market acceptance of these products and
technologies occurs at a slow rate, then our business, results of operations and
financial condition will be materially and adversely affected.





We, and
our competitors, are focused on developing and commercializing products and
technologies that enhance the use of voice, particularly in noisy environments,
for a broad range of computer and communications applications.  These
products and technologies have been rapidly evolving and the number of our
competitors has grown, but the markets for these products and technologies are
subject to a high level of uncertainty and have been developing
slowly.  We, alone or together with our industry, may be unsuccessful
in obtaining market acceptance of these products and technologies.





10




If
we fail to develop and successfully introduce new products and technologies in
response to competition and evolving technology, we may not be able to attract
new customers or retain current customers.





The
markets in which we sell our Andrea DSP Microphone and Audio Software and Andrea
Anti-Noise Headset products are highly competitive.  We may not
compete successfully with any of our competitors.  Most of our current
and potential competitors have significantly greater financial, technology
development, marketing, technical support and other resources than we
do.  Consequently, these competitors may be able to respond more
quickly to new or emerging technologies and changes in customer requirements, or
devote greater resources to the development, marketing, and sale of their
products than we can.  One or more of these competitors may
independently develop technologies that are substantially equivalent or superior
to our technology.  The introduction of products incorporating new
technologies could render our products obsolete and unmarketable and could exert
price pressures on existing products.





We are
currently engaged in the development of digital signal processing products and
technologies for the voice, speech and natural language interface markets. We
may not succeed in developing these new digital signal processing products and
technologies, and any of these new digital signal processing products or
technologies may not gain market acceptance.





Further,
the markets for our products and technologies are characterized by evolving
industry and government standards and specifications that may require us to
devote substantial time and expense to adapt our products and
technologies.  For example, certain of our Andrea DSP Microphone and
Audio Software and Andrea Anti-Noise Headset products are subject to the Federal
Communications Commission requirements.  We may not successfully
anticipate and adapt our products and technologies in a cost effective and
timely manner to changes in technology and industry standards or to
introductions of new products and technologies by others that render our then
existing products and technologies obsolete.





If
our marketing collaborators do not effectively market their products that
include or incorporate our products, our sales growth will be adversely
affected.





We have
entered into collaborative and distribution arrangements with software
publishers and computer hardware manufacturers relating to the marketing and
sale of Andrea DSP Microphone and Audio Software products through inclusion or
incorporation with the products of our collaborators.  Our success is
dependent to a substantial degree on the efforts of these collaborators to
market their products that include or incorporate our products.  Our
collaborators may not successfully market these products.  In
addition, our collaborators generally are not contractually obligated to any
minimum level of sales of our products or technologies, and we have no control
over their marketing efforts.  Furthermore, our collaborators may
develop their own microphone, earphone or headset products that may replace our
products or technologies or to which they may give higher priority.





Shortages
of, or interruptions in, the supply of more specialized components for our
products could have a material adverse effect on our sales of these
products.





The
majority of our assembly operations are fulfilled by subcontractors (primarily
in the Far East) using purchased components.  Some specialized
components for the Andrea DSP Microphone and Audio Software products and Andrea
Anti-Noise products, such as microphones and digital signal processing boards,
are available from a limited number of suppliers (and in some cases foreign) and
subject to long lead times.  We may not be able to continue to obtain
sufficient supplies of these more specialized components, particularly if the
sales of our products increase substantially or market demand for these
components otherwise increases.  If our subcontractors fail to meet
our production and shipment schedules, our business, results of operations and
financial condition would be materially and adversely affected.





Our
ability to compete may be limited by our failure to adequately protect our
intellectual property or by patents granted to third parties.


We rely on
a combination of patents, patent applications, trade secrets, copyrights,
trademarks, and nondisclosure agreements with our employees, independent
contractors, licensees and potential licensees, limited access to and
dissemination of our proprietary information, and other measures to protect our
intellectual property and proprietary rights.  However, the steps that
we have taken to protect our intellectual property may not prevent its
misappropriation or circumvention.  In addition, numerous patents have
been granted to other parties in the fields of noise cancellation, noise
reduction, computer voice recognition, digital signal processing and related
subject matter.  We expect that products in these fields will
increasingly be subject to claims under these patents as the numbers of products
and competitors in these fields grow and the functionality of products
overlap.  Claims of this type could have an adverse effect on our
ability to manufacture and market our products or to develop new products and
technologies, because the parties holding these patents may refuse to grant
licenses or only grant licenses with onerous royalty
requirements.  Moreover, the laws of other countries do not protect
our proprietary rights to our technologies to the same extent as the laws of the
United States.





11




An
unfavorable ruling in any current litigation proceeding or future proceeding may
adversely affect our business, results of operations and financial
condition.





From time
to time we are subject to litigation incidental to our business. For example, we
are subject to the risk of adverse claims, interference proceedings before the
U.S. Patent and Trademark Office, oppositions to patent applications outside the
United States, and litigation alleging infringement of the proprietary rights of
others. Litigation to establish the validity of patents, to assert infringement
claims against others, and to defend against patent infringement claims can be
expensive and time-consuming, even if the outcome is in our favor.





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





We
generate revenues to regions outside the United States, particularly in Asia.
For the years ended December 31, 2007 and 2006, net revenues to customers
outside the United States accounted for approximately 28% and 49%, respectively,
of our net sales. International sales and operations are subject to a number of
risks, including:





•
            trade
      restrictions in the form of license
  requirements;





•
            restrictions
      on exports and imports and other government
  controls;





•
            changes
      in tariffs and taxes;





•
            difficulties
      in staffing and managing international
  operations;





•
            problems
      in establishing and managing distributor
  relationships;





•
            general
      economic conditions; and





•
            political
      and economic instability or
conflict.





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





If
we are unable to attract and retain the necessary managerial, technical and
other personnel necessary for our business, then our business, results of
operations and financial condition will be harmed.





Our
performance is substantially dependent on the performance of our executive
officers and key employees.  The loss of the services of any of these
executive officers or key employees could have a material adverse effect on our
business, results of operations and financial condition.  Our future
success depends on our continuing ability to attract and retain highly qualified
managers and technical personnel.  Competition for qualified personnel
is intense and we may not be able to attract, assimilate or retain qualified
personnel in the future.





Compliance
with the Sarbanes-Oxley Act of 2002 will require substantial financial and
management resources and may result in additional expenses, which as a smaller
public company may be disproportionately high.





Section
404 of the Sarbanes-Oxley Act of 2002 requires that we evaluate and report on
our system of internal controls as of December 31, 2007 and requires that we
have such system of internal controls audited beginning with our Annual Report
on 10-KSB for the year ending December 31, 2008, though the Securities and
Exchange Commission (the “SEC”) has proposed to delay the audit requirement one
additional year.  If we fail to maintain the adequacy of our internal
controls, we could be subject to regulatory scrutiny, civil or criminal
penalties and/or stockholder litigation.  Any inability to provide
reliable financial reports could harm our business.  Section 404 of
the Sarbanes-Oxley Act of 2002 also requires that our independent registered
public accounting firm report on management’s evaluation of our system of
internal controls.  The documentation and further development of our
internal controls to achieve compliance with the Sarbanes-Oxley Act has been a
notable expense in this year and will continue to be an expense in the
future.  Additionally, we devoted a significant amount of our time to
ensure that we are compliant with Sarbanes-Oxley Act of
2002.  ..  Furthermore, any failure to implement required
new or improved controls, or difficulties encountered in the implementation of
adequate controls over our new or revised financial processes and reporting in
the future, could harm our operating results or cause us to fail to meet our
reporting obligations which will require us to continue to devote a large amount
of our general and administrative employees’ time to the continued
compliance..  Inferior internal controls could also cause investors to
lose confidence in our reported financial information, which could have a
negative effect on the trading price of our stock.




12




Results
Of Operations





Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006





Net
      Revenues




For
      the Year Ended December 31
            %
      Change2007
            2006Andrea
      Anti-Noise Products net Product revenuesSales
      of products to an OEM customer for use with
              speech
      recognition software
            $376,580
            $595,109
            (37)All
      other Andrea Anti-Noise net product revenues
            2,242,284
            1,995,946
            12Total
      Andrea Anti-Noise Products net Product revenues
            2,618,864
            2,591,055
            1
            (a)Andrea
      DSP Microphone and Audio Software Products
              revenuesSales
      of array microphone products to an OEM customer
            928,367
            1,442,112
            (36)
            (b)All
      other Andrea DSP Microphone and Audio product
              revenues
            803,759
            921,739
            (13)
            (c)License
      revenues
            695,223
            780,384
            (11)
            (d)Total
      Andrea DSP Microphone and Audio Software Products
              revenues
            2,427,349
            3,144,235
            (23)Total
      Revenues
            $5,046,213
            $5,735,290
            (12)




(a)
            The
      slight increase in Andrea Anti Noise Product revenues of 1% is primarily
      due to the 12% increase in sales to our Valued Added Resellers in the
      education learning space as well as to our customers utilizing our
      products for distance learning.  This increase was offset by the
      37% decrease in sales of Andrea Anti-Noise Products to an OEM customer for
      use with speech recognition software which decreased due to the OEM’s
      decreased demand for our products during 2007 as compared to
      2006.  We believe that this decreased demand is related to the
      OEM’s increased demand in 2006 due to their product revision whereas the
      OEM needed additional product in 2006.   We hope to improve
      these revenues in 2008 and to that end we were recently selected to
      participate in the OEM’s 2008/2009 product line quote
      process.




(b)
            The
      significant 36% decrease in sales of microphone array products to an OEM
      customer relates to the decreased demand from the OEM
      customer.  We believe that this decrease was due to the
      introduction of the OEM’s product in 2006 and the OEM customer’s need to
      supply all of its customers for the initial launch as opposed to regular
      fulfillment of a regularly stocked product.  Therefore the
      introduction in 2006 caused the first year of sales to be significantly
      higher than the second.  We believe that our 2008 volume will be
      consistent with our 2007 volume.




(c)
            The
      13% decrease in all other Andrea DSP Microphone and Audio product revenues
      is due to decreases from two customers.  Approximately $50,000
      of this decrease relates to OEM’s current production.  As of
      March 24, 2008, shipments to this OEM are consistent with the shipments in
      quarter ended March 31, 2007.  Approximately $45,000 of this
      decrease relates to the timing of a state funded project that incorporates
      our Andrea AutoArray Microphone in state police
  cars.




(d)
            The
      11% decrease in licensing revenues for the year ended December 31, 2007 is
      a result of one of OEM licensing partner not including one of our licensed
      products in their  new Vista bundles.  This decrease
      was partially offset in part by increases other licensing
      revenues.  We expect that our 2008 licensing revenues will be in
      line with our 2007 licensing
revenues.







Cost of
      Revenues





Cost of
revenues as a percentage of net revenues for the year ended December 31, 2007
decreased to 51% from 54% for the year ended December 31, 2006.  The
cost of revenues as a percentage of net revenues for the year ended December 31,
2007 for Andrea Anti-Noise Products was consistent with the percentage for the
year ended December 31, 2006 at 60%.  The cost of revenues as a
percentage of net revenues for the year ended December 31, 2007 for Andrea DSP
Microphone and Audio Software Products is 42% compared to 49% for the year ended
December 31, 2006.  The decrease is primarily the result of the
decreases in high volume low margin sales of Andrea Anti-Noise Products to an
OEM for use with speech recognition software and sales of array microphone
products to an OEM customer. as described under “Net Revenues”
above.





Research and
      Development





Research
and development expenses for the year ended December 31, 2007 increased 19% to
$676,977 from $571,288 for the year ended December 31, 2006.  This
increase primarily relates to the increase in stock based compensation expense
as well as employee




13




compensation
and related benefit costs related to an employee dedicated to product
development  For the year ended December 31, 2007, the increase in
research and development expenses reflects a 7% increase in our Andrea DSP
Microphone and Audio Software Technology efforts to $480,552, or 71% of total
research and development expenses and a 59% increase in our Andrea Anti-Noise
Headset Product efforts to $196,425, or 29% of total research and development
expenses.  With respect to DSP Microphone and Audio Software
technologies, research efforts are primarily focused on the pursuit of
commercializing a natural language-driven human/machine interface by developing
optimal far-field microphone solutions for various voice-driven interfaces,
incorporating Andrea’s digital super directional array microphone technology,
and certain other related technologies such as noise suppression and stereo
acoustic echo cancellation.  We believe that continued research and
development spending should provide Andrea with a competitive
advantage.





General,
      Administrative and Selling
Expenses





General,
administrative and selling expenses increased approximately 9% to $2,143,159 for
the year ended December 31, 2007 from $1,963,977 for the year ended December 31,
2006.  This increase is principally related to the increase in stock
based compensation expense as well as the employment agreement entered into with
the Company’s President and Chief Executive Officer in November
2006.  For the year ended December 31, 2007, the increase reflects a
3% increase in our Andrea DSP Microphone and Audio Software Technology efforts
to $1,255,588, or 59% of total general, administrative and selling expenses and
a 19% increase in our Andrea Anti-Noise Headset Product efforts to $887,571, or
41% of total general, administrative and selling expenses.





Interest Income
      (Expense), net





Other
income, net for the year ended December 31, 2007 was $8,623 compared to an
interest expense of $2,899 for the year ended December 31, 2006.  The
year to date increase in other income is the result of interest earned on higher
cash balances in 2007.





Provision for Income
      Taxes





The
provision for income taxes is a result of certain licensing revenues that are
subject to withholding of income tax as mandated by the foreign jurisdiction in
which the revenues are earned.  Amounts are based on net revenues and
are therefore subject to change.  Effective January 1, 2007, the
Company adopted the provisions of Financial Accounting Standards Board (“FASB”)
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an
interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48
establishes for all entities a minimum threshold for financial statement
recognition of the benefit of tax positions, and requires certain expanded
disclosures.  FIN 48 is effective for fiscal years beginning after
December 15, 2006, and is to be applied to all open tax years as of the date of
effectiveness.  The adoption of FASB Interpretation No. 48 did not
have a material effect on the Company’s condensed consolidated financial
position or results of operations or cash flows (See Note 9 of the accompanying
financial statements).





Net (loss)
Income





Net loss
for the year ended December 31, 2007 was $390,124 compared to a net income of
$18,666 for the year ended December 31, 2006.  The net income for the
year ended December 31, 2007 principally reflects the factors described
above.





Off-Balance Sheet
Arrangements





The
Company has no off-balance sheet arrangements that have or are reasonably likely
to have a current or future effect on its financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to
investors.





Liquidity
And Capital Resources





Our
principal sources of funds are and expected to continue to be gross cash flows
from operations.  At December 31, 2007, we had cash and cash
equivalents of $811,403 compared with $303,678 at December 31,
2006.  The balance of cash and cash equivalents at December 31, 2007
is primarily a result of our cash provided from operations during the year ended
December 31, 2007.





Working
capital balance at December 31, 2007 was $1,837,521 compared to a working
capital of $1,562,083 at December 31, 2006.  The increase in working
capital reflects a decrease in total current assets of $14,758 and a decrease in
total current liabilities of $290,196. The decrease in total current assets
reflects an increase in cash and cash equivalents of $507,725, an increase in
accounts receivable of $154,847, a decrease in inventory of $373,914, and a
decrease in prepaid expenses of $303,416.  The decrease in total
current liabilities reflects a decrease in trade accounts payable of $144,813, a
decrease in the current portion of capital lease of $5,068, and a decrease of
$140,315 in other current liabilities.




The
increase in cash and cash equivalents of 507,725 reflects $559,438 of net cash
provided by operating activities, $46,645 of net cash used by investing
activities and $5,068 of net cash used by financing activities.




14




The cash
provided by operating activities of $559,438, excluding non-cash charges, is
primarily attributable to the $390,124 net loss for the year ended December 31,
2007, a $159,848 increase in accounts receivable, a $398,953 decrease in
inventory, a $303,416 decrease in prepaid expenses and other current assets, a
$144,813 decrease in accounts payable, and a decrease of $123,603 in other
current liabilities.  The changes in inventory, accounts payable and
other current and long term liabilities primarily reflect differences in the
timing related to both the payments for and the acquisition of inventory as well
as for other services in connection with ongoing efforts related to Andrea’s
various product lines.  Additionally, we secured better pricing on
certain inventory items by purchasing in larger volumes.




The cash
used by investing activities of $46,645 reflects an increase in property and
equipment of $33,870 and an increase in patents and trademarks of
$12,775.  The increase in property and equipment reflects capital
expenditure associated with molds for our Andrea Anti Noise Headset business
line and computer related.  The increase in patents and trademarks
reflects capital expenditures associated with our intellectual
property.




The net
cash used by financing activities of $5,068 reflects payments of our capital
leases associated with communication related equipment.





We plan to
continue to improve our cash flows in 2008 by aggressively pursuing additional
licensing opportunities related to our Andrea DSP Audio Software and increasing
the sales of our Andrea Anti-Noise Headset Products through the introduction of
refreshed product line scheduled to be introduced in the early part of 2008 as
well as the increased efforts we are putting into our sales and marketing
efforts.  However, there can be no assurance that we will be able to
successfully execute the aforementioned plans.  As of March 24, 2008,
Andrea has approximately $750,000 of cash and cash equivalents.  We
believe that we have sufficient liquidity available to continue in operation
through at least December 2008.  To the extent that we do not generate
sufficient cash flows from our operations in the next twelve months, additional
financing might be required.  Although we have improved cash flows by
reducing overall expenses, if our revenues decline, these reductions may impede
our ability to be cash flow positive and our net income or loss may be
disproportionately affected.  We have no commitment for additional
financing and may experience difficulty in obtaining additional financing on
favorable terms, if at all.  Any financing we obtain may contain
covenants that restrict our freedom to operate our business or may have rights,
preferences or privileges senior to our common stock and may dilute our current
shareholders’ ownership interest in Andrea. We cannot assure that demand will
continue for any of our products, including future products related to our
Andrea DSP Microphone and Audio Software technologies, or, that if such demand
does exist, that we will be able to obtain the necessary working capital to
increase production and provide marketing resources to meet such demand on
favorable terms, or at all.





Recently Issued Accounting
Pronouncements




For a
discussion of the impact of recent accounting pronouncements, see Note 2 of the
accompanying financial statements.




Market
Risk




Our
principal source of financing activities is the issuance of convertible
preferred stock with financial institutions. We are affected by market risk
exposure primarily through any amounts payable in stock, or cash by us under
convertible securities. We do not utilize derivative financial instruments to
hedge against changes in interest rates or for any other purpose. In addition,
substantially all transactions entered into by us are denominated in U.S.
dollars. As such, we have shifted foreign currency exposure onto our foreign
customers. As a result, if exchange rates move against foreign customers, we
could experience difficulty collecting unsecured accounts receivable, the
cancellation of existing orders or the loss of future orders. The foregoing
could materially adversely affect our business, financial condition and results
of operations.





ITEM 7.FINANCIAL STATEMENTS





The
financial statements are included in this Report beginning on page
F-1.








ITEM 8.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE





None.





ITEM 8A(T).CONTROLS AND PROCEDURES




(a)           Disclosure
Controls and Procedures




The
Company’s management, including the Company’s principal executive officer and
principal financial officer, have evaluated the effectiveness of the Company’s
“disclosure controls and procedures,” as such term is defined in Rule 13a-15(e)
promulgated under the Securities Exchange Act of 1934, as amended, (the
“Exchange Act”).  Based upon their evaluation, the principal executive
officer and principal financial officer concluded that, as of the end of the
period covered by this report, the Company’s disclosure controls and procedures
were effective for the purpose of ensuring that the information required to be
disclosed in the reports that the Company files or submits under the Exchange
Act with the SEC(1) is recorded, processed, summarized and reported within the
time periods specified in the SEC’s rules and forms, and (2) is accumulated and
communicated to the Company’s management, including its principal executive and
principal financial officers, as appropriate to allow timely decisions regarding
required disclosure.




15




(b)           Internal
Controls Over Financial Reporting




Management’s
annual report on internal control over financial reporting is included herein by
reference to the section titled “Management’s Annual Report on Internal Control
Over Financial Reporting” immediately preceding the Company’s audited
Consolidated Financial Statements in this Report..






(c)           Changes
to Internal Control Over Financial Reporting




There were
no changes in the Company’s internal control over financial reporting during the
three months ended December 31, 2007 that have materially affected, or are
reasonable likely to materially affect, the Company’s internal control over
financial reporting.







ITEM 8B. OTHER INFORMATION




None.





PART
III




ITEM 9.DIRECTORS, EXECUTIVE OFFICERS PROMOTERS, CONTROL PERSONS
AND CORPORATE GOVERNACE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
ACT







Information
on the Directors of the Company follows (all Directors serve a one-year terms;
ages are as of December 31, 2007):





Douglas J. Andrea, age 45, has
been Chairman of the Board of Directors since November 2001, a Director of the
Company since 1991, Corporate Secretary since 2003 and Chief Executive Officer
since January 2005.  He was Co-Chairman and Co-Chief Executive Officer
of the Company from November 1998 until August 2001.  He served as
Co-President of the Company from November 1992 to November 1998, as Vice
President - Engineering of the Company from December 1991 to November 1992, and
as Secretary of the Company from 1989 to January 1993.





Gary A. Jones, age 62, has
been a Director of the Company since April 1996. He has served as President of
Digital Technologies, Inc. since 1994 and was Chief Engineer at Allied Signal
Ocean Systems from 1987 to 1994.  From March 1998 to December 2000,
Mr. Jones was the Managing Director of Andrea Digital Technologies, Inc, a
wholly-owned subsidiary of Andrea Electronics Corporation.





Louis Libin, age 49, has been
a Director of the Company since February 2002. He is President of Broad Comm,
Inc., a consulting group specializing in advanced television broadcast,
interactive TV, Internet Protocol and wireless communications. Prior to his
tenure at Broad Comm, Mr. Libin was Chief Technology Officer for NBC, and was
responsible for all business and technical matters for satellite, wireless and
communication issues for General Electric and NBC. Since 1989, Mr. Libin has
represented the United States on satellite and transmission issues at the
International Telecommunications Union (the ITU) in Geneva, Switzerland. Mr.
Libin is a Senior Member of the Institute of Electrical and Electronic Engineers
(IEEE), and is a member of the National Society of Professional
Engineers.


Joseph J. Migliozzi, age 58,
has been a Director of the Company since September 2003. He operates his own
management consulting firm since 2001.  From 1997 to 2001 Mr.
Migliozzi was the Chief Operating and Financial Officer of Voyetra Turtle
Beach.  Prior to that, he served in various executive management
positions in the electronics manufacturing industries, with both financial and
operational responsibilities.  Mr. Migliozzi is a Certified Public
Accountant.





Jonathan D. Spaet, age 51, has
been a Director of the Company since 2003. He is Vice-President of Advertising
Sales for Time Warner Cable National Advertising Sales since September 2004,
overseeing advertising sales for Time Warner Cable markets around the
country.  Previously, he was Vice-President of Sales for Westwood One
Radio Networks, managing ad sales for one of the largest radio groups in the
country.  From 2002 to 2003, he was the Chief Operating Officer of MEP
Media, a company that was starting a digital cable channel devoted to the music
enthusiast.  Prior to MEP, he was President of Ad Sales for USA
Networks, supervising ad sales, marketing, research and operations for both USA
and Sci-fi, two top-tier cable channels.  Previously, he was President
of Ad Sales for About.com.  This followed 15 years at NBC, where Mr.
Spaet’s career included a six-year position in NBC Cable and nine years in the
NBC Television Stations Group.





16


Information about Executive Officers
Who Are Not Directors





The
following information is provided for the Company’s executive officer who is not
also a director:





Corisa L. Guiffre, age 35, has
been the Company's Vice President and Chief Financial Officer since June 2003
and Assistant Corporate Secretary since October 2003.  Ms. Guiffre
joined the Company in November 1999 and served as Vice President and Controller
until June 2003.  Prior to joining the Company she was a member of the
Audit, Tax and Business Advisory divisions at Arthur Andersen
LLP.  She is a Certified Public Accountant, a member of the American
Institute of Certified Public Accountants and a member of the New York State
Society of Certified Public Accountants.





Ms.
Guiffre is elected annually and holds office until her successor has been
elected and qualified or until she is removed or replaced.





SECTION
16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE





Section
16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's
directors and officers and persons who beneficially own more than ten percent of
the Company's common stock to file with the Securities and Exchange Commission
("SEC") initial reports of ownership and reports of changes in ownership of
common stock in the Company. Officers, directors and greater-than-ten percent
shareholders are also required to furnish the Company with copies of all Section
16(a) reports they file.  Based solely upon a review of Forms 3 and 4
and amendments thereto furnished to the Company under Section 16(a) of the
Securities Exchange Act of 1934, as amended, during the year ended December 31,
2007 and Forms 5 and amendments thereto furnished to the Company with respect to
the year ended December 31, 2007, and written representations provided to the
Company from the individuals required to filed reports, the Company believes
that each of the individuals required to file reports complied with applicable
reporting requirements for transactions in the Company’s common stock during the
year ended December 31, 2007, except Mr. Libin filed late one Form 4 for one
transaction and Mr. Migliozzi filed late one Form 4 for two
transactions.





Code of Business Ethics and
Conduct





Andrea
Electronics has adopted a Code of Business Ethics and Conduct.  See
Exhibits to this Annual Report on Form 10-KSB.





Audit Committee and Audit Committee
Financial Expert. –





The
Company has a separately designated standing Audit Committee which currently
consists of Messrs. Jones, Libin, Migliozzi and Spaet.  The Board of
Directors has designated Mr. Migliozzi as an audit committee financial expert
under the rules of the Securities and Exchange Commission.





ITEM 10.EXECUTIVE COMPENSATION







Summary Compensation Table





The
following table sets forth information for the last two fiscal years relating to
compensation earned by each person who served as chief executive officer and the
other most highly compensated executive officers whose total compensation was
over $100,000 during the year ended December 31, 2007 and 2006.








Name
      and Principal Position
            
            Year
            
            Salary
            
            
            Bonus
            
            
            Stock Options(1)
            
            
            TotalDouglas
      J. Andrea, Chairman of the
              Board,
      Chief Executive Officer,
            
            2007
            
            $
            300,000
            
            
            $
            -
            
            
            $
            100,264
            
            
            $
            400,264and
      Corporate Secretary
            
            2006
            
            
            255,000
            
            
            
            35,516
            
            
            
            61,082
            
            
            
            351,598Corisa
      L. Guiffre, Vice President,
              Chief
      Financial Officer and
            
            2007
            
            $
            119,712
            
            
            $
            -
            
            
            $
            5,612
            
            
            $
            125,324Assistant
      Corporate Secretary
            
            2006
            
            
            96,923
            
            
            
            -
            
            
            
            4,886
            
            
            
            101,809


____________________________________




(1)
            Reflects
      the dollar amount recognized for financial statement reporting purposes in
      accordance with FAS 123(R) for 1,000,000 and 350,000 options in 2007 for
      Mr. Andrea and Ms. Guiffre, respectively, based upon a fair value of each
      option of $0.09 using the Black-Scholes option pricing
      model.  The weighted average assumptions used in the valuation
      of the options were as follows: dividend yield, 0%; expected volatility,
      101%; risk-free rate, 4.17%; and expected life in years of 6 years and
      2,000,000 and 400,000 options in 2006 for Mr. Andrea and Ms. Guiffre,
      respectively, based upon a fair value of each option of $0.12 using the
      Black-Scholes option pricing model.  The weighted average
      assumptions used in the valuation of the options were as follows: dividend
      yield, 0%; expected volatility, 102%; risk-free rate, 5.07%; and expected
      life in years of 7 years.





17


Outstanding Equity Awards at Fiscal
Year-End





The
following table provides information concerning unexercised options for each
named executive officer outstanding as of December 31, 2007.  None of
the named executive officers had stock awards that have not vested or unearned
equity incentive plan awards at December 31, 2007.





Option
      AwardsName
            
            Number
      of securities underlying unexercised options (#)
    exercisable
            
            
            Number
      of securities underlying unexercised options (#)
    unexercisable
            
            
            Option
      exercise price ($/share)
            
            
            Option
      expiration dateDouglas
      J. Andrea
            
            
            50,000
            
            
            
            -
            
            
            $
            14.625
            
            
            
            3-03-2008100,000
            
            
            
            -
            
            
            $
            14.125
            
            
            
            6-08-2008100,000
            
            
            
            -
            
            
            $
            6.250
            
            
            
            3-23-200950,000
            
            
            
            -
            
            
            $
            5.375
            
            
            
            8-17-200975,000
            
            
            
            -
            
            
            $
            6.875
            
            
            
            4-14-201050,000
            
            
            
            -
            
            
            $
            6.000
            
            
            
            8-01-2010250,000
            
            
            
            -
            
            
            $
            0.690
            
            
            
            1-31-2012400,000
            
            
            
            -
            
            
            $
            0.130
            
            
            
            6-14-2014250,000
            
            
            
            -
            
            
            $
            0.100
            
            
            
            8-04-2014250,000
            
            
            
            -
            
            
            $
            0.040
            
            
            
            8-04-2015600,000
            
            
            
            -
            
            
            $
            0.050
            
            
            
            8-10-2015333,000
            
            
            
            667,000
            (1)
            
            $
            0.120
            
            
            
            11-02-2016333,000
            
            
            
            667,000
            (1)
            
            $
            0.120
            
            
            
            11-16-2016-
            
            
            
            1,000,000
            (3)
            
            $
            0.110
            
            
            
            9-12-2017Corisa
      L. Guiffre
            
            
            25,000
            
            
            
            -
            
            
            $
            7.125
            
            
            
            11-22-200910,000
            
            
            
            -
            
            
            $
            6.875
            
            
            
            4-14-201010,000
            
            
            
            -
            
            
            $
            6.000
            
            
            
            8-01-201010,000
            
            
            
            -
            
            
            $
            1.780
            
            
            
            3-19-201125,000
            
            
            
            -
            
            
            $
            0.690
            
            
            
            1-31-2012250,000
            
            
            
            -
            
            
            $
            0.050
            
            
            
            8-10-2015133,200
            
            
            
            266,800
            (2)
            
            $
            0.120
            
            
            
            11-16-2016-
            
            
            
            400,000
            (3)
            
            $
            0.110
            
            
            
            9-12-2017


____________________________________




(1)
            The
      stock options vest 33.3% from and after August 1, 2007, 33.3% from and
      after August 1, 2008 and 33.4% from and after August 1,
    2009




(2)
            The
      stock options vest 33.3% from and after the first anniversary of the Date
      of Grant, 33.3% from and after the second anniversary of the Date of Grant
      and 33.4% from and after the third anniversary of the Date of Grant, which
      was November 16, 2006.




(3)
            The
      stock options vest 33.3% from and after the first anniversary of the Date
      of Grant, 33.3% from and after the second anniversary of the Date of Grant
      and 33.4% from and after the third anniversary of the Date of Grant, which
      was September 12, 2007.





Employment Agreements





In
November 2006, the Company entered into a new employment agreement with the
Chairman of the Board, Douglas J. Andrea.  The employment agreement
expires July 31, 2008 and is subject to renewal as approved by the Compensation
Committee of the Board of Directors.  Pursuant to his employment
agreement, Mr. Andrea will receive an annual base salary of $300,000 per
annum.  In addition, upon execution of the employment agreement, Mr.
Andrea was entitled to a salary adjustment from August 1, 2006 through the date
of the employment agreement.   The employment agreement provides
for quarterly bonuses equal to 25% of the Company’s pre-bonus net after tax
quarterly earnings in excess of $25,000 for a total quarterly bonus amount not
to exceed $12,500; and annual




18




bonuses
equal to 10% of the Company’s annual pre-bonus net after tax earnings in excess
of $300,000.  All bonuses shall be payable as soon as the Company's
cash flow permits.  All bonus determinations or any additional bonus
in excess of the above will be made in the sole discretion of the Compensation
Committee.  On November 2, 2006, in accordance with his employment
agreement, Mr. Andrea was granted 1,000,000 stock options. This grant provides
for a three year vesting period, an exercise price of $0.12 per share, which was
fair market value at the date of grant, and a term of 10 years.  These
stock options have a fair value of $100,000 and are being expensed over the
vesting period of three years.  The stock based compensation expenses
included in general, administrative and selling expenses.  On November
16, 2006, in accordance with his employment agreement, Mr. Andrea was granted an
additional 1,000,000 stock options. This grant provides for a three year vesting
period, an exercise price of $0.12 per share, which was fair market value at the
date of grant, and a term of 10 years.  These stock options have a
fair value of $100,000 and are being expensed over the vesting period of three
years.  The stock based compensation expenses included in general,
administrative and selling expenses.  Mr. Andrea is also entitled to a
change in control payment equal to two times his salary with continuation of
health and medical benefits for two years in the event of a change in
control.  At December 31, 2007, the future minimum cash commitments
under this agreement aggregate $175,000.





Director Compensation





The
following table provides the compensation received by individuals who served as
non-employee directors of the Company during the 2007 fiscal year.





Director
            
            Fees
      Earned
              of
      Paid in
              Cash
            
            
            Stock
      Awards(1)
            
            
            Stock
      Option
              Awards(2)
            
            
            TotalGary
      A Jones
            
            $
            1,750
            
            
            $
            5,625
            
            
            $
            1,960
            
            
            $
            9,335Louis
      Libin
            
            
            1,750
            
            
            
            5,625
            
            
            
            241
            
            
            
            7,616Joseph
      J. Migliozzi
            
            
            1,750
            
            
            
            5,625
            
            
            
            4,539
            
            
            
            11,914Jonathan
      D. Spaet
            
            
            1,500
            
            
            
            5,625
            
            
            
            1,960
            
            
            
            9,085


____________________________________




(1)
            Reflects
      the dollar amount recognized for financial statement reporting purposes in
      accordance with FAS 123(R) for 181,820 shares of Common Stock with a fair
      market value of $0.11, 166,668 shares of Common Stock with a fair market
      value of $0.12 and 400,000 shares of Common Stock with a fair market value
      of $0.05 of stock granted during the years ended December 31, 2007, 2006
      and 2005 of, respectively..


(2)
            Reflects
      the dollar amount recognized for financial statement reporting purposes in
      accordance with FAS 123(R) for 16,667, 16,667 and 41,667 options in 2006
      for Messrs. Jones, Migliozzi and Spaet, respectively, based upon a fair
      value of each option of $0.10 using the Black-Scholes option pricing model
      and 33,182, 15,000, 33,182 and 60,455 options in 2007 for Messrs. Jones,
      Libin, Migliozzi and Spaet, respectively, based upon a fair value of each
      option of $0.09 using the Black-Scholes option pricing
      model.  The assumptions used in the valuation of the 2006
      options were as follows:  dividend yield, 0%; expected
      volatility, 102%; risk-free rate, 5.07%; and expected life in years of 7
      years.  The assumptions used in the valuation of the 2007
      options were as follows:  dividend yield, 0%; expected
      volatility, 101%; risk-free rate, 4.17%; and expected life in years of 6
      years.  At December 31, 2007, Messrs. Jones, Libin, Migliozzi
      and Spaet held 194,849, 165,000, 277,122 and 159,849 options to purchase
      shares of common stock.





Annual Retainer and Meeting Fees for
Non-Employee Directors.





The
following tables set forth the applicable retainers and fees that will be paid
to non-employee directors for their service on the Board of Directors of the
Company during 2007 and 2008.  Employee directors do not receive any
retainers or fees for their services on the Boards of Directors.





Annual
      Retainer
            $
            5,000
            (paid
      in the form of common stock)(1)Fee
      per Board Meeting (Regular or Special)
            $
            500Fee
      per Committee Meeting
            $
            250Additional
      Annual Retainer for the Chairperson of
              the
      Compensation and Nomination and
              Governance
      Committee
            $
            2,500
            (paid
      in the form of stock options) (2)Additional
      Annual Retainer for the Chairperson of
              the
      Audit Committee
            $
            5,000
            (paid
      in the form of stock options) (2)


____________________________________




(1)
            This
      stock grant will be granted upon the nomination of each director at the
      Annual Meeting of Stockholders.


(2)
            Stock
      option grants will be granted based on the directors past year of service,
      and will have an exercise price equal to the fair market value of the
      Company’s common stock on the date of grant, an eighteen-month vesting
      period and a term of 10 years.




19




ITEM 11.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS




Stock Ownership





The
following table sets forth certain information as of March 24, 2008, with
respect to the common stock ownership of (i) each director of the Company, (ii)
each executive officer named in the Summary Compensation Table and (iii) all
directors and executive officers of the Company as a group.





Name
      of Beneficial Owner
            
            
            Number
      of
              Shares
      Owned
              (excluding
              options)
            Number
      of
              Shares
      That May be
              Acquired
      Within
              60
      days by
              Exercising
      Options
            Percent
      of
              Common
      Stock
              Outstanding(1)Douglas
      J. Andrea
            
            261,014
            (2)
            2,791,000
            4.9%Corisa
      L. Guiffre
            
            2,750
            
            463,200
            *Gary
      A. Jones
            
            244,159
            
            157,722
            *Louis
      Libin
            
            141,667
            
            150,000
            *Joseph
      J. Migliozzi
            
            226,534
            
            231,804
            *Jonathan
      D. Spaet
            
            226,534
            
            132,722
            *Current
      directors and executive officers as
              a
      group (6 persons)
            
            1,102,658
            
            3,926,448
            7.9%


____________________________________


*Less than
1%




(1)
            Percentages
      with respect to each person or group of persons have been calculated on
      the basis of 59,861,193 shares of Company common stock, plus the number of
      shares of Company common stock which such person or group of persons has
      the right to acquire within 60 days from March 24, 2008, by the exercise
      of options.  The information concerning the shareholders is
      based upon information furnished to the Company by such shareholders.
      Except as otherwise indicated none of the shares listed are pledged as
      security and all of the shares next to each identified person or group are
      owned of record and beneficially by such person or each person within such
      group and such persons have sole voting and investment power with respect
      thereto.




(2)
            Includes
      12,438 and 3,876 shares owned by Mr. Andrea’s spouse and Mr. Andrea’s
      daughter, respectively.





The
following table sets forth certain information as of March 24, 2008, with
respect to the stock ownership of beneficial owners of more than 5% of the
Company’s outstanding common stock:





Name
      and Address
            Shares
      of
              Common
      Stock
              Owned
            
            Common
      Stock Equivalents (1)
            Percent
      of
              Common
      Stock
              and
      Common
              Stock
              Equivalents
              Outstanding
      (2)Alpha
      Capital Anstalt
              Pradafant
      7,
              Furstentums
      9490
              Vaduz,
      Liechtenstein
            -
            
            
            5,722,159
      (3)
            
            9.6%Nickolas
      W. Edwards
              937
      Pine Ave, Long Beach, CA 90813
            5,390,000(4)
            
            
            -
            
            9.0%


____________________________________




20




(1)
            The
      issuance of shares of common stock upon conversion of the Series C
      Preferred Stock is limited to that amount which, after given effect to the
      conversion, would cause the holder not to beneficially own in excess of
      4.99% or, together with other shares beneficially owned during the 60 day
      period prior to such conversion, not to beneficially own in excess of
      9.99% of the outstanding shares of common stock.  The issuance
      of common stock upon conversion of the Series D Preferred Stock and the
      related warrants also are limited to that amount which, after given effect
      to the conversion, would cause the holder not to beneficially own an
      excess of 4.99% of then outstanding shares of our common stock, except
      that each holder has a right to terminate such limitation upon 61 days
      notice to us.




(2)
            Percentages
      with respect to each person or group of persons have been calculated on
      the basis of 59,861,193 shares of Company common stock, plus the number of
      shares of Company common stock which such person or groups of persons has
      the right to acquire within 60 days of the conversion of Series C
      Preferred Stock and Series D Preferred
Stock.




(3)
            Based
      on information filed with the Securities and Exchange Commission in a
      Schedule 13G (Amendment No. 1) on February 15, 2007.  Common
      stock ownership of Alpha Capital Anstalt (“Alpha Capital’) is not known as
      of March 24, 2008.  Based on Company records as of March 24,
      2008, Alpha Capital has 4,854,638 common stock equivalents from Series C
      Preferred Stock, Series D Preferred Stock and related
      warrants.  See footnote (1) above, for limitations on the
      conversion of such commons stock
equivalents.




(4)
            Based
      on information filed with the Securities and Exchange Commission in a
      Schedule 13G (Amendment No. 1) on October 20, 2006 by Nickolas W.
      Edwards.







The
following table sets forth certain information as of March 24, 2008, for all
compensation plans, including individual compensation arrangements under which
equity securities of the Company are authorized for issuance.







Plan
      Category
            
            Number
      of securities to be
              issued
      upon exercise of
              outstanding
      options, warrants
              and
      rights
              (a)
            
            
            Weighted-average
      exercise
              price
      of outstanding options.
              warrants
      and rights
              (b)
            
            
            Number
      of securities remaining
              available
      for future issuance
              under
      equity compensation plans
              (excluding
      securities reflected in
              column
      (a))
              (c)•Equity
      compensation plans approved
              by
      security holders
            
            
            9,626,820
            
            
            $
            0.68
            
            
            
            5,651,345•Equity
      compensation plans not
              approved
      by security holders
            
            
            -
            
            
            
            -
            
            
            
            -Total
            
            
            9,626,820
            
            
            $
            0.68
            
            
            
            5,651,345







ITEM 12.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
DIRECTOR INDEPENDENCE





Each
member of the Company’s Board of Directors is independent under the listing
standards of the Nasdaq Stock Market, except for Mr. Andrea, Chairman of the
Board, President and Chief Executive Officer of the Company.





ITEM 13. EXHIBITS





INDEX
TO EXHIBITS




Exhibit Number
            Description3.1
            Amended
      and Restated Certificate of Incorporation of Registrant (incorporated by
      reference to Exhibit 3.1 of the Registrant’s Form 10-K for the year ended
      December 31, 1992)3.2
            Certificate
      of Amendment of the Restated Certificate of Incorporation of Registrant
      (incorporated by reference to Exhibit 3.2 of the Registrant’s Form 10-K
      for the year ended December 31, 1997)3.3
            Certificate
      of Amendment of the Restated Certificate of Incorporation of Registrant
      (incorporated by reference to Exhibit 3.1 of the Registrant’s Current
      Report on Form 8-K filed November 30, 1998)3.4
            Certificate
      of Amendment to the Certificate of Incorporation of the Registrant
      (incorporated by reference to Exhibit 3.1 of the Registrant’s Current
      Report on Form 8-K filed June 22, 1999)3.5
            Certificate
      of Amendment to the Certificate of Incorporation of the Registrant
      (incorporated by reference to Exhibit 3.1 of the Registrant’s Current
      Report on Form 8-K filed October 12, 2000)3.6
            Certificate
      of Amendment to the Certificate of Incorporation of the Registrant dated
      August 22, 2001 (incorporated by reference to Exhibit 3.6 of the
      Registrant’s Annual Report on Form 10-K filed April 1,
    2002)3.7
            Certificate
      of Amendment to the Certificate of Incorporation of the Registrant dated
      February 5, 2003 (incorporated by reference to Exhibit 3.1 of the
      Registrant’s Registration Statement on Form 8-A/A filed February 6,
      2003)




21




3.8
            Certificate
      of Amendment to the Certificate of Incorporation of the Registrant dated
      February 23, 2004 (incorporated by reference to Exhibit 3.1 of the
      Registrant’s Registration Statement on Form 8-K filed February 26,
      2004)3.9
            Amended
      By-Laws of Registrant (incorporated by reference to Exhibit 3.2 of the
      Registrant’s Current Report on Form 8-K filed November 30,
      1998)4.1
            Rights
      Agreement dated as of April 23, 1999 between Andrea and Continental Stock
      Transfer and Trust Company, as Rights Agent, including the form of
      Certificate of Amendment to Certificate of Incorporation as Exhibit A, the
      form of Rights Certificate as Exhibit B and the Summary of Rights to
      Purchase Shares of Series A Preferred Stock (incorporated by reference to
      Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed May 7,
      1999)10.1
            *1991
      Performance Equity Plan, as amended (incorporated by reference to Exhibit
      4 of the Registrant’s Registration Statement on Form S-8, No. 333-45421,
      filed February 2, 1998)10.2
            *1998
      Stock Plan of the Registrant, as amended (incorporated by reference to
      Exhibit 4.1 of the Registrant’s Registration Statement on Form S-8, No.
      333-82375, filed July 7, 1999)10.3
            *Change
      in Control Agreement, dated as of November 22, 1999, by and between Corisa
      L. Guiffre and the Registrant (incorporated by reference to Exhibit 10.3
      of the Registrant’s Form 10-KSB for the year ended December 31,
      2006)10.4
            Exchange
      and Termination Agreement, dated as of February 11, 2004, by and among the
      Company and HFTP Investment L.L.C (incorporated by reference to Exhibit
      10.1 of the Registrant’s Registration Statement on Form 8-K filed February
      17, 2004)10.5
            Acknowledgement
      and Waiver Agreement, dated as of February 11, 2004, by the Company and
      the investors listed in such agreement (incorporated by reference to
      Exhibit 10.2 of the Registrant’s Registration Statement on Form 8-K filed
      February 17, 2004)10.6
            Securities
      Purchase Agreement, dated February 20, 2004, by and among the Company and
      the investors listed in such agreement (incorporated by reference to
      Exhibit 4.1 of the Registrant’s Registration Statement on Form 8-K filed
      February 26, 2004)10.7
            Registration
      Rights Agreement, dated February 23, 2004, by and among the Company and
      the investors listed in such agreement (incorporated by reference to
      Exhibit 4.2 of the Registrant’s Registration Statement on Form 8-K filed
      February 26, 2004)10.8
            Form
      of Common Stock Warrant (incorporated by reference to Exhibit 4.3 of the
      Registrant’s Registration Statement on Form 8-K filed February 26,
      2004)10.9
            *Employment
      Agreement, dated as of June 14, 2004, by and between Douglas J. Andrea and
      the Registrant (incorporated by reference to Exhibit 10.0 of the
      Registrant’s Form 10QSB filed on August 13, 2004)10.10
            *Amendment
      1 dated March 29, 2006 to Employment Agreement, dated as of June 14, 2004,
      by and between Douglas J. Andrea and the Registrant (incorporated by
      reference to Exhibit 10.9 of the Registrant’s Form 10KSB filed on March
      31, 2006)10.11
            *2006
      Equity Compensation Plan of the Registrant (incorporated by reference to
      Appendix A of the Registrant’s Schedule 14A filed on October 17,
      2006.10.12
            *Employment
      Agreement, dated as of November 11, 2006, by and between Andrea
      Electronics Corporation and Douglas J. Andrea (incorporated by reference
      to Exhibit 10.1 of the Registrant’s Form 8-K filed on November 8,
      2006)14.0
            Code
      of Business Ethics and Conduct (incorporated by reference to Exhibit 14.0
      of the Registrant’s
              Form
      10KSB filed April 15, 2005)21.0
            Subsidiaries
      of Registrant23.1
            Consent
      of Independent Public Accountants31.0
            Rule
      13a-14(a)/15d – 14(a) Certifications32.0
            Section
      1350 Certifications*
      Management contract or compensatory plan or
  arrangement





22




ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES







Audit
Fees





The
following table sets forth the fees billed to the Company for the fiscal years
ended December 31, 2007 and 2006 by Marcum & Kliegman LLP:





Marcum & Kliegman LLP
            
            2007
            
            
            2006Audit
      Fees
            
            $
            131,000
            
            
            $
            125,500Audit-related
      fees
            
            
            -
            
            
            
            -Tax
      fees
            
            
            -
            
            
            
            -All
      other fees
            
            
            -
            
            
            
            -





Pre-Approval
of Services by the Independent Auditor





The Audit
Committee has adopted a policy for pre-approval of audit and permitted non-audit
services by the Company’s independent auditor.  The Audit Committee
will consider annually and, if appropriate, approve the provision of audit
services by its external auditor and consider and, if appropriate, pre-approve
the provision of certain defined audit and non-audit services.  The
Audit Committee also will consider on a case-by-case basis and, if appropriate,
approve specific engagements that are not otherwise pre-approved.





Any
proposed engagement that does not fit within the definition of a pre-approved
service may be presented to the Audit Committee for consideration at its next
regular meeting or, if earlier consideration is required, to the Audit Committee
or one or more of its members.  The member or members to whom such
authority is delegated shall report any specific approval of services at its
next regular meeting.  The Audit Committee will regularly review
summary reports detailing all services being provided to the Company by its
external auditor.





During the
year ended December 31, 2007, all services were approved, in advance, by the
Audit Committee in compliance with these procedures.







Management’s
Report on Internal Control Over Financial Reporting
 
 
 The management of the Company is
responsible for establishing and maintaining adequate internal control over
financial reporting.  The internal control process has been designed
under our supervision to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of the Company’s financial statements
for external reporting purposes in accordance with accounting principles
generally accepted in the United States of America.
 
 Management conducted an assessment of
the effectiveness of the Company’s internal control over financial reporting as
of December 31, 2007, utilizing the framework established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  Based on this assessment, management has
determined that the Company’s internal control over financial reporting as of
December 31, 2007 is effective.
 
 Our internal control over financial
reporting includes policies and procedures that pertain to the maintenance of
records that accurately and fairly reflect, in reasonable detail, transactions
and dispositions of assets; and provide reasonable assurances
that:  (1) transactions are recorded as necessary to permit
preparation of financial statements in accordance with accounting principles
generally accepted in the United States; (2) receipts and expenditures are being
made only in accordance with authorizations of management and the directors of
the Company; and (3) unauthorized acquisition, use, or disposition of the
Company’s assets that could have a material effect on the Company’s financial
statements are prevented or timely detected.
 
 All internal control systems, no matter
how well designed, have inherent limitations.  Therefore, even those
systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation.  Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
 
 This annual report does not include an
attestation report of the Company’s registered public accounting firm regarding
internal control over financial reporting.  Management’s report was
not subject to attestation by the Company’s registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit the Company to provide only management’s report in this annual
report.
 
 
 F-1
  
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
  To The
Audit Committee of the Board of Directors and Shareholders of
 Andrea
Electronics Corporation:
 
 We have
audited the accompanying consolidated balance sheets of Andrea Electronics
Corporation (a New York corporation) and subsidiaries (the “Company”) as of
December 31, 2007 and 2006, and the related consolidated statements of
operations, changes in shareholders’ equity and cash flows for the years then
ended.  These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting.  Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting.  Accordingly, we express no such
opinion.  An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
 
 In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Andrea Electronics
Corporation and subsidiaries as of December 31, 2007 and 2006, and the
consolidated results its operations and its cash flows for the years then ended
in conformity with United States generally accepted accounting
principles.
 
 /s/ Marcum
& Kliegman LLP
  Marcum
& Kliegman LLP
 Melville,
New York
 March 28,
2008
  
  ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
  CONSOLIDATED
BALANCE SHEETS
 December 31,2007
              
              
              2006ASSETSCurrent
      assets:,Cash
      and cash equivalents
              
              $
              811,403
              
              
              $
              303,678Accounts
      receivable, net of allowance for doubtful accounts of $21,705 and $16,704,
      respectively
              
              
              994,446
              
              
              
              839,599Inventories,
      net
              
              
              714,864
              
              
              
              1,088,778Prepaid
      expenses and other current assets
              
              
              64,005
              
              
              
              367,421Total
      current assets
              
              
              2,584,718
              
              
              
              2,599,476Property
      and equipment, net
              
              
              57,751
              
              
              
              39,243Intangible
      assets, net
              
              
              2,977,673
              
              
              
              3,437,432Other
      assets, net
              
              
              12,864
              
              
              
              12,864Total
      assets
              
              $
              5,633,006
              
              
              $
              6,089,015LIABILITIES AND
      SHAREHOLDERS’ EQUITYCurrent
      liabilities:Trade
      accounts payable
              
              $
              474,346
              
              
              $
              619,159Short-term
      portion of capital lease
              
              
              -
              
              
              
              5,068Other
      current liabilities
              
              
              272,851
              
              
              
              413,166Total
      current liabilities
              
              
              747,197
              
              
              
              1,037,393Series
      B Redeemable Convertible Preferred Stock, $.01 par value; authorized:
      1,000 shares; issued and outstanding: 0 shares
              
              
              -
              
              
              
              -Commitments
      and contingenciesShareholders’
      equity:Preferred
      stock, $.01 par value; authorized: 2,497,500 shares; none issued and
      outstanding
              
              
              -
              
              
              
              -Series
      C Convertible Preferred Stock, net, $.01 par value; authorized: 1,500
      shares; issued and outstanding: 90.7 and 100.7 shares, respectively;
      liquidation value: $907,015 and $1,007,015, respectively
              
              
              1
              
              
              
              1Series
      D Convertible Preferred Stock, net, $.01 par value; authorized: 2,500,000
      shares; issued and outstanding:  1,192,858 and 1,242,858 shares,
      respectively; liquidation value:  $1,192,858 and $1,242,858,
      respectively
              
              
              11,929
              
              
              
              12,429Common
      stock, $.01 par value; authorized:  200,000,000 shares; issued
      and outstanding: 59,861,193 and 59,021,857 shares,
      respectively
              
              
              598,612
              
              
              
              590,219Additional
      paid-in capital
              
              
              76,568,825
              
              
              
              76,352,407Accumulated
      deficit
              
              
              (72,293,558
              )
              
              
              (71,903,434
              )Total
      shareholders’ equity
              
              
              4,885,809
              
              
              
              5,051,622Total
      liabilities and shareholders’ equity
              
              $
              5,633,006
              
              
              $
              6,089,015
  The
accompanying notes are an integral part of these consolidated financial
statements
 F-3
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
  CONSOLIDATED
STATEMENTS OF OPERATIONS
 For
      the Years EndedDecember 31,2007
              
              
              2006RevenuesNet
      product revenues
              
              $
              4,350,990
              
              
              $
              4,954,906License
      revenues
              
              
              695,223
              
              
              
              780,384Revenues
              
              
              5,046,213
              
              
              
              5,735,290Cost
      of revenues
              
              
              2,595,414
              
              
              
              3,115,273Gross
      margin
              
              
              2,450,799
              
              
              
              2,620,017Research
      and development expenses
              
              
              676,977
              
              
              
              571,288General,
      administrative and selling expenses
              
              
              2,143,159
              
              
              
              1,963,977(Loss)
      income from operations
              
              
              (369,337
              )
              
              
              84,752Other
      income (expense), netInterest
      income
              
              
              10,858
              
              
              
              497Interest
      expense
              
              
              (2,235
              )
              
              
              (3,396
              )Other
      income (expense), net
              
              
              8,623
              
              
              
              (2,899
              )(Loss)
      income before provision for income taxes
              
              
              (360,714
              )
              
              
              81,853Provision
      for income taxes
              
              
              29,410
              
              
              
              63,187Net
      (loss) income
              
              $
              (390,124
              )
              
              $
              18,666Basic
      weighted average shares
              
              
              59,559,623
              
              
              
              58,470,811Diluted
      weighted average shares
              
              
              59,559,623
              
              
              
              68,325,677Basic
      and diluted net (loss) income per share
              
              $
              (0.01
              )
              
              $
              0.00
  The
accompanying notes are an integral part of these consolidated financial
statements.
 F-4
  ANDREA ELECTRONICS CORPORATION
      AND SUBSIDIARIES
 
 CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS’ EQUITY
 FOR
      THE YEARS ENDED DECEMBER 31, 2007 AND
2006
 
 
 Series
      C
                  Convertible
                  Preferred
                  Stock
                  Outstanding
              
              
              Series
      C
                  Convertible
      Preferred
                  Stock
              
              
              Series
      D
                  Convertible
      Preferred
                  Stock
                  Outstanding
              
              
              Series
      D
                  Convertible
      Preferred
                  Stock
              
              
              Common
                  Stock
                  Shares
                  Outstanding
              
              
              Common
                  Stock
              
              
              Additional
                  Paid-In
                  Capital
              
              
              Accumulated
                  Deficit
              
              
              Total
                  Shareholders’
                  EquityBalance,
      January 1, 2006
              
              
              105.701477
              
              
              $
              1
              
              
              
              1,328,572
              
              
              $
              13,286
              
              
              
              58,283,575
              
              
              $
              582,836
              
              
              $
              76,246,870
              
              
              $
              (71,922,100
              )
              
              $
              4,920,893Conversions
      of Series C Convertible Preferred Stock
              
              
              (5.00000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              228,758
              
              
              
              2,287
              
              
              
              6,069
              
              
              
              -
              
              
              
              8,356Conversions
      of Series D Convertible Preferred Stock
              
              
              -
              
              
              
              -
              
              
              
              (85,714
              )
              
              
              (857
              )
              
              
              342,856
              
              
              
              3,429
              
              
              
              (2,572
              )
              
              
              -
              
              
              
              -Stock
      Grant to Outside Directors and related expense
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              166,668
              
              
              
              1,667
              
              
              
              18,333
              
              
              
              -
              
              
              
              20,000Expense  of
      Stock Option Grants
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              83,707
              
              
              
              -
              
              
              
              83,707Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              18,666
              
              
              
              18,666Balance,
      December 31, 2006
              
              
              100.701477
              
              
              $
              1
              
              
              
              1,242,858
              
              
              
              12,429
              
              
              
              59,021,857
              
              
              
              590,219
              
              
              
              76,352,407
              
              
              
              (71,903,434
              )
              
              
              5,051,622Conversions
      of Series C Convertible Preferred Stock
              
              
              (10.00000
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              457,516
              
              
              
              4,575
              
              
              
              12,137
              
              
              
              -
              
              
              
              16,712Conversions
      of Series D Convertible Preferred Stock
              
              
              -
              
              
              
              -
              
              
              
              (50,000
              )
              
              
              (500
              )
              
              
              200,000
              
              
              
              2,000
              
              
              
              (1,500
              )
              
              
              -
              
              
              
              -Stock
      Grant to Outside Directors and related expense
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              181,820
              
              
              
              1,818
              
              
              
              20,682
              
              
              
              -
              
              
              
              22,500Expense
      of Stock Option Grants
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              185,099
              
              
              
              -
              
              
              
              185,099Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (390,124
              )
              
              
              (390,124
              )Balance,
      December 31, 2007
              
              
              90.701477
              
              
              $
              1
              
              
              
              1,192,858
              
              
              $
              11,929
              
              
              
              59,861,193
              
              
              $
              598,612
              
              
              $
              76,568,825
              
              
              $
              (72,293,558
              )
              
              $
              4,885,809
  The
accompanying notes are an integral part of these consolidated financial
statements.
 F-5
  ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 
 For the Years Ended December
      31,Cash
      flows from operating activities:
              
              2007
              
              
              2006Net (loss) income
              
              $
              (390,124
              )
              
              $
              18,666Adjustments to reconcile net
      (loss) income to net cash used in operating activities:Depreciation and
      amortization
              
              
              487,896
              
              
              
              488,422Stock based compensation
      expense
              
              
              207,599
              
              
              
              103,707Provision for bad
      debt
              
              
              5,001
              
              
              
              (2,152
              )Inventory reserve
              
              
              (25,039
              )
              
              
              (81,837
              )Change in:Accounts
    receivable
              
              
              (159,848
              )
              
              
              (231,484
              )Inventories
              
              
              398,953
              
              
              
              (327,939
              )Prepaid expenses and other
      current assets
              
              
              303,416
              
              
              
              (148,800
              )Trade accounts
      payable
              
              
              (144,813
              )
              
              
              159,015Other current and long term
      liabilities
              
              
              (123,603
              )
              
              
              (35,690
              )Net cash provided by (used in)
      operating operations
              
              
              559,438
              
              
              
              (58,092
              )Cash
      flows from investing activities:Purchases of property and
      equipment
              
              
              (33,870
              )
              
              
              (21,598
              )Purchases of patents and
      trademarks
              
              
              (12,775
              )
              
              
              (22,768
              )Net
      cash used in investing activities
              
              
              (46,645
              )
              
              
              (44,366
              )Cash
      flows from financing activities:Payments under capital
      lease
              
              
              (5,068
              )
              
              
              (12,461
              )Net
      cash used in financing activities
              
              
              (5,068
              )
              
              
              (12,461
              )Net
      increase (decrease) in cash and cash equivalents
              
              
              507,725
              
              
              
              (114,919
              )Cash
      and cash equivalents, beginning of period
              
              
              303,678
              
              
              
              418,597Cash
      and cash equivalents, end of period
              
              $
              811,403
              
              
              $
              303,678Supplemental
      disclosures of cash flow information:Non-cash investing and financing
      activities:Conversion of Series C
      Convertible Preferred Stock and related dividends into common
      stock
              
              $
              16,712
              
              
              $
              8,356Cash paid for:Interest
              
              $
              2,235
              
              
              $
              2,899Income Taxes
              
              $
              76,420
              
              
              $
              29,421
  The
accompanying notes are an integral part of these consolidated financial
statements.
 F-6
 
  ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  1. ORGANIZATION AND
BUSINESS
 Andrea
Electronics Corporation, incorporated in the State of New York in 1934,
(together with its subsidiaries, “Andrea” or the “Company”) has been engaged in
the electronic communications industry since its inception. Since the early
1990s, Andrea has been primarily focused on developing and manufacturing
state-of-the-art microphone technologies and products for enhancing speech-based
applications software and communications, primarily in the computer and business
enterprise markets that require high quality, clear voice signals. Andrea’s
technologies eliminate unwanted background noise to enable the optimum
performance of various speech-based and audio applications.  Andrea
DSP Microphone and Audio Software Products and Andrea Anti-Noise Products have
been designed for applications that are controlled by or depend on speech across
a broad range of hardware and software platforms. These products incorporate
Digital Signal Processing, Noise Cancellation, Active Noise Cancellation and
Active Noise Reduction microphone technologies, and are designed to cancel
background noise in a wide range of noisy environments, such as homes, offices,
factories and automobiles. Andrea also manufactures a line of accessories for
these products for the consumer and commercial markets in the United States as
well as in Europe and Asia.
 
 Management’s Liquidity
Plans
 
 As of
December 31, 2007, Andrea had a working capital of $1,837,521 and cash and cash
equivalents of $811,403.  Andrea’s loss from operations was $369,337
for the year ended December 31, 2007.  Andrea plans to continue to
improve its cash flows during 2008 by aggressively pursuing additional licensing
opportunities related to Andrea DSP Audio Software and increasing its Andrea
Anti-Noise Headset Products sales through the introduction of refreshed product
line scheduled to be introduced in the early part of 2008 as well as the
increased efforts the Company is dedicating to its sales and marketing
efforts.  However, there can be no assurance that Andrea will be able
to successfully execute the aforementioned plans.
 
 As of
March 24, 2008, Andrea has approximately $750,000 (unaudited) of cash.
Management projects that Andrea has sufficient liquidity available to operate
through at least December 2008.While Andrea explores opportunities to increase
revenues in new business areas, the Company also continues to examine additional
opportunities for cost reduction and further diversification of its
business.  Andrea was cash flow positive in 2007 and
2006.  Although these steps are encouraging, if Andrea fails to
develop additional revenues from sales of its products and licensing of its
technology or to generate adequate funding from operations, or if Andrea fails
to obtain additional financing through a capital transaction or other type of
financing, Andrea will be required to continue to significantly reduce its
operating expenses and/or operations or Andrea may have to relinquish its
products, technologies or markets which could have a materially adverse effect
on revenue and operations. Andrea has no commitment for additional financing and
may experience difficulty in obtaining additional financing on favorable terms,
if at all.
 2. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
  Principles of
Consolidation
 The
financial statements include the accounts of Andrea and its wholly-owned
subsidiaries. All intercompany balances and transactions have been eliminated in
consolidation.
 
 Loss (earnings) Per
Share
 
 Basic
(loss) earnings per share is computed by dividing the net (loss) income by the
weighted average number of common shares outstanding during the
period.  Diluted (loss) earnings adjusts basic (loss) earnings per
share for the effects of convertible securities, stock options and other
potentially dilutive financial instruments, only in the periods in which such
effect is dilutive.  Securities that could potentially dilute basic
earnings per share (“EPS”) in the future that were not included in the
computation of the diluted EPS because to do so would have been anti-dilutive
for the periods presented, consist of the following:
 
 Total
      potentially dilutive common shares as of:
              
              December
      31, 2007
              
              
              December
      31, 2006Options
      to purchase common stock (Note 13)
              
              
              9,686,820
              
              
              
              1,925,000Series
      C Convertible Preferred Stock and related accrued dividends (Note
      7)
              
              
              4,149,736
              
              
              
              -Series
      D Convertible Preferred Stock and related warrants (Note
8)
              
              
              9,929,776
              
              
              
              5,158,344Total
      potentially dilutive common shares
              
              
              23,766,332
              
              
              
              7,083,344
   F-7
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
 The
following table sets forth the components used in the computation of basic and
diluted earnings per share for the year ended December 31, 2006
 
 December
      31, 2006Numerator:Net
      (loss) income
              
              $
              18,666Denominator:Weighted
      average shares
              
              
              58,470,811Effect
      of dilutive securities:Series
      C Convertible Preferred Stock
              
              
              4,607,252Series
      D Convertible Preferred Stock
              
              
              4,971,432Employee
      stock options
              
              
              276,182Denominator
      for diluted earnings per share-adjusted weighted average shares after
      assumed conversions
              
              
              68,325,677
 The above
computation was not necessary for the year ended December 31, 2007 as the period
had a net loss.
 
 Cash and Cash
Equivalents
 Cash and
cash equivalents include cash and highly liquid investments with original
maturities of three months or less.  The Company has cash deposits in
excess of the maximum amounts insured by the Federal Deposit Insurance
Corporation at December 31, 2007 and 2006.  The Company mitigates its
risk by investing in or through major financial institutions.
 
 Concentration of Credit
Risk
 Andrea is
a manufacturer of audio communications equipment for several
industries.  Revenues of Superbeam array microphone products were
significant to one customer and its affiliates, accounting for approximately 18%
and 25% of the total net revenues for the year ended December 31, 2007 and 2006,
respectively, and accounted for 20% and 24% of total accounts receivable at
December 31, 2007 and 2006, respectively. Revenues of noise canceling and active
noise canceling products were significant to one customer and its affiliates,
accounting for approximately 7% and 10% of the total net revenues for the year
ended December 31 2007 and 2006, respectively, and accounted for 23% and 3% of
total accounts receivable at December 31, 2007 and 2006,
respectively.  Licensing revenues and other revenues of noise
canceling and active noise canceling products were significant to one customer
and its affiliates, accounting for approximately 8% and 11% of the total net
revenues for the year ended December 31, 2007 and 2006, respectively, and
accounted for 5% and 41% of total accounts receivable at December 31, 2007 and
2006, respectively. Licensing revenues and other service related revenues to one
customer were approximately 11% and 8% of the total net revenues for the year
ended December 31, 2007 and 2006 respectively, and account for 5% and 8% of
total accounts receivable at December 31, 2007 and 2006
respectively.
 
 During the
years ended December 31, 2007 and 2006, Andrea purchased a substantial portion
of its finished goods from two suppliers. Purchases from these two suppliers
amounted to 55% and 34% in 2007 and 79% and 3% in 2006, of total
purchases.  At December 31, 2007, the amounts due to these suppliers
in accounts payable were $191,411 and $104,760 respectively.  At
December 31, 2006, the amounts due to these suppliers in accounts payable were
$377,019 and $0 respectively.
 
 Allowance for Doubtful
Accounts
 The
Company performs on-going credit evaluations of its customers and adjusts credit
limits based upon payment history and the customer’s current credit worthiness,
as determined by the review of their current credit
information.  Collections and payments from customers are continuously
monitored.  The Company maintains an allowance for doubtful accounts,
which is based upon historical experience as well as specific customer
collection issues that have been identified.  While such bad debt
expenses have historically been within expectations and allowances established,
the Company cannot guarantee that it will continue to experience the same credit
loss rates that it has in the past.  If the financial condition of
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required.
 
 Inventories
  Inventories
are stated at the lower of cost (on a first-in, first-out) or market
basis.  The cost elements of inventories include materials, labor and
overhead.  Andrea reviews its inventory reserve for obsolescence on a
quarterly basis and establishes reserves on inventories when the cost of the
inventory is not expected to be recovered.  Andrea’s policy is to
reserve for inventory that shows slow movement over the
  F-8
  ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  preceding
six consecutive quarters.  Andrea records charges in inventory
reserves as part of cost of revenues.
 
 Property and
Equipment
  Property
and equipment is stated at cost less accumulated depreciation and
amortization.  Depreciation is provided on a straight-line basis over
the estimated useful lives of the assets ranging from 3 to 7 years. Leasehold
improvements are amortized on a straight-line basis over the shorter of the
lives of the respective leases or the expected useful lives of those
improvements.
 
 Expenditures
for maintenance and repairs that do not materially prolong the normal useful
life of an asset are charged to operations as incurred. Improvements that
substantially extend the useful lives of the assets are capitalized. Upon sale
or other disposition of assets, the cost and related accumulated depreciation
and amortization are removed from the accounts and the resulting gain or loss,
if any, is reflected in the statement of operations.
  Other Intangible
Assets
 Andrea
amortizes its core technology and patents and trademarks on a straight-line
basis over their estimated useful lives that range from 15 to 17
years.
  Long-Lived
Assets
 Andrea
accounts for its long-lived assets in accordance with Statement of Financial
Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets,” for purposes of determining and measuring
impairment of its long-lived assets (primarily intangible assets) other than
goodwill. Andrea’s policy is to review the value assigned to its long lived
assets to determine if they have been permanently impaired by adverse conditions
which may affect Andrea whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable.  If Andrea identifies
a permanent impairment such that the carrying amount of Andrea’s long lived
assets is not recoverable using the sum of an undiscounted cash flow projection
(gross margin dollars from product sales), the impaired asset is adjusted to its
estimated fair value, based on an estimate of future discounted cash flows which
becomes the new cost basis for the impaired asset.  Considerable
management judgment is necessary to estimate undiscounted future operating cash
flows and fair values and, accordingly, actual results could vary significantly
from such estimates.  No impairment charges were recognized during the
years ended December 31, 2007 and 2006.
 
 Revenue
Recognition
 
 Non
software-related revenue, which is generally comprised of microphones and
microphone connectivity product revenues, is recognized when title and risk of
loss pass to the customer, which is generally upon shipment.  With
respect to licensing revenues, Andrea recognizes revenue in accordance with
Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended,
and Staff Accounting Bulletin Topic 13 “Revenue Recognition in Financial
Statement.”  License revenue is recognized based on the terms and
conditions of individual contracts.  In addition, fee based services,
which are short-term in nature, are generally performed on a time-and-material
basis under separate service arrangements and the corresponding revenue is
generally recognized as the services are performed.
 
 Income
Taxes
 
 The
provision for income taxes is a result of certain licensing revenues that are
subject to withholding of income tax as mandated by the foreign jurisdiction in
which the revenues are earned.  For all other income taxes, Andrea
accounts for income taxes in accordance with SFAS No. 109, “Accounting for
Income Taxes.” SFAS No. 109 requires an asset and liability approach for
financial accounting and reporting for income taxes.  The provision
for income taxes is based upon income or loss after adjustment for those
permanent items that are not considered in the determination of taxable income.
Deferred income taxes represent the tax effects of differences between the
financial reporting and tax bases of the Company’s assets and liabilities at the
enacted tax rates in effect for the years in which the differences are expected
to reverse.  The Company evaluates the recoverability of deferred tax
assets and establishes a valuation allowance when it is more likely than not
that some portion or all of the deferred tax assets will not be
realized.  If it becomes more likely than not that a tax asset will be
used, the related valuation allowance on such assets would be
reversed.  Management makes judgments as to the interpretation of the
tax laws that might be challenged upon an audit and cause changes to previous
estimates of tax liability.  In management’s opinion, adequate
provisions for income taxes have been made for all years.  If actual
taxable income by tax jurisdiction varies from estimates, additional allowances
or reversals of reserves may be necessary.  Income tax expense
consists of the tax payable for the period and the change during the period in
deferred tax assets and liabilities.
  F-9
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
 Effective
January 1, 2007, the Company adopted the provisions of Financial Accounting
Standards Board (“FASB) issued Interpretation No. 48 “Accounting for Uncertainty
in Income Taxes”—an Interpretation of FASB Statement No. 109 (“FIN
48”).  FIN 48 establishes for all entities a minimum threshold for
financial statement recognition of the benefit of tax positions, and requires
certain expanded disclosures.  The adoption of FIN. 48 did not have a
material effect on the Company’s condensed consolidated financial position or
results of operations or cash flows (Note 11).
 
 Stock-Based
Compensation
 
 At
December 31, 2007, Andrea had three stock-based employee compensation plans,
which are described more fully in Note 13. Effective, January 1, 2006, the
Company adopted the provisions of SFAS No. 123R, “Share-Based
Payment.”  SFAS No. 123R establishes accounting for stock-based awards
exchanged for employee services.  Under the provisions of SFAS No.
123R, share-based compensation cost is measured at the grant date, based on the
fair value of the award, and is recognized as expense over the employee’s
requisite service period (generally the vesting period of the equity
grant).  The fair value of the Company’s common stock options are
estimated using the Black Scholes option-pricing model with the following
assumptions:  expected volatility, dividend rate, risk free interest
rate and the expected life.  The Company expenses stock-based
compensation by using the straight-line method.  The Company elected
to adopt the modified prospective transition method as provided by SFAS No.
123R.  In accordance with the requirements of the modified prospective
transition method, consolidated financial statements for prior year periods have
not been restated to reflect the fair value method of expensing share-based
compensation.  Additionally, effective with the adoption of SFAS No.
123R excess tax benefits realized from the exercise of stock-based awards are
classified in cash flows from financing activities.  The future
realization of the reserved deferred tax assets related to these tax benefits
associated with the exercise of stock option will result in a credit to
additional paid in capital if the related tax deduction reduces taxes
payable.
 
 Research and
Development
  Andrea
expenses all research and development costs as incurred.
 
 Shipping and Handling
Costs
 
 Andrea
incurs shipping and handling costs in its operations.  These costs are
included in "Cost of revenues" in the consolidated statements of
operations.  $79,243 and $85,809 were billed to customers and are
included in net revenues for the years ended December 31, 2007 and 2006,
respectively.
 
 Advertising
Expenses
  In
accordance with SOP 93-7, “Reporting on Advertising Costs,” all media costs of
newspaper and magazine advertisements as well as trade show costs are expensed
as incurred.  Total advertising and marketing expenses for the years
ended December 31, 2007 and 2006 were $20,677 and $16,087, respectively and are
included in general, administrative and selling expenses.
  Fair Value of Financial
Instruments
  Andrea
calculates the fair value of financial instruments and includes this additional
information in the notes to financial statements when the fair value is
different than the book value of those financial instruments. When the book
value approximates fair value, no additional disclosure is made. Andrea uses
quoted market prices whenever available to calculate these fair values. When
quoted market prices are not available, Andrea uses standard pricing models for
various types of financial instruments which take into account the present value
of estimated future cash flows. As of December 31, 2007 and 2006, the carrying
value of all financial instruments approximated fair value.
 
 Recently Issued Accounting
Pronouncements
  In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS
141R”), which replaces SFAS No. 141, “Business Combinations.” SFAS 141R
establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent consideration, and certain acquired contingencies. SFAS 141R also
requires acquisition-related transaction expenses and restructuring costs be
expensed as incurred rather than capitalized as a component of the business
combination. SFAS 141R will be applicable prospectively to business combinations
for which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. SFAS 141R would have
an impact on accounting for any businesses acquired after the effective date of
this pronouncement.
 
 In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, "Fair Value Measurements" (“SFAS 157”). SFAS 157 clarifies the principle
that fair value should be based on the
  F-10
  ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  assumptions
market participants would use when pricing an asset or liability and establishes
a fair value hierarchy that prioritizes the information used to develop those
assumptions. SFAS 157 requires fair value measurements to be separately
disclosed by level within the fair value hierarchy. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The Company does not believe the
provisions of this standard will have a significant effect on its consolidated
financial statements.
 
 In
February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial
Assets and Financial Liabilities – Including an amendment of FASB Statement No.
115” (“SFAS No. 159”), which permits entities to choose to measure many
financial instruments and certain other items at fair value.  The fair
value option established by this Statement permits all entities to choose to
measure eligible items at fair value at specified election dates. A business
entity shall report unrealized gains and losses on items for which the fair
value option has been elected in earnings at each subsequent reporting
date.  Adoption is required for fiscal years beginning after November
15, 2007.  Early adoption is permitted as of the beginning of a fiscal
year that begins on or before November 15, 2007, provided the entity also elects
to apply the provisions of SFAS  No. 159.   The
adoption of this pronouncement is not expected to have any material effects on
the Company’s consolidated financial position, results of operations or cash
flows.
 
 In
December 2007, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 110 (“SAB 110”).  SAB 110 amends and replaces Question 6
of Section D.2 of Topic 14, Share-Based Paymentof the Staff Accounting
Bulletin series. Question 6 of Section D.2 of Topic 14 expresses the views of
the staff regarding the use of the “simplified” method in developing an estimate
of the expected term of “plain vanilla” share options and allows usage of that
method for option grants prior to December 31, 2007.  SAB 110 allows
public companies which do not have sufficient historical experience to provide a
reasonable estimate to continue the use of this method for estimating the
expected term of “plain vanilla” share option grants after December 31,
2007.  The adoption of this pronouncement by the Company in fiscal
2008 is not expected to have a significant effect on its financial
statements.
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – An Amendment of ARB No. 51” (“SFAS 160”).
SFAS 160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary (previously referred to as minority interests). SFAS
160 also requires that a retained noncontrolling interest upon the
deconsolidation of a subsidiary be initially measured at its fair value. Upon
adoption of SFAS 160, the Company would be required to report any noncontrolling
interests as a separate component of stockholders’ equity.  The
Company would also be required to present any net income allocable to
noncontrolling interests and net income attributable to the stockholders of the
Company separately in its consolidated statements of operations. SFAS 160 is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. SFAS 160 requires retroactive adoption
of the presentation and disclosure requirements for existing minority interests.
All other requirements of SFAS 160 shall be applied prospectively. SFAS 160
would have an impact on the presentation and disclosure of the noncontrolling
interests of any non wholly-owned businesses acquired in the
future.
 
 Reclassifications
  Certain
prior year amounts have been reclassified to conform to the current year
presentation.
 Use of
Estimates
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period.
 
 Management
bases its estimates on historical experience and on various assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources.  The most
significant estimates, among other things, are used in accounting for allowances
for bad debts, inventory valuation and obsolescence, product warranty,
depreciation, deferred income taxes, expected realizable values for assets
(primarily intangible assets), contingencies, revenue recognition as well as the
recording and presentation of the Company’s convertible preferred stock.
Estimates and assumptions are periodically reviewed and the effects of any
material revisions are reflected in the consolidated financial statements in the
period that they are determined to be necessary. Actual results could differ
from those estimates and assumptions.
  F-12
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  3. INTANGIBLE
ASSETS
 
 Intangible
assets, net, consists of the following:
 December 31,2007
              
              
              2006Core
      Technology
              
              $
              8,567,448
              
              
              $
              8,567,448Trademarks
      and Patents
              
              
              529,271
              
              
              
              516,4969,096,719
              
              
              
              9,083,944Less:
      accumulated amortization
              
              
              (6,119,046
              )
              
              
              (5,646,512
              )$
              2,977,673
              
              
              $
              3,437,432
 
 The
changes in the carrying amount of intangible assets during the years ended
December 31, 2007 and 2006 were as follows:
 
 Core
                Technology
              
              
              Trademarks
                and Patents
              
              
              TotalsBalance
      as of January 1, 2006
              
              $
              3,531,369
              
              
              $
              355,124
              
              
              $
              3,886,493Additions
      during the period
              
              
              -
              
              
              
              22,768
              
              
              
              22,768Amortization
              
              
              (441,421
              )
              
              
              (30,408
              )
              
              
              (471,829
              )Balance
      as of December 31, 2006
              
              
              3,089,948
              
              
              
              347,484
              
              
              
              3,437,432Additions
      during the period
              
              
              -
              
              
              
              12,775
              
              
              
              12,775Amortization
              
              
              (441,421
              )
              
              
              (31,113
              )
              
              
              (472,534
              )Balance
      as of December 31, 2007
              
              $
              2,648,527
              
              
              $
              329,146
              
              
              $
              2,977,673
 
 Andrea
accounts for its long-lived assets in accordance with SFAS No. 144, “Accounting
for the Impairment or Disposal of Long-Lived Assets” for purposes of determining
and measuring impairment of its long-lived assets (primarily intangible assets)
other than goodwill. Andrea’s policy is to periodically review the value
assigned to its long-lived assets to determine if they have been permanently
impaired by adverse conditions which may affect Andrea. If Andrea identifies a
permanent impairment such that the carrying amount of Andrea’s long lived assets
are not recoverable using the sum of an undiscounted cash flow projection (gross
margin dollars from product revenues), a new cost basis for the impaired asset
will be established. If required, an impairment charge is recorded based on an
estimate of future discounted cash flows.  This new cost basis will be
net of any recorded impairment.
 
 In 2007
and 2006, because the revenues from the Andrea DSP Microphone and Audio Software
Products business segment were lower than expected and this business segment was
still operating at a loss, management compared the sum of Andrea’s undiscounted
cash flow projections (gross margin dollars from product sales) of the Andrea
DSP Microphone and Audio Software core technology to the carrying value of that
technology.  The results of this test indicated that there was not an
impairment.  This process utilized probability weighted undiscounted
cash flow projections which include a significant amount of management’s
judgment and estimates as to future revenue.  If these probability
weighted projections do not come to fruition, the Company could be required to
record an impairment charge in the near term and such impairment could be
material.
 
 Amortization
expense was $472,534 and $471,829 for the years ended December 31, 2007 and
2006, respectively. Amortization of core technology is expected to be
approximately $441,421 per year for the next six years. Trademarks and patents
are amortized on a straight-line basis over 17 years.  Assuming no
changes in the Company's intangible assets, estimated amortization expense for
each of the five succeeding fiscal years ending December 31 is expected to be
approximately $472,322 per year.
 
 4. INVENTORIES,
net
  Inventories,
net, consist of the following:
 
 December 31,2007
              
              
              2006Raw
      materials
              
              $
              62,834
              
              
              $
              40,237Finished
      goods
              
              
              1,218,971
              
              
              
              1,640,5211,281,805
              
              
              
              1,680,758Less:
      reserve for obsolescence
              
              
              (566,941
              )
              
              
              (591,980
              )$
              714,864
              
              
              $
              1,088,778
   F-12
 
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  5. PROPERTY AND EQUIPMENT,
net
 Property
and equipment, net, consists of the following:
 
 December 31,2007
              
              
              2006Machinery
      and equipment
              
              $
              492,989
              
              
              $
              459,119Less:
      accumulated depreciation and amortization
              
              
              (435,238
              )
              
              
              (419,876
              )$
              57,751
              
              
              $
              39,243
 
 Depreciation
and amortization of property and equipment was $15,362 and $16,593 for the years
ended December 31, 2007 and 2006, respectively.
 
 6. OTHER CURRENT
LIABILITIES
 Other
current liabilities consist of the following:
 
 December 31,2007
              
              
              2006Accrued
      payroll and related expenses
              
              $
              55,634
              
              
              $
              45,766Accrued
      bonus for Chief Executive Officer (Note 12)
              
              
              -
              
              
              
              121,349Accrued
      professional and other service fees
              
              
              65,451
              
              
              
              77,450Accrued
      interest and dividend expense
              
              
              151,583
              
              
              
              168,296Accrued
      other
              
              
              183
              
              
              
              305$
              272,851
              
              
              $
              413,166
 
 7. SERIES C CONVERTIBLE
PREFERRED STOCK
  On October
10, 2000, Andrea issued and sold in a private placement $7,500,000 of Series C
Redeemable Convertible Preferred Stock (the “Series C Preferred
Stock”).  Each of these shares of Series C Preferred Stock had a
stated value of $10,000 plus $671.23 increase in the stated value, which sum is
convertible into Common Stock at a conversion price of $0.2551.  On
February 17, 2004, Andrea announced that it had entered into an Exchange and
Termination Agreement and an Acknowledgment and Waiver Agreement, which
eliminated the dividend of 5% per annum on the stated value.  The
additional amount of $671.23 represents the 5% per annum from October 10, 2000
through February 17, 2004.
 
 On May 24,
2006, 5 shares of Series C Preferred Stock, together with $8,356 of previously
accrued dividends, were converted into 228,758 shares of Common Stock at the
conversion price of $0.2551.
 
 On April
11, 2007, 10 shares of Series C Preferred Stock, together with related accrued
dividends of $16,712, were converted into 457,516 shares of Common Stock at a
conversion price of $0.2551.
 
 As of
December 31, 2007, there were 90.701477 shares of Series C Preferred Stock
outstanding, which were convertible into 4,149,736 shares of Common Stock and
remaining accrued dividends of $151,583.
 
 8. SERIES D CONVERTIBLE
PREFERRED STOCK
  On
February 17, 2004, Andrea entered into a Securities Purchase Agreement
(including a Registration Rights Agreement) with certain holders of the Series C
Preferred Stock and other investors (collectively, the “Buyers”) pursuant to
which the Buyers agreed to invest a total of $2,500,000.  In
connection with this agreement, on February 23, 2004, the Buyers purchased, for
a purchase price of $1,250,000, an aggregate of 1,250,000 shares of a new class
of preferred stock, the Series D Preferred Stock, convertible into 5,000,000
shares of Common Stock (an effective conversion price of $0.25 per share) and
Common Stock warrants exercisable for an aggregate of 2,500,000 shares of Common
Stock.  The warrants are exercisable at any time after August 17, 2004
and before February 23, 2009 at an exercise price of $0.38 per
share.
 
 In
addition, on June 4, 2004, the Buyers purchased for an additional $1,250,000, an
additional 1,250,000 shares of Series D Preferred Stock convertible into
5,000,000 shares of Common Stock (an effective conversion price of $0.25 per
share) and Common Stock warrants exercisable for an aggregate of 2,500,000
shares of Common Stock.  The warrants are exercisable at any time
after December 4, 2004 and before June 4, 2009 at an exercise price of $0.17 per
share.
  F-13
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  Knightsbridge
Capital served as a financial advisor to Andrea in connection with the
aforementioned transactions and the initial issuance of the Series D Preferred
Stock and related warrants.  In connection with these transactions,
Andrea agreed to pay Knightsbridge Capital $300,000 in cash and to issue
warrants exercisable for an aggregate of 377,094 shares of Common Stock. The
warrants are exercisable at any time after August 17, 2004 and before February
23, 2009 at an exercise price of $0.38 per share.
 
 The
Company is required to maintain an effective registration statement from the
time of issuance through June 4, 2010.  In the event that the holder
of the Series D Preferred Stock and related warrants is unable to convert these
securities into Andrea Common stock the Company shall pay to each such holder of
such registrable securities a Registration Delay Payment.  This
payment is to be paid in cash and is equal to the product of (i) the stated
value of such Preferred Shares multiplied by (ii) the product of (1) .0005
multiplied by (2) the number of days that sales cannot be made pursuant to the
Registration Statement (excluding any days during that may be considered grace
periods as defined by the Registration Rights Agreement).
 
 Prior to
2006, there were 281,250 exercises of Series D Preferred Stock
Warrants.  There were no Series D Preferred Stock Warrant exercises
during the year ended December 31, 2007 and 2006.
 
 On
December 1, 2006, 85,714 shares of Series D Preferred Stock were converted into
342,856 shares of Common Stock at a conversion price of $0.25.  On
March 16, 2007, 25,000 shares of Series D Preferred Stock were converted into
100,000 shares of Common Stock at a conversion price of $0.25.  On
April 11, 2007, 25,000 shares of Series D Preferred Stock were converted into
100,000 shares of Common Stock at a conversion price of $0.25.
 
 As of
December 31, 2007, there are 1,192,858 shares of Series D Preferred Stock and
5,158,344 related warrants outstanding, which are convertible and exercisable
into 9,929,776 shares of Common Stock.
  9. LICENSING
AGREEMENTS
  The
Company has entered into various licensing, production and distribution
agreements with manufacturers of PC and related components.  These
agreements provide for revenues based on the terms of each individual
agreement.  The Company's three largest licensing customers accounted
for $244,558, $233,033 and $159,525 of revenues in 2007 and $134,017, $582,569
and $0 of revenues in 2006.
  10. RETIREMENT
PLAN
 Andrea has
a defined contribution profit sharing plan that is qualified under Section
401(k) of the Internal Revenue Code and is available to substantially all of its
employees. Andrea did not make any contributions to this plan for the years
ended December 31, 2007 and 2006.
 
 11. INCOME
TAXES
 
 The
Company has adopted the provisions of FIN 48, on January 1, 2007.  FIN
48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB Statement 109,
"Accounting for Income Taxes," and prescribes a recognition threshold and
measurement process for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return.  FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim period, disclosure and transition.  There were
no unrecognized tax benefits as of January 1, 2007.
 
 Upon the
adoption of FIN 48, the Company was required to evaluate all of its tax
positions including any limitations from the result of a change in control under
Section 382.  During 2007, the Company performed a preliminary
evaluation as to whether a change in control had taken
place.  Management has determined that a change in control may have
taken place.  As a result of its preliminary evaluation management has
determined that $30 million of its $50 million of total NOL may be subject to
limitation and accordingly reduced its net deferred tax asset and related
evaluation allowance by $11.7 million.
 
 The
Company has identified its federal tax return and its state tax return in New
York as "major" tax jurisdictions, as defined in FIN 48.  Based on the
Company's evaluation, it has been concluded that there are no significant
uncertain tax positions requiring recognition in the Company's financial
statements.  The Company's evaluation was performed for tax years
ended 2003 through 2007.  The Company believes that its income tax
positions and deductions will be sustained on audit and does not anticipate any
adjustments that will result in a material change to its financial
position.  In addition, the Company did not record a cumulative effect
adjustment related to the adoption of FIN 48.
 
 The
Company's policy for recording interest and penalties associated with audits is
to record such items as a component of income tax expense.  There were
no amounts accrued for penalties or interest as of or during the year ended
December 31, 2007.  The Company does not expect its unrecognized tax
benefit position to change during the next twelve months.  Management
is currently unaware of any issues under review that could result in significant
payments, accruals or material deviations from its position.
  F-14
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  The
components of earnings before income taxes are as follows:
 
 For the Years Ended December
      31,2007
              
              
              
              
              2006Domestic
              
              
              $
              (630,420
              )
              
              
              $
              (530,560
              )Foreign
              
              
              
              269,705
              
              
              
              
              
              612,413(Loss)
      income before income taxes
              
              
              $
              (360,715
              )
              
              
              
              $
              81,853
 
 The
provision for income tax consists of the following:
 
 For the Years Ended December
      31,2007
              
              
              2006Current:Federal
              
              $
              -
              
              
              $
              -Foreign
              
              
              29,409
              
              
              
              63,187State
      and Local:
              
              
              -
              
              
              
              -DeferredFederal
              
              
              (11,762,000
              )
              
              
              (165,000
              )Foreign
              
              
              -
              
              
              
              -State
      and Local:
              
              
              -
              
              
              
              -Adjustment
      to valuation allowance related to net deferred tax assets
              
              
              11,762,000
              
              
              
              165,000$
              29,409
              
              
              $
              63,187
 
 A
reconciliation between the effective rate for income taxes and the amount
computed by applying the statutory Federal income tax rate to loss from
continuing operations before provision (benefit) for income taxes is as
follows:
 For
      the Years Ended December 31,2007
              
              
              2006Tax
      provision at statutory rate
              
              
              (34
              )%
              
              
              34
              %State
      and local taxes
              
              
              (4
              )%
              
              
              32
              %Core
      technology amortization
              
              
              42
              %
              
              
              -
              %Stock
      Option Expense Related to Incentive Stock Options
              
              
              18
              %
              
              
              184
              %Foreign
      income and withholding taxes
              
              
              8
              %
              
              
              77
              %Change
      in valuation allowance for net deferred tax assets
              
              
              (22
              )%
              
              
              (250
              )%8
              %
              
              
              77
              %
 
 The
effective tax rate for the year ended December 31, 2006 and subsequent decrease
in effective tax rate for the year ended December 31, 2007 is a result of
certain licensing revenues that are subject to withholding of income tax as
mandated by the respective foreign jurisdiction in which the revenues are
earned.
 
 The
components of temporary differences that give rise to significant portions of
the deferred tax asset, net, are as follows:
 
 For the Years Ended December
      31,2007
              
              
              2006Deferred
      tax assets:Reserve
      for accrued expenses
              
              $
              50,000
              
              
              $
              91,000Allowance
      for doubtful accounts
              
              
              8,000
              
              
              
              7,000Reserve
      for obsolescence
              
              
              221,000
              
              
              
              231,000Foreign
      tax credit
              
              
              93,000
              
              
              
              63,000NOL
      carryforward
              
              
              7,837,000
              
              
              
              19,580,0008,209,000
              
              
              
              19,972,000Less:
      valuation allowance
              
              
              (8,209,000
              )
              
              
              (19,972,000
              )Deferred
      tax asset, net
              
              $
              -
              
              
              $
              -
  F-15
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
  The change
in the valuation allowance for deferred tax assets are summarized as
follows:
 
 For the Years Ended December
      31,2007
              
              
              2006Beginning
      Balance
              
              $
              19,972,000
              
              
              $
              20,137,000Change
      in Allowance
              
              
              (11,763,000
              )
              
              
              (165,000
              )Ending
      Balance
              
              $
              8,209,000
              
              
              $
              19,972,000
 
 SFAS No.
109 requires that a valuation allowance be established when it is “more likely
than not” that all or a portion of deferred tax assets will not be realized. A
review of all available positive and negative evidence needs to be considered,
including a company’s performance, the market environment in which the company
operates, the length of carryback and carryforward periods, and expectations of
future profits, etc.
 
 SFAS No.
109 further states that forming a conclusion that a valuation allowance is not
needed is difficult when there is negative evidence such as cumulative losses in
recent years. Therefore, cumulative losses weigh heavily in the overall
assessment.  Andrea will provide a full valuation allowance on future
tax benefits until it can sustain a level of profitability that demonstrates its
ability to utilize the assets, or other significant positive evidence arises
that suggests Andrea’s ability to utilize such assets.
 
 As of
December 31, 2007, Andrea had net operating loss and credit carryforwards of
approximately $20.1 million (net amount after potential Section 382 limitations)
expiring in varying amounts beginning in 2008 through 2027.  Andrea
has foreign tax credits of approximately $30,000 and $63,000 which will expire
in 2017 and 2016, respectively.  Some of this fully reserved deferred
tax asset of approximately $8.2 million, may have tax benefits associated with
the exercise of stock options, which will not result in a tax benefit in the
consolidated statements of operations in future periods but, rather, will result
in further increases to additional paid-in capital, if and when
realized.  The Company has elected the “with and without approach”
regarding ordering of windfall tax benefits to determine whether the windfall
tax benefit did reduce taxes payable in the current year.   Under
this approach the windfall tax benefit would be recognized in additional
paid-in-capital only if an incremental tax benefit is realized after considering
all other benefits presently available.
 12. COMMITMENTS AND
CONTINGENCIES
  Leases
 In March
2005, Andrea entered into a new lease for its corporate headquarters located in
Bohemia, New York, where Andrea leases space for warehousing, sales and
executive offices from an unrelated party. The lease is for approximately 11,000
square feet and expires in April 2010. Rent expense under this operating lease
was approximately $81,279 and $78,911 for the year ended December 31, 2007 and
2006, respectively.
 
 As of
December 31, 2007, the minimum annual future lease payments, under this lease
and all other noncancellable operating leases, are as follows:
 
 2008
              
              $
              102,3262009
              
              
              93,5412010
              
              
              29,171Total
              
              $
              225,038
 
 Employment
Agreements
 
 In
November 2006, the Company entered into a new employment agreement with the
Chairman of the Board, Douglas J Andrea.  The employment agreement
expires July 31, 2008 and is subject to renewal as approved by the Compensation
Committee of the Board of Directors.  Pursuant to his employment
agreement, Mr. Andrea will receive an annual base salary of $300,000 per
annum.  In addition, upon execution of the employment agreement, Mr.
Andrea was entitled to a salary adjustment from August 1, 2006 through the date
of the employment agreement.   The employment agreement provides
for quarterly bonuses equal to 25% of the Company’s pre-bonus net after tax
quarterly earnings in excess of $25,000 for a total quarterly bonus amount not
to exceed $12,500; and annual bonuses equal to 10% of the Company’s annual
pre-bonus net after tax earnings in excess of $300,000.  All bonuses
shall be payable as soon as the Company's cash flow permits.  All
bonus determinations or any additional bonus in excess of the above will be made
in the sole discretion of the Compensation Committee.  On November 2,
2006, in accordance with his employment agreement, Mr. Andrea was granted
1,000,000 stock options with a fair value of $100,000. This grant provides for a
three year vesting period, an exercise price of $0.12 per share, which was fair
market value at the date of grant, and a term of 10 years.  On
November 16, 2006, in accordance
  F-16
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER 31, 2007
 with his
employment agreement, Mr. Andrea was granted an additional 1,000,000 stock
options with a fair value of $100,000. This grant provides for a three year
vesting period, an exercise price of $0.12 per share, which was fair market
value at the date of grant, and a term of 10 years.  Mr. Andrea is
also entitled to a change in control payment equal to two times his salary with
continuation of health and medical benefits for two years in the event of a
change in control.  At December 31, 2007, the future minimum cash
commitments under this agreement aggregate $175,000.
 
 In
November 1999, the Company entered into a change in control agreement with the
Chief Financial Officer, Corisa L. Guiffre.  This agreement provides
for a change in control payment equal to three times her average annual
compensation for the five preceding taxable years, with continuation of health
and medical benefits for three years in the event of a change in control of the
Company, as defined in the agreement, and subsequent termination of employment
other than for cause.
 
 Legal
Proceedings
  Andrea is
involved in routine litigation incidental to the normal course of business.
While it is not feasible to predict or determine the final outcome of the
claims, Andrea believes the resolution of these matters will not have a material
adverse effect on Andrea’s financial position, results of operations or
liquidity.
 
 13. STOCK PLANS AND STOCK-BASED
COMPENSATION
 
 In 1991,
the Board of Directors of Andrea (the “Board”) adopted the 1991 Performance
Equity Plan (“1991 Plan”), which was approved by the shareholders. The 1991
Plan, as amended, authorizes the granting of awards, the exercise of which would
allow up to an aggregate of 4,000,000 shares of Andrea’s Common Stock to be
acquired by the holders of those awards.  Stock options granted to
employees and directors under the 1991 Plan were granted for terms of up to 10
years at an exercise price equal to the market value at the date of
grant.  No further awards will be granted under the 1991
Plan.
 
 In 1998,
the Board adopted the 1998 Stock Option Plan (“1998 Plan”), which was
subsequently approved by the shareholders. The 1998 Plan, as amended, authorizes
the granting of awards, the exercise of which would allow up to an aggregate of
6,375,000 shares of Andrea’s Common Stock to be acquired by the holders of those
awards.  The awards can take the form of stock options, stock
appreciation rights, restricted stock, deferred stock, stock reload options or
other stock-based awards. Awards may be granted to key employees, officers,
directors and consultants.  At December 31, 2007, there were 14,984
shares available for further issuance under the 1998 Plan.
 
 In October
2006, the Board adopted the Andrea Electronics Corporation 2006 Equity
Compensation Plan (“2006 Plan”), which was subsequently approved by the
shareholders.  The 2006 Plan authorizes the granting of awards, the
exercise of which would allow up to an aggregate of 10,000,000 shares of
Andrea’s Common Stock to be acquired by the holders of those
awards.  The awards can take the form of stock options, stock
appreciation rights, restricted stock or other stock-based awards. Awards may be
granted to key employees, officers, directors and consultants.  At
December 31, 2007, there were 5,636,361 shares available for further issuance
under the 2006 Plan.
 
 During
2006, the Board granted 400,000 stock options to the Vice President and Chief
Financial Officer and 755,000 stock options to employees of the
Company.  Each option grant provides for vesting periods of up to
three years, a weighted average exercise price of $0.12 per share, which was the
fair market value of the Company’s common stock at the date of grant, and a term
of 10 years.  The compensation expense related to these awards was
$58,339 and $16,793 for the year ended December 31, 2007 and 2006,
respectively.
 
 On
November 16, 2006, the Board granted 16,667 stock options to each chairperson on
the Nominating and Compensation Committees and 41,667 stock options to the
chairperson on the Audit Committee.  The grants provide for an
eighteen-month vesting period, an exercise price of $0.12 per share, which was
the fair market value of the Company’s common stock at the date of grant, and a
term of 10 years.  The compensation expense related to these awards
was $5,112 and $1,832 for the year ended December 31, 2007 and 2006,
respectively.
 
 On
September 12, 2007, the Board granted 1,000,000 stock options to the President
and Chief Executive Officer, 350,000 stock options to the Vice President and
Chief Financial Officer, 60,000 stock options to the Board of Directors and
760,000 stock options to employees and consultants of the
Company.  Each option grant provides for vesting periods of up to
three years, an exercise price of $0.11 per share, which was the fair market
value of the Company’s common stock at the date of grant, and a term of 10
years.  Compensation expense related to these awards was $34,793 for
the year ended December 31, 2007.  There was no compensation expense
related to these awards for the year ended December 31, 2006.
 
 On
September 12, 2007, the Board granted 18,182 stock options to each chairperson
on the Nominating and Compensation Committees and 45,455 stock options to the
chairperson on the Audit
  F-17
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 DECEMBER
31, 2007
 Committee.  The
grants provide for an eighteen-month vesting period, an exercise price of $0.11
per share, which was the fair market value of the Company’s common stock at the
date of grant, and a term of 10 years.  Compensation expense related
to these awards was $2,625 for the year ended December 31,
2007.  There was no compensation expense related to these awards for
the year ended December 31, 2006.
 
 Total
compensation expense recognized related to all stock option awards was $185,099
and $83,707 for the year ended December 31, 2007 and 2006,
respectively.  In the accompanying consolidated statement of
operations $145,607 of the 2007 expense is included in general, administrative
and selling expenses, $37,608 is included in research and development expenses
and $1,884 is included in cost of revenues.  In the accompanying
consolidated statement of operations $74,348 of the 2006 expense is included in
general, administrative and selling expenses, $8,668 is included in research and
development expenses and $691 is included in cost of revenues.
 
 The fair
values of the stock options granted were estimated on the date of grant using
the Black-Scholes option-pricing model that uses the following weighted-average
assumptions for the year ended December 31, 2007 and 2006:
 
 December
      31, 2007
              
              
              December
      31, 2006Expected
      life in years (based on simplified method)
              
              
              5.98
              
              
              
              7Risk-free
      interest rates
              
              
              4.17
              %
              
              
              5.05
              %Volatility
      (based on historical volatility)
              
              
              101
              %
              
              
              102
              %Dividend
      yield
              
              
              0
              %
              
              
              0
              %
 
 The
weighted average fair value of options at the date of grant using the
Black-Scholes fair value based method for the year ended December 31, 2007 is
estimated at $0.09.  The weighted average fair value of options at the
date of grant using the Black-Scholes fair value based method for the year ended
December 31, 2006 is estimated at $0.04.
 
 Option
activity during 2007 and 2006 is summarized as follows:
 
 Options
      Outstanding
              
              Options
      ExercisableOptions
      Outstanding
              
              
              Weighted
      Average Exercise
Price
              
              Weighted
      Average Remaining Contractual
      Life
              
              Options
      Exercisable
              
              
              Weighted
                Average
                Exercise Price
              
              Weighted
                Average
                Remaining
                Contractual LifeAt
      January 1, 2006
              
              
              4,512,500
              
              
              $
              1.71
              
              7.74 years
              
              
              4,182,500
              
              
              $
              1.84
              
              7.59 yearsGranted
              
              
              3,230,001
              
              
              
              0.12Cancelled
              
              
              (152,500
              )
              
              
              0.98At
      December 31, 2006
              
              
              7,590,001
              
              
              
              1.05
              
              8.01 years
              
              
              4,397,500
              
              
              $
              1.72
              
              6.26 yearsGranted
              
              
              2,251,819
              
              
              
              0.11Cancelled
              
              
              (155,000
              )
              
              
              5.20At
      December 31, 2007
              
              
              9,686,820
              
              
              
              0.76
              
              7.79 years
              
              
              5,355,590
              
              
              $
              1.29
              
              6.57
  years
 
 During
2007, 1,113,090 options vested with a weighted average exercise price of $0.12
and a weighted average fair value of $0.10 per option.  During 2006,
367,500 options vested with a weighted average exercise price and fair value of
$0.04 per share.
 
 Based on
the December 31, 2007, fair market value of the company’s common stock of $0.06,
the aggregate intrinsic value of the 9,686,820 options outstanding and 5,355,590
shares exercisable is $26,500.
 
 As of
December 31, 2007, there was $258,208 of total unrecognized compensation cost
related to nonvested share-based compensation arrangements granted under the
1998 and 2006 Plans.  This unrecognized compensation cost is expected
to be recognized over the next 3 years ($174,479 in 2008, $68,319 in 2009 and
$15,410 in 2010).
 
 During the
years ended December 31, 2007, 2006 and 2005, pursuant to Andrea’s compensation
policy for outside directors, Andrea granted 181,820 shares of Common Stock with
a fair market value of $0.11, 166,668 shares of Common Stock with a fair market
value of $0.12 and 400,000 shares of Common Stock with a fair market value of
$0.05, respectively.  Compensation expense related to these awards was
$22,500 and $20,000 for the years ended December 31, 2007 and 2006,
respectively.
 
 14. SEGMENT
INFORMATION
  Andrea
follows the provisions of SFAS No. 131, “Disclosures about Segments of an
Enterprise and Related Information.” Reportable operating segments are
determined based on Andrea’s management approach.
  F-18
 ANDREA
ELECTRONICS CORPORATION AND SUBSIDIARIES NOTES TO
CONSOLIDATED STATEMENTS OF CASH FLOWS
 The
management approach, as defined by SFAS No. 131, is based on the way that the
chief operating decision-maker organizes the segments within an enterprise for
making operating decisions and assessing performance. While Andrea’s results of
operations are primarily reviewed on a consolidated basis, the chief operating
decision-maker also manages the enterprise in two segments: (i) Andrea DSP
Microphone and Audio Software Products and (ii) Andrea Anti-Noise
Products.  Andrea DSP Microphone and Audio Software Products primarily
include products based on the use of some, or all, of the following
technologies: Andrea Digital Super Directional Array microphone technology
(DSDA), Andrea Direction Finding and Tracking Array microphone technology
(DFTA), Andrea PureAudio noise filtering technology, and Andrea EchoStop, an
advanced acoustic echo cancellation technology.  Our Andrea Anti-Noise
Products include noise cancellation and active noise cancellation computer
headset products and related computer peripheral products.  The
following represents selected consolidated financial information for Andrea’s
segments for the years ended December 31, 2007 and 2006:
 
 2007 Segment
      Data
              
              Andrea
      DSP
                Microphone
      and
                Audio
      Software
                Products
              
              
              Andrea
      Anti-
                Noise Products
              
              
              Total 2007Net
      revenues from external customers
              
              $
              1,732,126
              
              
              $
              2,618,864
              
              
              $
              4,350,990License
      revenues
              
              
              695,223
              
              
              
              -
              
              
              
              695,223Loss
      from operations
              
              
              329,097
              
              
              
              40,240
              
              
              
              369,337Depreciation
      and Amortization
              
              
              468,706
              
              
              
              19,190
              
              
              
              487,896Capital
      expenditures
              
              
              -
              
              
              
              33,870
              
              
              
              33,870Purchases
      of patents and trademarks
              
              
              3,700
              
              
              
              9,075
              
              
              
              12,775Assets
              
              
              4,021,688
              
              
              
              1,611,318
              
              
              
              5,633,006Total
      long lived assets
              
              
              2,852,281
              
              
              
              183,143
              
              
              
              3,035,424
  2006 Segment
      Data
              
              Andrea
      DSP
                Microphone
      and
                Audio
      Software
                Products
              
              
              Andrea
      Anti-
                Noise Products
              
              
              Total 2006Net
      revenues from external customers
              
              $
              2,363,851
              
              
              $
              2,591,055
              
              
              $
              4,954,906License
      revenues
              
              
              780,384
              
              
              
              -
              
              
              
              780,384Income
      (loss) from operations
              
              
              (69,591
              )
              
              
              154,343
              
              
              
              84,752Depreciation
      and Amortization
              
              
              466,976
              
              
              
              21,446
              
              
              
              488,422Capital
      expenditures
              
              
              19,009
              
              
              
              2,589
              
              
              
              21,598Purchases
      of patents and trademarks
              
              
              5,403
              
              
              
              17,365
              
              
              
              22,768Assets
              
              
              4,329,036
              
              
              
              1,759,979
              
              
              
              6,089,015Total
      long lived assets
              
              
              3,297,304
              
              
              
              179,371
              
              
              
              3,476,675
 
 Management
of Andrea assesses assets and non-operating income statement data on a
consolidated basis only. International revenues are based on the country in
which the end-user is located. For the years ended December 31, 2007 and 2006,
and as of each respective year-end, net revenues and accounts receivable by
geographic area are as follows:
 
 Geographic
      Data
              
              2007
              
              
              2006Net
      Revenues:United
      States
              
              $
              3,609,523
              
              
              $
              2,923,120Foreign(1)
              
              
              1,436,690
              
              
              
              2,812,170$
              5,046,213
              
              
              $
              5,735,290Accounts
      receivable:United
      States
              
              $
              736,122
              
              
              $
              231,416Foreign
              
              
              258,324
              
              
              
              608,183$
              994,446
              
              
              $
              839,599
 ____________________________________
  (1)
              Net
      revenue to the People’s Republic of China and Singapore represented 19%
      and 4%, respectively of total net revenues for year ended December 31,
      2007. Net revenue to the People’s Republic of China and Singapore
      represented 21% and 11%, respectively of total net revenues for year ended
      December 31, 2006.  .
 
 $50,498 of
our property and equipment, net represents product tools and
molds.  These tools and molds are located in Asia at the manufacturing
facility, which produces the respective product.  All of our remaining
property and equipment, net is located at our facility in Bohemia, New
York.
   F-19
 
 SIGNATURES
 
 Pursuant
to the requirements of the 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.
 
 ANDREA
      ELECTRONICS CORPORATIONBy:
              /s/    DOUGLAS J.
      ANDREAName:Douglas J.
      AndreaTitle:Chairman of the Board,
      President,
                Chief Executive Officer and
      Corporate
                Secretary
 
 Date:    March
      31, 2007
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report has been
signed below by the following persons in the capacities and on the dates
indicated.
 
 /s/    DOUGLAS
      J. ANDREA
              Chairman
      of the Board, President, Chief Executive
              March
      31, 2008Douglas
      J. Andrea
              Officer
      and Corporate Secretary/s/    CORISA
      L. GUIFFRE
              Vice
      President, Chief Financial Officer and
              March
      31, 2008Corisa
      L. Guiffre
              Assistant
      Corporate Secretary/s/    GARY
      A. JONES
              Director
              March
      31, 2008Gary
      A. Jones/s/    LOUIS
      LIBIN
              Director
              March
      31, 2008Louis
      Libin/s/    JOSEPH
      J. MIGLIOZZI
              Director
              March
      31, 2008Joseph
      J. Migliozzi/s/    JONATHAN
      D. SPAET
              Director
              March
      31, 2008Jonathan
      D. Spaet