---

---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549____________________FORM 10-K

|  |                                                                                          
|- | -----------------------------------------------------------------------------------------
|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 EXCHANGE ACT OF 1934    
|  |                                                                                          
|  | For the Fiscal Year Ended December 31, 2010                                              
|  | or                                                                                       
|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Commission file number 1-4324___________________

ANDREA ELECTRONICS CORPORATION(Exact name of registrant as specified in its charter)

|                                                                |  |                                     
|--------------------------------------------------------------- |  | ------------------------------------
|New York                                                        |  | 11-0482020                          
|(State or other jurisdiction of incorporation or
 organization) |  | (I.R.S. employer identification no.)

|                                         |  |           
|---------------------------------------- |  | ----------
|65 Orville Drive, Bohemia, New York      |  | 11716     
|(Address of principal executive offices) |  | (Zip Code)

Registrants telephone number, including area code:
631-719-1800
______________Securities registered pursuant to Section 12(b) of the
Act: None

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

Common Stock, par value $.01 per share
______________
Title of class
______________

Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes o No x

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act. Yes o No x

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

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

Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of the registrants
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

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

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

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

The aggregate market value of
the voting and non-voting common equity held by non-affiliates was $5,438,546
based upon the closing price of $0.10 as quoted on the OTC Bulletin Board on
June 30, 2010.

The number of shares
outstanding of the registrants Common Stock as of March 15, 2011, was
63,721,035.

DOCUMENTS INCORPORATED BY REFERENCE 
None

---

---



TABLE OF CONTENTS

|           |                                                                                                                |     
|---------- | -------------------------------------------------------------------------------------------------------------- | ----
|TITLE      |                                                                                                                | PAGE
|           | PART I                                                                                                         |     
|ITEM 1.    | Business                                                                                                       | 1   
|ITEM 1A.   | Risk Factors                                                                                                   | 6   
|ITEM 1B.   | Unresolved Staff Comments                                                                                      | 10  
|ITEM 2.    | Properties                                                                                                     | 10  
|ITEM 3.    | Legal Proceedings                                                                                              | 10  
|           |                                                                                                                |     
|ITEM 4.    | [Removed and Reserved]                                                                                         |     
|           | PART II                                                                                                        |     
|ITEM 5.    | Market for Registrants
 Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
 Securities | 10  
|ITEM 6.    | Selected Financial Data                                                                                        | 11  
|ITEM 7.    | Managements Discussion
 and Analysis of Financial Condition and Results of Operations                         | 11  
|ITEM 7A.   | Quantitative and
 Qualitative Disclosures About Market Risk                                                    | 15  
|ITEM 8.    | Financial Statements and
 Supplementary Data                                                                   | 15  
|ITEM 9.    | Changes in and
 Disagreements With Accountants on Accounting and Financial Disclosure                          | 15  
|ITEM 9A    | Controls and Procedures                                                                                        | 16  
|ITEM 9B.   | Other Information                                                                                              | 16  
|           | PART III                                                                                                       |     
|ITEM 10.   | Directors, Executive
 Officers and Corporate Governance                                                        | 16  
|ITEM 11.   | Executive Compensation                                                                                         | 18  
|ITEM 12.   | Security Ownership Of
 Certain Beneficial Owners and Management and Related Stockholder Matters ..             | 21  
|ITEM 13.   | Certain Relationships and
 Related Transactions, and Director Independence                                     | 22  
|ITEM 14.   | Principal Accountant Fees
 And Services                                                                        | 22  
|           |                                                                                                                |     
|           | PART IV                                                                                                        |     
|ITEM 15.   | Exhibits and Financial Statement
 Schedules                                                                    | 23  
|           |                                                                                                                |     
|SIGNATURES |                                                                                                               

---



PART I

ITEM 1. 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:

| |   |                                                                    
| | - | -------------------------------------------------------------------
| |  | computer speech recognition
 applications;                         
| |   |                                                                    
| |  | computer voice over the
 internet protocol (VoIP) applications; and
| |   |                                                                    
| |  | consumer electronics
 accessories.                                 

Andrea Digital Signal Processing (DSP) Microphone and
Audio Software Business
 Our patented and patent-pending digital noise canceling technologies enable a
speaker to be at a distance from the microphone (we refer to this capability as
far-field microphone use), and free the speaker from having to use a close
talking microphone. 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 or a rear view
mirror, and can be used individually or combined depending on particular
customer requirements.

We are currently targeting
our far-field technologies at 1) the desktop and laptop computing market; 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. Our far-field, digital noise canceling
technologies and related products, together with implementations of other
high-end audio technologies (for example, our software 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,
2010 and 2009 approximated 49% and 32%, respectively, of our total net
revenues. We dedicate a significant amount 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 VoIP 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 technology uses 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, 2010 and 2009, our Andrea Anti-Noise Headset Product
segment approximated 51% and 68%, respectively, of our total net revenues.

For more financial
information regarding our operating segments, see Note 14 of the accompanying
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

1

---



microprocessors. We are
designing and marketing our products and technologies to be used for these
natural language, human/machine interfaces with:

| |   |                                                                                                 
| | - | ------------------------------------------------------------------------------------------------
| |  | desktop, laptop and
 hand-held computers, mobile personal computing devices and cellular phones;
| |   |                                                                                                 
| |  | 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 at a distance 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 allow 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 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 to new
market bases such as consumer electronics accessory distributors and existing
market bases such as those companies increasingly using distance learning
applications.

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 through ongoing marketing efforts.                                 

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.

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

2

---



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 using a notebook computer with embedded web cam and array
microphone who wants to video conference using VoIP with a friend in another
country. 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®). Andreas patented DSDA adaptive beam
forming system powers Andreas SuperBeam microphone which enables more
intelligible audio by forming a beam toward the speaker and eliminating
background noises that are outside of the beam. 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®. Andreas PureAudio patented and award winning noise reduction speech
enhancement algorithm significantly improves intelligibility of voice audio and
accuracy in speech driven applications, particularly in high noise
environments. PureAudio is especially effective for use with speech recognition
and mobile devices. 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®. Andreas patented EchoStop provides a full
duplex acoustic echo cancellation algorithm enabling both speakers to broadcast
and microphone to transmit simultaneously turning your PC into a high quality
speakerphone. 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.

SuperBeam. 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.

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 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-based lessons and training
 information);    
| |   |                                                                                                        
| |  | Audio/videoconferencing;                                                                               
| |   |                                                                                                        
| |  | Internet telephony and
 Voice Chat;                                                                    
| |   |                                                                                                        
| |  | 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. Andreas patented DSDA adaptive beam forming system powers Andreas
SuperBeam Array Microphone which enables more intelligible audio by forming a
beam toward the speaker and eliminating background noises that are outside of
the beam. DSDA is particularly effective for small office/home office use,
providing an untethered noise cancelling microphone experience while gaining
all the benefits of a regular headset.

Andrea
USB-SA External Digital Sound Card.Andreas PureAudio USB-SA with patented noise reduction technology
eliminates noise problems by utilizing high quality digital circuitry and state
of the art noise reduction algorithm software. This format bypasses the desktop
or laptop computers sound system, providing increased intelligibility and
performance of stereo microphone input and stereo speaker output for all of a
users digital audio applications including VoIP and speech recognition
programs.

Andrea
AudioCommander.Andreas
PC Audio Control Panel, AudioCommander, includes a speaker volume adjustment
with received PureAudio noise reduction control and a 10-band graphic equalizer
with 18 built-in presets to customize sound for a users listening preference.
It also includes a microphone volume adjustment with noise reduction, beam
forming, and acoustic echo cancellation controls. 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 AutoArray 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 several technologies, including DSDA and
PureAudio.

Andrea
VoiceCenter (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.
Our headsets are designed so you can get the most out of your PC audio
experience. In addition, with our new USB headset products, Andrea has combined
the benefits of PureAudio USB digital audio which includes Andreas complete
PureAudio Voice Solutions Software Suite (including Audio Commander, Voice
Center and Pure Audio Technology) with our noise cancelling PC headsets
delivering a high fidelity audio experience with the highest voice recognition
industry rating.

BlueTooth
NC Products. Andrea
Electronics is now offering our noise cancellation boom microphone technology
in our BT-200 Bluetooth headset. This wireless headset solution enhances sound
quality in noisy environments and provides the user with a PureAudio
experience, as well as delivering superior speech dialing performance. As an
added value, these products can be combined with a USB audio adapter that can
be used to seamlessly communicate to a PC as well as with a cellular phone.

ANC
Products. ANC
Products are our premium close talking microphone platform for enhancing speech
recognition applications. All of our ANC products are sold through our internal
contact center. ANC headset products incorporate a dual microphone system
design that optimizes the acoustic performance of the sound.

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.

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. In
addition to the arrangements we are involved in, 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 2013 to 2025. 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, 2010 and 2009, total research and development
expenses were $731,297 and $607,877, respectively. During 2011, we expect
research and development expenses to remain at the same level when compared to
2010. 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, and therefore, heightened emphasis will be
placed on application engineering, sales and marketing activity and less
emphasis will be placed on research and development. No assurance can be given
that our research and development efforts will succeed. See Part II  Item 7 
Managements Discussion and Analysis of Financial Condition and Results of
Operations.

5

---



Sales and Marketing

We employ a sales staff as
well as outside sales representatives and sales 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 Original Equipment Manufacturers
(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 2010 and 2009, all of our
assembly operations were performed 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, 2010, we had
20 employees, of whom 4 were engaged in production and related operations, 6
were engaged in research and development, and 10 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 8 independent consultants (4 are sales representatives, 2
are engaged for administration purposes and 2 are engaged in research and
development activities).

ITEM 1A. 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;               

6

---



| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | fluctuations in the
 computer and communications hardware and software marketplace; and
| |   |                                                                                        
| |  | general economic
 conditions.                                                          

We cannot assure that the
level of revenues and gross profit, if any, that we achieve in any particular
fiscal period will not be significantly lower than in other fiscal periods. Our
net revenues for the years ended December 31, 2010 and 2009 were approximately
$4.9 million and $4.7 million, respectively. Net loss for the year ended
December 31, 2010 was approximately $78,000, or $0.00 per share on a basic and diluted
basis, versus a net loss of approximately $167,000, or $0.00 per share on a
basic and diluted basis for the year ended December 31, 2009. We continue to
explore opportunities to grow sales in other business areas; we are also
examining additional opportunities for cost reduction, production efficiencies
and further diversification of our business.

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 or increase current net
revenues and continue to look for ways to control expenses. We might also need
to sell additional assets or raise capital as a means of funding continued
operations. In recent years, we have sustained significant operating losses. We
may have to raise additional capital from external sources. These sources may
include private or public financings through the issuance of debt, convertible
debt or equity, or collaborative arrangements. Such additional capital and
funding may not be available on favorable terms, if at all. Additionally, we
may only be able to obtain additional capital or funds through arrangements
that require us to relinquish rights to our products, technologies or potential
markets, in whole or in part, or result in our sale. As a result of the past
few years of performance, we believe that we have sufficient liquidity to
continue our operations at least through December 2011, provided our net
revenues do not decline and our operating expenses do not increase. Although we
are always attempting to reduce or limit our expenses and capital expenditures,
we cannot assure you that we will be successful in generating positive cash
flows or obtaining access to additional sources of funding in amounts necessary
to continue our operations. Failure to maintain sufficient access to funding
may also result in our inability to continue operations.

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

Sales of a substantial
number of shares of our common stock in the public market could have the effect
of depressing the prevailing market price of our common stock. Of the
200,000,000 shares of common stock presently authorized, 63,721,035 were
outstanding as of March 15, 2011. The number of shares outstanding does not
include an aggregate of 27,806,991 shares of common stock that are issuable.
This number of issuable common shares is equal to approximately 44% of the 63,
721,035 outstanding shares. These issuable common shares are comprised of: a)
17,940,821 shares of our common stock reserved for issuance upon exercise of
outstanding awards granted under our 1998 Stock Plan and 2006 Stock Plan; b)
4,213,936 shares reserved for future grants under our 2006 Stock Plan; c)
2,023,658 shares of common stock that are issuable upon conversion of the
Series C Preferred Stock; and d) 3,628,576 shares of common stock issuable upon
conversion of the Series D Preferred Stock.

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 15, 2011, we had
44.231432 shares of Series C Preferred Stock and 907,144 shares of Series D
Preferred Stock outstanding. The issuance of shares of common stock upon
conversion of the Series C Preferred Stock is limited to that amount which,
after giving 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 giving effect to the
conversion, would cause the holder not to beneficially own in excess of 4.99%
of the 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, 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 5,652,234 shares, which is equal to approximately 9% of
the 63,721,035 outstanding shares.

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.

7

---



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 and
continued development of our Andrea Anti-Noise Headset products. We introduced
our first Andrea DSP Microphone products in 1998 and we continued to introduce
complementary products and technologies over the last several years. For both
product lines, we primarily target 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.

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, research and 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

8

---



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.

The Company depends on component and product manufacturing
and logistical services provided by third parties, many of whom are located
outside of the United States.

Substantially all of the
Companys components and products are manufactured in whole or in part by a few
third-party manufacturers. Many of these manufacturers are located outside of
the United States. The Company has also outsourced much of its transportation
and logistics management. While these arrangements may lower operating costs,
they also reduce the Companys direct control over production and distribution.
It is uncertain what effect such diminished control will have on the quality or
quantity of products or the Companys flexibility to respond to changing
conditions. If manufacturing or logistics in these locations is disrupted for
any reason, including but not limited to, natural disasters, information
technology system failures, military actions or economic, business, labor,
environmental, public health, or political issues, the Companys consolidated
financial condition and operating results could be materially 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.

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 from
regions outside the United States. For the years ended December 31, 2010 and
2009, net revenues from sales to customers outside the United States accounted
for approximately15% and 8%, 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.

9

---



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 has required
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 required that we evaluate and report on our system
of internal controls beginning as of December 31, 2008. If we fail to maintain
the adequacy of our internal controls, we could be subject to regulatory
scrutiny, civil or criminal penalties and/or shareholder litigation. Any
inability to provide reliable financial reports could harm our business. 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.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Andrea has a lease for its
corporate headquarters, which is located in Bohemia, New York. The lease, which
currently expires in April 2015, 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 any of these matters will not have a material
adverse effect on Andreas financial position, results of operations or
liquidity.

ITEM 4. [REMOVED AND RESERVED]

PART II

ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND 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,
2010. Andreas common stock is currently quoted on the OTCQB tier of the OTC
Market Groups quotation platform. On March 15, 2011, there were approximately
429 holders of record of Andreas Common Stock.

|                   |  |      |      |     |   |      | 
|------------------ |  | ---- | ---- | --- | - | ---- | 
|Quarter
 Ended     |  | High |      | Low |  
|March 31, 2009     |  | $    | 0.06 |     | $ | 0.02 | 
|June 30, 2009      |  | $    | 0.05 |     | $ | 0.02 | 
|September 30, 2009 |  | $    | 0.17 |     | $ | 0.03 | 
|December 31, 2009  |  | $    | 0.13 |     | $ | 0.06 | 
|March 31, 2010     |  | $    | 0.07 |     | $ | 0.05 | 
|June 30, 2010      |  | $    | 0.12 |     | $ | 0.05 | 
|September 30, 2010 |  | $    | 0.13 |     | $ | 0.05 | 
|December 31, 2010  |  | $    | 0.11 |     | $ | 0.05 | 

No cash dividends were paid
on Andreas Common Stock in 2010 or 2009.

10

---



During the three months
ended December 31, 2010, the Company did not repurchase any of its common
stock.

ITEM 6. SELECTED FINANCIAL DATA

Not applicable as Andrea is
a smaller reporting company.

ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Overview

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

Examples of the applications
and interfaces for which Andrea DSP Microphone and Audio Software Products and
Andrea Anti-Noise Products provide 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.

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 and could
have a material impact on the Companys consolidated results of operations or
financial condition.

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
consolidated 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 of 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 Financial
Accounting Standards Board Accounting Standards Codification (the ASC) 985,
Software and ASC 605 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

11

---



due to 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, 2010
and 2009, our allowance for doubtful accounts were $11,442 and $6,262,
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 $773,674 and $842,428 at December 31, 2010 and
2009, respectively, are net of reserves of $678,251 and $653,008, 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  ASC 360
Property, Plant and Equipment (ASC 360) 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 ASC 360 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 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, 2010 and 2009.

Deferred Tax Assets  We
currently have significant deferred tax assets. ASC 740, Income Taxes (ASC
740), 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, ASC 740 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 reduced our valuation allowance by approximately $174,000
and $143,000 for the years ended December 31, 2010 and 2009, respectively. In
addition, we will reduce our valuation in future periods to the extent that we
can demonstrate our ability to utilize the 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.

Cautionary Statement Regarding Forward-Looking Statements

Certain information
contained in this Managements Discussion and Analysis of Financial Condition
and Results of Operations for the year ended December 31, 2010 and other items
set forth in this Annual Report on Form 10-K 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. These statements
are based on current expectations and speak as of the date of such statements.
We undertake no obligation to publicly update or revise any forward-looking
statement, whether as a result of future events, new information or otherwise.
In order to obtain

12

---



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 the risks noted in Item 1A.

Results Of Operations

Year
Ended December 31, 2010 Compared to Year Ended December 31, 2009

Net
Revenues

|                                                                               |  |                                 |           |      |   |           |  |  |      |      | 
|------------------------------------------------------------------------------ |  | ------------------------------- | --------- | ---- | - | --------- |  |  | ---- | ---- | 
|                                                                               |  | For
 the Year Ended December 31 | %         |      |  
|                                                                               |  |                                 |           |      |  
|                                                                               |  | 2010                            |           | 2009 |   | Change    |  | 
|                                                                               |  |                                 |           |      |   |           |  | 
|Andrea Anti-Noise Products net Product revenues                                |  |                                 |           |      |   |           |  |  |      |      | 
|Sales of products to an OEM customer for use with speech recognition
 software |  | $                               | 12,706    |      | $ | 513,081   |  |  | (98  | )(a) | 
|Sales of products to OEM customers for use with educational software           |  |                                 | 451,208   |      |   | 741,076   |  |  | (39  | )(b) | 
|Revenues related to LED headphone products                                     |  |                                 |          |      |   | 335,864   |  |  | (100 | )(c) | 
|All other Andrea Anti-Noise net product revenues                               |  |                                 | 2,034,480 |      |   | 1,619,743 |  |  | 26   | (d)  | 
|                                                                               |  |                                 |           |      |   |           |  |  |      |      | 
|Total Andrea Anti-Noise Products net Product revenues                          |  |                                 | 2,498,394 |      |   | 3,209,764 |  |  | (22  | )    | 
|                                                                               |  |                                 |           |      |   |           |  |  |      |      | 
|Andrea DSP Microphone and Audio Software Products revenues                     |  |                                 |           |      |   |           |  |  |      |      | 
|Sales of automotive array microphone products                                  |  |                                 | 610,373   |      |   | 72,051    |  |  | 747  | (e)  | 
|All other Andrea DSP Microphone and Audio product revenues                     |  |                                 | 217,480   |      |   | 269,841   |  |  | (19  | )(f) | 
|License revenues                                                               |  |                                 | 1,589,266 |      |   | 1,144,033 |  |  | 39   | (g)  | 
|                                                                               |  |                                 |           |      |   |           |  |  |      |      | 
|Total Andrea DSP Microphone and Audio Software Products revenues               |  |                                 | 2,417,119 |      |   | 1,485,925 |  |  | (35  | )    | 
|                                                                               |  |                                 |           |      |   |           |  |  |      |      | 
|Total Revenues                                                                 |  | $                               | 4,915,513 |      | $ | 4,695,689 |  |  |     |      | 
|                                                                               |  |                                 |           |      |   |           |  |  |      |      | 

|    |                                                                                                                                                                                                                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | The decrease of revenues
 of Andrea Anti-Noise Products is directly related to a speech recognition
 software OEMs decreased demand for our products. We believe this decreased
 demand is associated with the OEMs decision to select a lesser quality
 headset with their new software update during the year ended 2010 as compared
 to the same period in 2009.
|    |                                                                                                                                                                                                                                                                                                                                                                      
|(b) | The decrease of
 approximately $290,000 in sales of customized products to OEM customers for
 use with educational software is the result of decreased purchases from these
 customers.                                                                                                                                                                              
|    |                                                                                                                                                                                                                                                                                                                                                                      
|(c) | The decrease in revenues
 related to blinking LED earbud products are primarily associated with initial
 sales of a custom retail product for an OEM customer in 2009. No sales were
 made in 2010 and Andrea does not expect any further sales of this product.                                                                                                     
|    |                                                                                                                                                                                                                                                                                                                                                                      
|(d) | The increase of
 approximately $415,000 in all other Andrea Anti-Noise net product revenues
 for 2010 as compared to 2009 is related to increased demand from distributor
 and reseller customers who sell both to distance learning customers and speech
 recognition end users.                                                                                    
|    |                                                                                                                                                                                                                                                                                                                                                                      
|(e) | The increase of
 approximately $538,000 for 2010 as compared to 2009 relate to increased sales
 of automotive array microphone products to integrators of public safety
 vehicle solutions.                                                                                                                                                                          
|    |                                                                                                                                                                                                                                                                                                                                                                      
|(f) | The decrease of
 approximately $52,000 for 2010 as compared to 2009 in all other Andrea DSP
 Microphone and Audio Software product revenues is related to change in demand
 from our distance learning, distributor and reseller customers who sell both
 to distance learning customers and speech recognition end users.                                           
|    |                                                                                                                                                                                                                                                                                                                                                                      
|(g) | The 39% increase in
 licensing revenues for the year ended December 31, 2010 is related to an
 increase in sales of PC models which feature our technology.                                                                                                                                                                                                          

Cost
of Revenues

Cost of revenues as a
percentage of net revenues for the year ended December 31, 2010 decreased to
37% from 45% for the year ended December 31, 2009. The cost of revenues as a
percentage of net revenues for the year ended December 31, 2010 for Andrea
Anti-Noise Products was 55% as compared to 60% for the year ended December 31,
2009. The cost of revenues as a percentage of net revenues for the year ended
December 31, 2010 for Andrea DSP Microphone and Audio Software Products was 18%
compared to 13% for the year ended December 31, 2009. The changes are primarily
the result of the changes in revenue as described under Net

13

---



Revenues
above. Specifically, the decrease in cost of revenues as a percentage of
revenues for the Andrea Anti-Noise Products is a result of a decrease in high
volume low margin sales of products to an OEM customer for use with speech
recognition software. The increase in cost of revenues as a percentage of
revenues for the Andrea DSP Microphone and Audio Software relates to increased
product sales of automotive array microphone products to integrators of public
safety vehicle solutions The overall decrease in cost of revenues as a
percentage of net revenues is a result of a decrease in high volume low margin
sales of products and increased license revenues.

Research and Development

Research and
development expenses for the year ended December 31, 2010 increased by 20% to
$731,297 from $607,877 for the year ended December 31, 2009. This increase
primarily relates to the increases in employee compensation and related benefit
costs as well as increases in cost associated with the development of new
products. For the year ended December 31, 2010, research and development
expenses reflected a 25% increase in our Andrea DSP Microphone and Audio
Software Technology efforts to $402,402, or 55% of total research and
development expenses and an increase in our Andrea Anti-Noise Headset Product
efforts to $328,895, or 45% of total research and development expenses. With
respect to DSP Microphone and Audio Software technologies, research efforts are
primarily focused on the pursuit of commercializing a natural language-driven
human/machine interface by developing optimal far-field microphone solutions
for various voice-driven interfaces, incorporating Andreas digital super
directional array microphone technology, and certain other related technologies
such as noise suppression and stereo acoustic echo cancellation. We believe
that continued research and development spending should provide Andrea with a
competitive advantage.

General, Administrative and Selling Expenses

General,
administrative and selling expenses increased by approximately 9% to $2,487,620
for the year ended December 31, 2010 from $2,286,332 for the year ended
December 31, 2009. This increase is related to increases in employee
compensation and related benefit costs as well as increases in promotional and
marketing expenses. For the year ended December 31, 2010, the increase reflects
a 4% decrease in our Andrea DSP Microphone and Audio Software Technology
efforts to $1,100,193, or 44% of total general, administrative and selling
expenses and a 21% increase in our Andrea Anti-Noise Headset Product efforts to
$1,387,427, or 56% of total general, administrative and selling expenses.

Interest Income, net

Interest
income, net for the year ended December 31, 2010 was $5,382 compared to
interest income, net of $13,930 for the year ended December 31, 2009.

Benefit for Income Taxes

The income tax
benefit for the year ended December 31, 2010 was $30,514, compared to an income
tax benefit of $141,210 for the year ended December 31, 2009. The income tax
benefit is primarily the result of a reduction in the valuation allowance
against the Companys deferred tax assets.

Net loss

Net loss for
the year ended December 31, 2010 was $77,519 compared to a net loss $166,698
for the year ended December 31, 2009. The net loss for the year ended December
31, 2010 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 consolidated financial condition,
changes in consolidated 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 currently are and are expected to continue to be gross cash
flows from operations. At December 31, 2010, we had cash of $2,220,994 compared
with $1,805,091 at December 31, 2009. The balance of cash at December 31, 2010
is primarily a result of our cash provided from operations during the year
ended December 31, 2010.

Our working
capital balance at December 31, 2010 was $3,039,308 compared to a working
capital of $2,718,077 at December 31, 2009. The increase in working capital
reflects an increase in total current assets of $234,503 and a decrease in
total current liabilities of $86,728. The increase in total current assets
reflects an increase in cash of $415,903, a decrease in accounts receivable of
$9,195, a decrease in inventory of $68,754, a decrease in short term customer
deposits of 13,536, a decrease in deferred income tax assets of $120,130, and
an increase in prepaid expenses and other current assets of $30,215. The
decrease in total current liabilities reflects a decrease in trade accounts
payable of $88,930, an increase in the current portion in long-term debt of
$5,054, a decrease in short-term deferred revenue of $13,536, a decrease in
accrued interest of $6,685 and an increase of $17,369 in other current
liabilities.

14

---



The increase
in cash of $415,903 reflects $616,856 of net cash provided by operating
activities, $119,626 of net cash used by investing activities and $81,327 of
cash used by financing activities.

The cash
provided by operating activities of $616,856, excluding non-cash charges, is
primarily attributable to the $77,519 net loss for the year ended December 31,
2010, a $4,015 decrease in accounts receivable, a $43,511 decrease in
inventory, a $13,536 decrease in short term customer deposits, a $30,215
increase in prepaid expenses and other current assets, a $88,930 decrease in
accounts payable, a $13,536 decrease in short-term deferred revenue and an
increase of $17,369 in other current liabilities. The changes in receivables,
inventory and accounts payable primarily reflect differences in the timing
related to both the payments for and the acquisition of inventory as well as
for other services in connection with ongoing efforts related to Andreas
various product lines.

The cash used
by investing activities of $119,626 reflects purchases of property and
equipment of $99,808 and an increase in patents and trademarks of $19,818. The
significant increase in property and equipment reflects capital expenditures
associated with information technology purchases including and, to a lesser
extent, molds associated with our Andrea Anti-Noise Headset Products. The
increase in patents and trademarks reflects capital expenditures associated
with our intellectual property.

The cash used
by financing activities of $81,327, reflects payments made on a loan from HSBC.
We obtained this loan to finance a significant upgrade to our information
technologies systems.

We plan to
continue to improve our cash flows in 2011 by aggressively pursuing additional
licensing opportunities related to our Andrea DSP Audio Software and increasing
the sales of our Andrea Anti-Noise Headset Products through the introduction of
new products as well as the increased efforts we are putting into our sales and
marketing efforts. However, there can be no assurance that we will be able to
successfully execute the aforementioned plans. As of March 15, 2011, Andrea has
approximately $2,300,000 of cash deposits. 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 consolidated financial statements.

Market Risk

Historically,
our principal source of financing activities had been 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 7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURE ABOUT MARKET RISK

Not
Applicable.

ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA

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

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

15

---



ITEM 9A. 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.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(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, 2010 that have materially affected, or are reasonably
 likely to materially affect, the Companys internal control over financial
 reporting.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND
CORPORATE GOVERNACE

Information on
the Directors of the Company follows (all Directors serve one-year terms; ages
are as of December 31, 2010):

Douglas
J. Andrea, age 48, 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.

Mr.
Andreas extensive experience in the software and communications industry
affords the Board valuable insight regarding the business and operation of the
Company. In addition, Mr. Andreas extensive background in corporate management
provides him a unique and broad-based decision-making capability for the
Company. Mr. Andrea has held various positions within the Company, which has
given him knowledge of all aspects of the Companys business and history, which
position him well to continue to serve as a member of the Board.

Gary
A. Jones, age 65, 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.

Mr.
Joness extensive experience in the software and communications industry
affords the Board valuable insight regarding the business and operation of the
Company. In addition, Mr. Jones was the Managing Director of a wholly-owned
subsidiary of Andrea Electronics, which has given him knowledge of all aspects
of the Companys business and history, which position him well to continue to
serve as a member of the Board.

Louis
Libin, age 52, 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

16

---



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 in Geneva, Switzerland. Mr. Libin is a
Senior Member of the Institute of Electrical and Electronic Engineers, and is a
member of the National Society of Professional Engineers. Mr. Libin also serves
on the boards of directors of several private and not-for profit companies.

Mr.
Libins extensive experience in the communications industry affords the Board
valuable insight regarding the business and operation of the Company. Mr. Libins
technical background, as well as his experiences from his other board
memberships makes him a valuable asset to continue to serve as a member of the
Board.

Joseph
J. Migliozzi, age 60, has been a Director of the
Company since September 2003. He is the Executive Vice President of Ionian
Management Inc., a Petroleum Shipping, Trading and Distribution company. Prior
to that he was the Engagement Partner at Tatum LLC, an Interim CFO practice. He
has operated 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.

Mr.
Migliozzis accounting, finance and corporate management experience affords the
Board valuable insight regarding the business, finances and operation of the
Company. Mr. Migliozzis extensive background provides him the distinctive
skill set required to continue to serve as a member of the Board.

Jonathan
D. Spaet, age 54, has been a Director of the Company
since 2003. He currently is a Senior Director and heads the Advanced
Advertising Group for Viamedia, a Cable Television Advertising Representation
company that represents many cable providers including Verizon FiOS and RCN.
Previously, he was Executive Vice President of Vault.com, an internet site in
the career and recruitment space. Before Vault, he was Vice-President/General
Manager of Advertising Sales for Time Warner Cable in New York City, where he
had been since 2008. Prior to that appointment, he was at 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 started 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. Mr. Spaet holds a Bachelor and Masters of
Business Administration degrees from New York University and is a member of the
National Sales Advisory Board of the Cable Advertising Bureau, and is a member
of the Internet Advertising Bureau.

Mr.
Spaets extensive experience in media sales, marketing, promotion and finance
brings the Board valuable insight regarding the business and operation of the
Company. Mr. Spaets background in producing, packaging, positioning and
experience in the communication industry make him a valuable asset to continue
to serve as a member of the Board.

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 38, 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 as the Chief Financial Officer 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, 2010 and Forms 5 and amendments thereto furnished to the

17

---



Company with
respect to the year ended December 31, 2010, 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, 2010, with the exception of three late
filings by Director Jonathan Spaet with respect to five transactions.

Code
of Business Ethics and Conduct

Andrea has
adopted a Code of Business Ethics and Conduct. See Item 15  Exhibits to this
Annual Report on Form 10-K.

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 11. 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, 2010, and 2009.

|                                    |  |      |      |        |   |         |  |                  |        |       |   |         |  |   |         | 
|----------------------------------- |  | ---- | ---- | ------ | - | ------- |  | ---------------- | ------ | ----- | - | ------- |  | - | ------- | 
|Name and Principal Position         |  | Year |      | Salary |   | Bonus   |  | Option Awards(1) |        | Total |  
|                                    |  |      |      |        |   |         |  |                  |        |       |  
|Douglas J.
 Andrea, Chairman of the |  |      | 2010 |        | $ | 330,208 |  | $                | 12,869 |       | $ | 130,000 |  | $ | 473,077 | 
|Board, Chief Executive Officer,     |  |      | 2009 |        |   | 317,708 |  |                  | 13,487 |       |   | 110,000 |  |   | 441,195 | 
|and Corporate Secretary             |  |      |      |        |   |         |  |                  |        |       |   |         |  |   |         | 
|Corisa L.
 Guiffre, Vice President, |  |      | 2010 |        | $ | 162,535 |  | $                | 15,000 |       | $ | 20,000  |  | $ | 197,535 | 
|Chief Financial Officer and         |  |      | 2009 |        |   | 133,479 |  |                  |       |       |   | 22,000  |  |   | 155,479 | 
|Assistant Corporate Secretary       |  |      |      |        |   |         |  |                  |        |       |   |         |  |   |         | 



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(1) | Reflects the
 dollar amount recognized for financial statement reporting purposes in accordance
 with ASC 718 Compensation  Stock Compensation (ASC 718) for the
 following stock option grants: 1) 1,000,000 options in 2010 for Mr. Andrea
 based upon a fair value of each option of $0.13 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,
 167%; risk-free rate, 2.08%; and expected life in years of 6 years); and 2)
 250,000 options in 2010 for Ms. Guiffre, based upon a fair value of each
 option of $0.08 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, 170%; risk-free rate, 1.65%; and
 expected life in years of 6 years).

18

---



Outstanding
Equity Awards at December 31, 2010

The following
table provides information concerning outstanding unexercised options as of
December 31, 2010 for each named executive officer. None of the named executive
officers had stock awards that have not vested or unearned equity incentive
plan awards at December 31, 2010.

|                   |  |                                                                          |           |                                                                              |  |                                   |   |                          |      |  |  |            | 
|------------------ |  | ------------------------------------------------------------------------ | --------- | ---------------------------------------------------------------------------- |  | --------------------------------- | - | ------------------------ | ---- |  |  | ---------- | 
|                   |  | Option Awards                                                            |          
|                   |  |                                                                          |          
|Name               |  | Number of securities 
 underlying 
 unexercised options
 (#) exercisable |           | Number of 
 securities 
 underlying 
 unexercised options
 (#) unexercisable |  | Option exercise 
 price ($/share) |   | Option 
 expiration date |     
|                   |  |                                                                          |           |                                                                              |  |                                   |   |                          |     
|                   |  |                                                                          |           |                                                                              |  |                                   |   |                          |      |  |  |            | 
|Douglas J.
 Andrea |  |                                                                          | 250,000   |                                                                              |  |                                  |   | $                        | 0.69 |  |  | 1-31-2012  | 
|                   |  |                                                                          | 400,000   |                                                                              |  |                                  |   | $                        | 0.13 |  |  | 6-14-2014  | 
|                   |  |                                                                          | 250,000   |                                                                              |  |                                  |   | $                        | 0.10 |  |  | 8-04-2014  | 
|                   |  |                                                                          | 250,000   |                                                                              |  |                                  |   | $                        | 0.04 |  |  | 8-04-2015  | 
|                   |  |                                                                          | 600,000   |                                                                              |  |                                  |   | $                        | 0.05 |  |  | 8-10-2015  | 
|                   |  |                                                                          | 1,000,000 |                                                                              |  |                                  |   | $                        | 0.12 |  |  | 11-02-2016 | 
|                   |  |                                                                          | 1,000,000 |                                                                              |  |                                  |   | $                        | 0.12 |  |  | 11-16-2016 | 
|                   |  |                                                                          | 1,000,000 |                                                                              |  |                                  |   | $                        | 0.11 |  |  | 9-12-2017  | 
|                   |  |                                                                          | 1,332,000 |                                                                              |  | 668,000 (1                        | ) | $                        | 0.04 |  |  | 8-8-2018   | 
|                   |  |                                                                          | 333,000   |                                                                              |  | 667,000 (2                        | ) | $                        | 0.04 |  |  | 8-8-2018   | 
|                   |  |                                                                          | 333,000   |                                                                              |  | 667,000 (3                        | ) | $                        | 0.11 |  |  | 7-24-2019  | 
|                   |  |                                                                          |          |                                                                              |  | 1,000,000 (4                      | ) | $                        | 0.13 |  |  | 8-01-2020  | 
|Corisa L.
 Guiffre |  |                                                                          | 10,000    |                                                                              |  |                                  |   | $                        | 1.78 |  |  | 3-19-2011  | 
|                   |  |                                                                          | 25,000    |                                                                              |  |                                  |   | $                        | 0.69 |  |  | 1-31-2012  | 
|                   |  |                                                                          | 250,000   |                                                                              |  |                                  |   | $                        | 0.05 |  |  | 8-10-2015  | 
|                   |  |                                                                          | 400,000   |                                                                              |  |                                  |   | $                        | 0.12 |  |  | 11-16-2016 | 
|                   |  |                                                                          | 350,000   |                                                                              |  |                                  |   | $                        | 0.11 |  |  | 9-12-2017  | 
|                   |  |                                                                          | 333,000   |                                                                              |  | 167,000 (5                        | ) | $                        | 0.04 |  |  | 8-8-2018   | 
|                   |  |                                                                          | 66,600    |                                                                              |  | 133,400 (3                        | ) | $                        | 0.11 |  |  | 7-24-2019  | 
|                   |  |                                                                          |          |                                                                              |  | 250,000 (6                        | ) | $                        | 0.08 |  |  | 9-22-2020  | 



|    |                                                                                                                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                
|(1) | The stock
 options vest 33.3% from and after August 1, 2009, 33.3% from and after August
 1, 2010 and 33.4% from and after August 1, 2011.                                                                                                                     
|    |                                                                                                                                                                                                                                                                
|(2) | The stock
 options vest 33.3% from and after August 1, 2010, 33.3% from and after August
 1, 2011 and 33.4% from and after August 1, 2012.                                                                                                                     
|    |                                                                                                                                                                                                                                                                
|(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 July 24,
 2009.     
|    |                                                                                                                                                                                                                                                                
|(4) | The stock
 options vest 33.3% from and after August 1, 2011, 33.3% from and after August
 1, 2012 and 33.4% from and after August 1, 2013.                                                                                                                     
|    |                                                                                                                                                                                                                                                                
|(5) | 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 August
 8, 2008.    
|    |                                                                                                                                                                                                                                                                
|(6) | 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 22, 2010.

Employment
Agreements

In July 2010,
the Company entered into an employment agreement with the President, Chief
Executive Officer and Chairman of the Board, Douglas J. Andrea. The effective
date of the employment agreement was August 1, 2010. The employment agreement
expires July 31, 2012 and is subject to renewal as approved by the Compensation
Committee of the Board of Directors. Pursuant to his employment agreement, Mr.
Andrea will receive an annual base salary of $337,500 for the period of August
1, 2010 through July 31, 2011 and for the period of August 1, 2011 through July
31, 2012 Mr. Andrea will receive an annual base salary of $350,000. The
employment agreement provides for quarterly bonuses equal to 25% of the
Companys pre-bonus net after tax quarterly earnings in excess of $25,000 for a
total quarterly bonus amount not to exceed $12,500; and annual bonuses equal to
10% of the Companys annual
pre-bonus net after tax earnings in excess of $300,000. All bonuses shall be
payable as soon as the Companys cash flow

19

---



permits. All bonus determinations or
any additional bonus in excess of the above will be made in the sole discretion
of the Compensation Committee. On August 1, 2010, the Board granted Mr. Andrea
1,000,000 stock options with an aggregate fair value of $130,000 (fair value
was estimated using the Black-Scholes option-pricing model). The 1,000,000
stock option grant vests in three equal annual installments over a three year
period commencing August 1, 2011. These 1,000,000 stock options have an
exercise price of $0.13 per share, which was the fair market value of the
Companys common stock at the date of grant, and a term of 10 years. Pursuant
to the employment agreement and subject to the approval of the Board of
Directors, the Compensation Committee will recommend a second grant of
1,000,000 stock options as soon as practical after August 1, 2011, with an
exercise price equal to the per share fair market value of the Companys common
stock on the date of grant. Mr. Andrea is also entitled to a change in control
payment equal to two times his salary with continuation of health and medical
benefits for two years in the event of a change in control, as defined in the
agreement. At December 31, 2010, the future minimum cash commitments under this
agreement aggregate $546,875.

On November
11, 2008, the Company entered into an amended and restated change in control
agreement with Corisa Guiffre, Vice President, Chief Financial Officer and
Assistant Corporate Secretary of the Company. The change in control agreement
provides Ms. Guiffre with a severance benefit upon termination in connection
with a change in control (as defined in the agreement). If Ms. Guiffre is
terminated following a change in control, the Company will pay Ms. Guiffre a
sum equal to three times Ms. Guiffres average annual compensation for the five
preceding taxable years. All restrictions on any restricted stock will lapse
immediately and incentive stock options and stock appreciation rights, if any,
will become immediately exercisable in the event of a change in control. Upon
the occurrence of a change in control followed by Ms. Guiffres termination of
employment, the Company will cause to be continued life, medical, dental and
disability coverage. Such coverage and payments shall cease upon the expiration
of 36 full calendar months following the date of termination.

Director
Compensation

The following
table provides the compensation received by individuals who served as
non-employee directors of the Company during the 2010 fiscal year.

|                     |  |                             |        |                        |   |       |  |   |        | 
|-------------------- |  | --------------------------- | ------ | ---------------------- | - | ----- |  | - | ------ | 
|Director             |  | Fees Earned or Paid in Cash |        | Stock Option Awards(1) |   | Total | 
|                     |  |                             |        |                        |   |       | 
|Gary A Jones         |  | $                           | 8,750  |                        | $ | 2,000 |  | $ | 10,750 | 
|Louis Libin          |  |                             | 9,750  |                        |   | 2,000 |  |   | 11,750 | 
|Joseph J.
 Migliozzi |  |                             | 10,500 |                        |   | 5,000 |  |   | 15,500 | 
|Jonathan D.
 Spaet   |  |                             | 10,500 |                        |   | 2,000 |  |   | 12,500 | 



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(1) | Reflects the
 dollar amount recognized for financial statement reporting purposes in
 accordance with ASC 718 for: 25,000, 25,000, 62,500 and 25,000 options
 granted in 2010 for Messrs. Jones, Libin, Migliozzi and Spaet, respectively,
 based upon a fair value of each option of $0.08 using the Black-Scholes option
 pricing model. The assumptions used in the valuation of the 2010 options were
 as follows: dividend yield, 0%; expected volatility, 170%; risk-free rate,
 1.65%; and expected life in years of 6 years. At December 31, 2010, Messrs.
 Jones, Libin, Migliozzi and Spaet held 243,031, 223,182, 525,077 and 268,031
 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 2010. Employee directors do not receive any retainers or fees
for their services on the Boards of Directors.

|                                                                       |  |                                                                             
|---------------------------------------------------------------------- |  | ----------------------------------------------------------------------------
|Annual Retainer                                                        |  | $7,000
 ($5,000 by check and $2,000 (paid in the form of stock options) (1))
|Fee per Board Meeting (Regular or Special)                             |  | $500                                                                        
|Fee per Committee Meeting                                              |  | $250                                                                        
|Fee for Annual Board Meeting                                           |  | $500 if
 attending in person                                                
|Additional Annual Retainer for the
 Chairperson of the Audit Committee |  | $3,000 (paid
 in the form of stock options) (1)                             

|    |                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                 
|(1) | 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.

20

---



ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Stock
Ownership

The following
table sets forth certain information as of March 15, 2011, 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)                                                                         |  | 6,748,000                              |  |  | 9.9  | %
|Corisa L.
 Guiffre                                               |  |                                            | 2,750     |                                                                             |  | 1,483,753                              |  |  | 2.3  | %
|Gary A. Jones                                                    |  |                                            | 439,472   |                                                                             |  | 221,346                                |  |  | 1.0  | %
|Louis Libin                                                      |  |                                            | 352,149   |                                                                             |  | 201,497                                |  |  | *    |  
|Joseph J.
 Migliozzi                                             |  |                                            | 596,261   |                                                                             |  | 478,380                                |  |  | 1.7  | %
|Jonathan D.
 Spaet                                               |  |                                            | 29,261    |                                                                             |  | 246,346                                |  |  | *    |  
|Current
 directors and executive officers as a group (6 persons) |  |                                            | 1,680,907 |                                                                             |  | 9,379,322                              |  |  | 15.1 | %



|               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|*Less than
 1%
|               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(1)            | Percentages
 with respect to each person or group of persons have been calculated on the
 basis of 63,721,035 shares of Company common stock outstanding, 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 15, 2011, 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 15, 2011, with respect to the
stock ownership of beneficial owners of more than 5% of the Companys
outstanding common stock other than Mr. Andrea whose stock ownership is set
forth above:

|                                    |  |                              |           |                              |  |                                                                       |     |  |     |  
|----------------------------------- |  | ---------------------------- | --------- | ---------------------------- |  | --------------------------------------------------------------------- | --- |  | --- | -
|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              |  |                              |          |                              |  | 5,722,159                                                             | (3) |  | 8.2 | %
|Pradafant 7,                        |  |                              |           |                              |  |                                                                       |     |  |     |  
|Furstentums
 9490                   |  |                              |           |                              |  |                                                                       |     |  |     |  
|Vaduz,
 Liechtenstein               |  |                              |           |                              |  |                                                                       |     |  |     |  
|Nickolas W.
 Edwards                |  |                              | 5,390,000 | (4)                          |  |                                                                      |     |  | 8.5 | %
|937 Pine
 Ave, Long Beach, CA 90813 |  |                              |           |                              |  |                                                                       |     |  |     |  
|                                    |  |                              |           |                              |  |                                                                       |     |  |     |  



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(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 the
 outstanding shares of our common stock, except that each holder has a right
 to terminate such limitation upon 61 days notice to us.

21

---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Percentages
 with respect to each person or group of persons have been calculated on the
 basis of 63,721,035 shares of Company common stock outstanding, 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 15, 2011. Based on
 Company records as of March 15, 2011, Alpha Capital has 3,585,731 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 15, 2011, 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     |  |                                                                                                    | 17,940,821 |                                                                                  | $ | 0.10                                                                                                                                               |  |  | 4,213,936 | 
|Equity compensation plans not approved by
 security holders |  |                                                                                                    |           |                                                                                  |   |                                                                                                                                                   |  |  |          | 
|                                                            |  |                                                                                                    |            |                                                                                  |   |                                                                                                                                                    |  |  |           | 
|Total                                                       |  |                                                                                                    | 17,940,821 |                                                                                  | $ | 0.10                                                                                                                                               |  |  | 4,213,936 | 

ITEM 13. 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 14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES

Audit Fees

The following
table sets forth the fees billed or expected to be billed to the Company for
the fiscal years ended December 31, 2010 and 2009 by Marcum LLP:

| |                     |  |      |         |      |   |         | 
| | ------------------- |  | ---- | ------- | ---- | - | ------- | 
| | Marcum LLP          |  | 2010 |         | 2009 |  
| |                     |  |      |         |      |  
| | Audit Fees          |  | $    | 122,000 |      | $ | 125,520 | 
| | Audit-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, 2010, all services were approved, in advance, by the
Audit Committee in compliance with these procedures.

22

---



ITEM 15. EXHIBITS

INDEX TO EXHIBITS

|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Number  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|3.1     | 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)                                                                                                                                                                                                                              
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|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    | *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)                                                                                                                                                                                                                                                                           
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.2    | *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)                                                                                                                                                                                                                             
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.3    | 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)                                                                                                                                                                                                              
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.4    | 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)                                                                                                                                                                                                     
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.5    | 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)                                                                                                                                                                                                        
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.6    | 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)                                                                                                                                                                                                        
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.7    | *2006 Equity Compensation
 Plan of the Registrant (incorporated by reference to Appendix A of the
 Registrants Schedule 14A filed on October 17, 2006).                                                                                                                                                                                                                                                                                                         
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.8    | *Change in Control
 Agreement, dated as of November 11, 2008, by and between Andrea Electronics
 Corporation and Corisa L. Guiffre (incorporated by reference to Exhibit 10.1
 of the Registrants Form 10-Q filed on November 14, 2008)                                                                                                                                                                                                                         
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.9    | * Amendment to the 2006
 Equity Compensation Plan (incorporated by reference to Exhibit 10.12 of the
 Registrants From 10-K filed on March16, 2010)                                                                                                                                                                                                                                                                                                             
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.10   | *Employment Agreement,
 dated as of August 1, 2010 by and between Andrea Electronics Corporation and
 Douglas J. Andrea (incorporated by reference to Exhibit 10.1 of the
 Registrants Form 10-Q filed on August 10, 2010)                                                                                                                                                                                                                                      
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|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 Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|23.1    | Consent of Independent
 Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                                                                                                                        
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|31.0    | Rule 13a-14(a)/15d  14(a)
 Certifications                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|32.0    | Section 1350 Certifications                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | * Management contract or
 compensatory plan or arrangement                                                                                                                                                                                                                                                                                                                                                                                                       

23

---



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 consolidated 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, 2010, 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, 2010 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 consolidated 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 consolidated 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 consolidated 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.

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 and Subsidiaries (the Company) as of December 31, 2010 and 2009,
and the related consolidated statements of operations, shareholders equity and
cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated 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 consolidated
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 audits 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 consolidated 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 consolidated 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, 2010 and 2009, and
the consolidated results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States of America.

/s/ Marcum LLP

Marcum LLP 
Melville, NY 
March 17, 2011

F-2

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED
BALANCE SHEETS

|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | ---- | - | ----------- | -
|                                                                                                                                                                                                           |  | December 31, |            
|                                                                                                                                                                                                           |  |              |            
|                                                                                                                                                                                                           |  | 2010         |             | 2009 |  
|                                                                                                                                                                                                           |  |              |             |      |  
|ASSETS                                                                                                                                                                                                     |  |              |             |      |   |             |  
|Current
 assets:                                                                                                                                                                                           |  |              |             |      |   |             |  
|Cash                                                                                                                                                                                                       |  | $            | 2,220,994   |      | $ | 1,805,091   |  
|Accounts receivable, net of allowance for
 doubtful accounts of $11,442 and $6,262, respectively                                                                                                           |  |              | 505,132     |      |   | 514,327     |  
|Inventories, net                                                                                                                                                                                           |  |              | 773,674     |      |   | 842,428     |  
|Short term customer deposit                                                                                                                                                                                |  |              | 79,632      |      |   | 93,168      |  
|Deferred income taxes, net                                                                                                                                                                                 |  |              | 23,000      |      |   | 143,130     |  
|Prepaid expenses and other current assets                                                                                                                                                                  |  |              | 123,767     |      |   | 93,552      |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Total current assets                                                                                                                                                                                       |  |              | 3,726,199   |      |   | 3,491,696   |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Property and equipment, net                                                                                                                                                                                |  |              | 249,027     |      |   | 215,974     |  
|Intangible assets, net                                                                                                                                                                                     |  |              | 1,648,863   |      |   | 2,106,507   |  
|Deferred income taxes, net                                                                                                                                                                                 |  |              | 150,700     |      |   |            |  
|Other assets, net                                                                                                                                                                                          |  |              | 12,864      |      |   | 12,864      |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Total assets                                                                                                                                                                                               |  | $            | 5,787,653   |      | $ | 5,827,041   |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                       |  |              |             |      |   |             |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Current liabilities:                                                                                                                                                                                       |  |              |             |      |   |             |  
|Trade accounts payable                                                                                                                                                                                     |  | $            | 303,198     |      | $ | 392,128     |  
|Current portion of long-term debt                                                                                                                                                                          |  |              | 26,268      |      |   | 21,214      |  
|Accrued Series C Preferred Stock Dividends                                                                                                                                                                 |  |              | 73,921      |      |   | 80,606      |  
|Short-term deferred revenue                                                                                                                                                                                |  |              | 109,632     |      |   | 123,168     |  
|Other current liabilities                                                                                                                                                                                  |  |              | 173,872     |      |   | 156,503     |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Total current liabilities                                                                                                                                                                                  |  |              | 686,891     |      |   | 773,619     |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Long term debt, net of current portion                                                                                                                                                                     |  |              | 13,405      |      |   | 99,786      |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Series B Redeemable Convertible Preferred
 Stock, $.01 par value; authorized: 1,000 shares; issued and outstanding: 0
 shares                                                                              |  |              |            |      |   |            |  
|Commitments and contingencies                                                                                                                                                                              |  |              |             |      |   |             |  
|Shareholders 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: 44.2 and
 48.2 shares, respectively; liquidation value: $442,314 and $482,314,
 respectively |  |              | 1           |      |   | 1           |  
|Series D Convertible Preferred Stock, net,
 $.01 par value; authorized: 2,500,000 shares; issued and outstanding: 907,144
 shares; liquidation value: $907,144                                             |  |              | 9,072       |      |   | 9,072       |  
|Common stock, $.01 par value; authorized:
 200,000,000 shares; issued and outstanding: 63,721,035 and 63,538,029 shares,
 respectively                                                                     |  |              | 637,210     |      |   | 635,380     |  
|Additional paid-in capital                                                                                                                                                                                 |  |              | 77,305,587  |      |   | 77,096,177  |  
|Accumulated deficit                                                                                                                                                                                        |  |              | (72,864,513 | )    |   | (72,786,994 | )
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Total shareholders equity                                                                                                                                                                                 |  |              | 5,087,357   |      |   | 4,953,636   |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  
|Total liabilities and shareholders equity                                                                                                                                                                 |  | $            | 5,787,653   |      | $ | 5,827,041   |  
|                                                                                                                                                                                                           |  |              |             |      |   |             |  

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 Ended 
 December 31, |           
|                                              |  |                                    |           
|                                              |  | 2010                               |            | 2009 |  
|                                              |  |                                    |            |      |  
|Revenues                                      |  |                                    |            |      |   |            |  
|Net product revenues                          |  | $                                  | 3,326,247  |      | $ | 3,551,656  |  
|License revenues                              |  |                                    | 1,589,266  |      |   | 1,144,033  |  
|                                              |  |                                    |            |      |   |            |  
|Net Revenues                                  |  |                                    | 4,915,513  |      |   | 4,695,689  |  
|                                              |  |                                    |            |      |   |            |  
|Cost of revenues                              |  |                                    | 1,810,011  |      |   | 2,123,318  |  
|                                              |  |                                    |            |      |   |            |  
|Gross margin                                  |  |                                    | 3,105,502  |      |   | 2,572,371  |  
|                                              |  |                                    |            |      |   |            |  
|Research and
 development expenses            |  |                                    | 731,297    |      |   | 607,877    |  
|                                              |  |                                    |            |      |   |            |  
|General,
 administrative and selling expenses |  |                                    | 2,487,620  |      |   | 2,286,332  |  
|                                              |  |                                    |            |      |   |            |  
|Loss from operations                          |  |                                    | (113,415   | )    |   | (321,838   | )
|                                              |  |                                    |            |      |   |            |  
|Interest
 income, net                         |  |                                    | 5,382      |      |   | 13,930     |  
|                                              |  |                                    |            |      |   |            |  
|Loss before benefit for income taxes          |  |                                    | (108,033   | )    |   | (307,908   | )
|                                              |  |                                    |            |      |   |            |  
|Benefit for
 income taxes, net                |  |                                    | (30,514    | )    |   | (141,210   | )
|                                              |  |                                    |            |      |   |            |  
|Net loss                                      |  | $                                  | (77,519    | )    | $ | (166,698   | )
|                                              |  |                                    |            |      |   |            |  
|Basic and
 diluted weighted average shares    |  |                                    | 63,622,262 |      |   | 62,121,186 |  
|                                              |  |                                    |            |      |   |            |  
|Basic and
 diluted net loss per share         |  | $                                  | (0.00      | )    | $ | (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, 2010 AND 2009

|                                                                               |  |                                                      |            |                                          |   |                                                       |  |                                          |           |                                    |   |               |   |                              |            |                      |   |                              |  |   |            |   |   |             |   |   |           |  
|------------------------------------------------------------------------------ |  | ---------------------------------------------------- | ---------- | ---------------------------------------- | - | ----------------------------------------------------- |  | ---------------------------------------- | --------- | ---------------------------------- | - | ------------- | - | ---------------------------- | ---------- | -------------------- | - | ---------------------------- |  | - | ---------- | - | - | ----------- | - | - | --------- | -
|                                                                               |  | 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
 Equity | 
|                                                                               |  |                                                      |            |                                          |   |                                                       |  |                                          |           |                                    |   |               |   |                              |            |                      |   |                              | 
|Balance, January 1, 2009                                                       |  |                                                      | 89.701477  |                                          | $ | 1                                                     |  |                                          | 1,050,001 |                                    | $ | 10,500        |   |                              | 60,978,373 |                      | $ | 609,784                      |  | $ | 76,814,249 |   | $ | (72,620,296 | ) | $ | 4,814,238 |  
|Conversion of Series C Convertible Preferred Stock                             |  |                                                      | (41.470045 | )                                        |   |                                                      |  |                                          |          |                                    |   |              |   |                              | 1,897,320  |                      |   | 18,973                       |  |   | 50,333     |   |   |            |   |   | 69,306    |  
|Conversion of Series D Convertible Preferred Stock                             |  |                                                      |           |                                          |   |                                                      |  |                                          | (142,857  | )                                  |   | (1,428        | ) |                              | 571,428    |                      |   | 5,714                        |  |   | (4,286     | ) |   |            |   |   |          |  
|Stock-based Compensation Expense related to Stock Grants to Outside
 Directors |  |                                                      |           |                                          |   |                                                      |  |                                          |          |                                    |   |              |   |                              | 90,908     |                      |   | 909                          |  |   | 20,756     |   |   |            |   |   | 21,665    |  
|Stock-based Compensation Expense related to Stock Option Grants                |  |                                                      |           |                                          |   |                                                      |  |                                          |          |                                    |   |              |   |                              |           |                      |   |                             |  |   | 215,125    |   |   |            |   |   | 215,125   |  
|Net loss                                                                       |  |                                                      |           |                                          |   |                                                      |  |                                          |          |                                    |   |              |   |                              |           |                      |   |                             |  |   |           |   |   | (166,698    | ) |   | (166,698  | )
|                                                                               |  |                                                      |            |                                          |   |                                                       |  |                                          |           |                                    |   |               |   |                              |            |                      |   |                              |  |   |            |   |   |             |   |   |           |  
|Balance, December 31, 2009                                                     |  |                                                      | 48.231432  |                                          | $ | 1                                                     |  |                                          | 907,144   |                                    | $ | 9,072         |   |                              | 63,538,029 |                      | $ | 635,380                      |  | $ | 77,096,177 |   | $ | (72,786,994 | ) | $ | 4,953,636 |  
|                                                                               |  |                                                      |            |                                          |   |                                                       |  |                                          |           |                                    |   |               |   |                              |            |                      |   |                              |  |   |            |   |   |             |   |   |           |  
|Conversions of Series C Convertible Preferred Stock                            |  |                                                      | (4.000000  | )                                        |   |                                                      |  |                                          |          |                                    |   |              |   |                              | 183,006    |                      |   | 1,830                        |  |   | 4,855      |   |   |            |   |   | 6,685     |  
|Stock-based Compensation Expense related to Stock Option Grants                |  |                                                      |           |                                          |   |                                                      |  |                                          |          |                                    |   |              |   |                              |           |                      |   |                             |  |   | 204,555    |   |   |            |   |   | 204,555   |  
|Net loss                                                                       |  |                                                      |           |                                          |   |                                                      |  |                                          |          |                                    |   |              |   |                              |           |                      |   |                             |  |   |           |   |   | (77,519     | ) |   | (77,519   | )
|                                                                               |  |                                                      |            |                                          |   |                                                       |  |                                          |           |                                    |   |               |   |                              |            |                      |   |                              |  |   |            |   |   |             |   |   |           |  
|Balance, December 31, 2010                                                     |  |                                                      | 44.231432  |                                          | $ | 1                                                     |  |                                          | 907,144   |                                    | $ | 9,072         |   |                              | 63,721,035 |                      | $ | 637,210                      |  | $ | 77,305,587 |   | $ | (72,864,513 | ) | $ | 5,087,357 |  
|                                                                               |  |                                                      |            |                                          |   |                                                       |  |                                          |           |                                    |   |               |   |                              |            |                      |   |                              |  |   |            |   |   |             |   |   |           |  

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:                                                       |  | 2010                              |           | 2009 |  
|                                                                                            |  |                                   |           |      |  
|Net loss                                                                                    |  | $                                 | (77,519   | )    | $ | (166,698  | )
|Adjustments to reconcile net loss to net cash provided by operating
 activities:            |  |                                   |           |      |   |           |  
|Depreciation and amortization                                                               |  |                                   | 544,217   |      |   | 517,725   |  
|Stock based compensation expense                                                            |  |                                   | 204,555   |      |   | 236,790   |  
|Bad debt expense                                                                            |  |                                   | 5,180     |      |   |          |  
|Inventory reserve                                                                           |  |                                   | 25,243    |      |   | (48,813   | )
|Deferred income taxes                                                                       |  |                                   | (30,570   | )    |   | (143,130  | )
|Change in:                                                                                  |  |                                   |           |      |   |           |  
|Accounts receivable                                                                         |  |                                   | 4,015     |      |   | 290,106   |  
|Inventories                                                                                 |  |                                   | 43,511    |      |   | 74,598    |  
|Short term customer deposit                                                                 |  |                                   | 13,536    |      |   | (93,168   | )
|Prepaid expenses and other current assets                                                   |  |                                   | (30,215   | )    |   | 31,143    |  
|Trade accounts payable                                                                      |  |                                   | (88,930   | )    |   | 119,689   |  
|Short-term deferred revenue                                                                 |  |                                   | (13,536   | )    |   | 83,168    |  
|Other current liabilities                                                                   |  |                                   | 17,369    |      |   | 11,251    |  
|                                                                                            |  |                                   |           |      |   |           |  
|Net
 cash provided by operating activities                                                  |  |                                   | 616,856   |      |   | 912,661   |  
|                                                                                            |  |                                   |           |      |   |           |  
|Cash flows from investing activities:                                                       |  |                                   |           |      |   |           |  
|Purchases of property and equipment                                                         |  |                                   | (99,808   | )    |   | (196,257  | )
|Purchases of patents and trademarks                                                         |  |                                   | (19,818   | )    |   | (39,264   | )
|                                                                                            |  |                                   |           |      |   |           |  
|Net cash used in investing activities                                                       |  |                                   | (119,626  | )    |   | (235,521  | )
|                                                                                            |  |                                   |           |      |   |           |  
|Cash flows from financing activities:                                                       |  |                                   |           |      |   |           |  
|Proceeds from long term debt                                                                |  |                                   |          |      |   | 121,000   |  
|Principal repayments of long term debt                                                      |  |                                   | (81,327   | )    |   |          |  
|                                                                                            |  |                                   |           |      |   |           |  
|Net cash (used in) provided by financing activities                                         |  |                                   | (81,327   | )    |   | 121,000   |  
|                                                                                            |  |                                   |           |      |   |           |  
|Net increase in cash and cash equivalents                                                   |  |                                   | 415,903   |      |   | 798,140   |  
|                                                                                            |  |                                   |           |      |   |           |  
|Cash, beginning of year                                                                     |  |                                   | 1,805,091 |      |   | 1,006,951 |  
|                                                                                            |  |                                   |           |      |   |           |  
|Cash, end of year                                                                           |  | $                                 | 2,220,994 |      | $ | 1,805,091 |  
|                                                                                            |  |                                   |           |      |   |           |  
|Supplemental disclosures of cash flow information:                                          |  |                                   |           |      |   |           |  
|Non-cash investing and financing activities:                                                |  |                                   |           |      |   |           |  
|Conversion of Series C Convertible Preferred Stock and related
 dividends into common stock |  | $                                 | 6,685     |      | $ | 69,306    |  
|                                                                                            |  |                                   |           |      |   |           |  
|Cash paid for:                                                                              |  |                                   |           |      |   |           |  
|Income Taxes                                                                                |  | $                                 | 2,656     |      | $ | 7,040     |  
|                                                                                            |  |                                   |           |      |   |           |  
|Interest                                                                                    |  | $                                 | 7,015     |      | $ |          |  
|                                                                                            |  |                                   |           |      |   |           |  

The accompanying notes are an integral part
of these consolidated financial statements.

F-6

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

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.

2. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES

Principles of Consolidation

The
consolidated 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:

|                                                                             |  |              |            |              |  |            | 
|---------------------------------------------------------------------------- |  | ------------ | ---------- | ------------ |  | ---------- | 
|                                                                             |  | December 31, |            | December 31, | 
|Total potentially dilutive common shares as
 of:                             |  | 2010         |            | 2009         | 
|                                                                             |  |              |            |              | 
|Options to purchase common stock (Note 13)                                   |  |              | 17,940,821 |              |  | 16,141,821 | 
|Series C Convertible Preferred Stock and
 related accrued dividends (Note 7) |  |              | 2,023,658  |              |  | 2,206,664  | 
|Series D Convertible Preferred Stock and
 related warrants (Note 8)          |  |              | 3,628,576  |              |  | 3,628,576  | 
|                                                                             |  |              |            |              |  |            | 
|Total potentially dilutive common shares                                     |  |              | 23,593,055 |              |  | 21,977,061 | 
|                                                                             |  |              |            |              |  |            | 

Cash

Cash includes
cash and highly liquid investments with original maturities of three months or
less. At times during the years ended December 31, 2010 and 2009, the Company
has cash deposits in excess of the maximum amounts insured by the Federal
Deposit Insurance Corporation insurance limits. At December 31, 2010, the
Companys cash is held at three financial institutions.

Concentration of Credit Risk

The following
customers accounted for 10% or more of Andreas consolidated net revenues
during at least one of the periods presented below:

|           |  |              |    |      |  |    |  
|---------- |  | ------------ | -- | ---- |  | -- | -
|           |  | December 31, |   
|           |  |              |   
|           |  | 2010         |    | 2009 | 
|           |  |              |    |      | 
|Customer A |  |              | 25 | %    |  | 20 | %
|Customer B |  |              |    | *    |  | 11 | %

| |                              | 
| | ---------------------------- | 
| |                             
| | * Amounts
 are less than 10%

As of December
31, 2010, Customer A accounted for approximately 53% of accounts receivable and
as of December 31, 2009, Customer B accounted for approximately 55% of accounts
receivable.

F-7

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2010

The following
suppliers accounted for 10% or more of Andreas purchases during the periods
presented below:

|           |  |              |    |      |  |    |  
|---------- |  | ------------ | -- | ---- |  | -- | -
|           |  | December 31, |   
|           |  |              |   
|           |  | 2010         |    | 2009 | 
|           |  |              |    |      | 
|Supplier A |  |              | 75 | %    |  | 96 | %
|Supplier B |  |              | 20 | %    |  | *  |  

| |                              | 
| | ---------------------------- | 
| |                             
| | * Amounts
 are less than 10%

At December
31, 2010 and December 31, 2009, Supplier A accounted for approximately $170,000
or 56% and $248,000 or 63%, respectively of accounts payable, respectively.

Allowance for Doubtful Accounts

The Company
performs on-going credit evaluations of its customers and adjusts credit limits
based upon payment history and the customers current credit worthiness, as
determined by the review of their current credit information. Collections and
payments from customers are continuously monitored. The Company maintains an
allowance for doubtful accounts, which is based upon historical experience as
well as specific customer collection issues that have been identified. While
such bad debt expenses have historically been within expectations and
allowances established, the Company cannot guarantee that it will continue to
experience the same credit loss rates that it has in the past. If the financial
condition of customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.

Inventories

Inventories
are stated at the lower of cost (on a first-in, first-out) or market basis. The
cost of inventory is based on the respective cost of materials. Andrea reviews
its inventory reserve for obsolescence on a quarterly basis and establishes
reserves on inventories based on the specific identification method as well as
a general reserve. Andrea records 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 10 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 Board (FASB) Accounting Standard
Codification (ASC) 360 Plant, Property and Equipment, for purposes of
determining and measuring impairment of its long-lived assets (primarily
intangible assets) other than goodwill. Andreas policy is to review the value
assigned to its long lived assets to determine if they have been permanently
impaired by adverse conditions which may affect Andrea whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. If Andrea identifies a permanent impairment such that the carrying
amount of Andreas long lived assets is not recoverable using the sum of an
undiscounted cash flow projection (gross margin dollars from product sales),
the impaired asset is adjusted to its estimated fair value, based on an
estimate of future discounted cash flows which becomes the new cost basis for
the impaired asset. Considerable management judgment is necessary to estimate
undiscounted future operating cash flows and fair values and, accordingly,
actual results could vary significantly from such estimates. No impairment
charges were recognized during the years ended December 31, 2010 and 2009.

F-8

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

Revenue Recognition

Non
software-related revenue, which is generally comprised of microphones and
microphone connectivity product revenues, is recognized when title and risk of
loss pass to the customer, which is generally upon shipment. With respect to
licensing revenues, Andrea recognizes revenue in accordance with ASC 985,
Software and ASC 605 Revenue Recognition. License revenue is recognized
based on the terms and conditions of individual contracts. In addition, fee
based services, which are short-term in nature, are generally performed on a
time-and-material basis under separate service arrangements and the
corresponding revenue is generally recognized as the services are performed.

Income Taxes

Andrea
accounts for income taxes in accordance with ASC 740, Income Taxes (ASC
740). ASC 740 requires an asset and liability approach for financial
accounting and reporting for income taxes and establishes for all entities a
minimum threshold for financial statement recognition of the benefit of tax
positions, and requires certain expanded disclosures. The provision for income
taxes is based upon income or loss after adjustment for those permanent items
that are not considered in the determination of taxable income. Deferred income
taxes represent the tax effects of differences between the financial reporting
and tax bases of the Companys assets and liabilities at the enacted tax rates
in effect for the years in which the differences are expected to reverse. The
Company evaluates the recoverability of deferred tax assets and establishes a
valuation allowance when it is more likely than not that some portion or all of
the deferred tax assets will not be realized. Accordingly, and after
considering changes in previously existing positive evidence, the Company
reduced its valuation allowance to recognize a deferred tax asset of
approximately $174,000 and $143,000 for the years ended December 31, 2010 and
2009, respectively. In addition, Andrea expects it will reduce its valuation in
future periods to the extent that it can demonstrate its ability to utilize the
assets. Management makes judgments as to the interpretation of the tax laws
that might be challenged upon an audit and cause changes to previous estimates
of tax liability. In managements opinion, adequate provisions for income taxes
have been made for all years. If actual taxable income by tax jurisdiction
varies from estimates, additional allowances or reversals of reserves may be
necessary. Income tax expense consists of the tax payable for the period and
the change during the period in deferred tax assets and liabilities. The
Company has identified its federal tax return and its state tax return in New
York as major tax jurisdictions. Based on the Companys evaluation, it has
been concluded that there are no significant uncertain tax positions requiring
recognition in the Companys consolidated financial statements. The Companys
evaluation was performed for tax years ended 2007 through 2010. 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 consolidated financial position.

Stock-Based Compensation

At December
31, 2010, Andrea had two stock-based employee compensation plans, which are
described more fully in Note 13. Andrea accounts for stock based compensation
in accordance with ASC 718, Compensation  Stock Compensation (ASC 718).
ASC 718 establishes accounting for stock-based awards exchanged for employee
services. Under the provisions of ASC 718, share-based compensation cost is
measured at the grant date, based on the fair value of the award, and is
recognized as expense over the employees requisite service period (generally
the vesting period of the equity grant). The fair value of the Companys common
stock options are estimated using the Black Scholes option-pricing model with
the following assumptions: expected volatility, dividend rate, risk free
interest rate and the expected life. The Company expenses stock-based
compensation by using the straight-line method. In accordance with ASC 718,
excess tax benefits realized from the exercise of stock-based awards are
classified in cash flows from financing activities. The future realization of
the reserved deferred tax assets related to these tax benefits associated with
the exercise of stock options will result in a credit to additional paid in
capital if the related tax deduction reduces taxes payable. The Company has
elected the with and without approach regarding ordering of windfall tax
benefits to determine whether the windfall tax benefit did reduce taxes payable
in the current year. Under this approach, the windfall tax benefit would be
recognized in additional paid-in-capital only if an incremental tax benefit is
realized after considering all other benefits presently available.

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. $83,313 and
$98,696 were billed to customers and are included in net revenues for the years
ended December 31, 2010 and 2009, respectively.

F-9

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

Advertising Expenses

In accordance
with ASC 720 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, 2010 and 2009 were $62,766 and
$16,880, respectively and are included in general, administrative and selling
expenses.

Fair Value of Financial Instruments

ASC 820,
defines fair value, establishes a framework for measuring fair value in
accordance with generally accepted accounting principles, and expands
disclosures about paid to transfer a liability in an orderly transaction
between market participants at the measurement date. ASC 820 applies to all
assets and liabilities that are measured and reported on a fair value basis.

The Company
will apply the provisions of ASC 820 to nonfinancial assets and liabilities.
Andrea calculates the fair value of financial instruments and includes this
additional information in the notes to consolidated 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,
2010 and 2009, the carrying value of all financial instruments approximated
fair value.

Recently Issued Accounting Pronouncements

In March 2010,
the FASB issued Accounting Standards Update (ASU) No. 2010-17, Revenue Recognition Milestone Method (Topic 605):
Milestone Method of Revenue Recognition.This standard provides that
the milestone method is a valid application of the proportional performance
model for revenue recognition if the milestones are substantive and there is
substantive uncertainty about whether the milestones will be achieved.
Determining whether a milestone is substantive requires judgment that should be
made at the inception of the arrangement. To meet the definition of a
substantive milestone, the consideration earned by achieving the milestone (1)
would have to be commensurate with either the level of effort required to
achieve the milestone or the enhancement in the value of the item delivered,
(2) would have to relate solely to past performance, and (3) should be
reasonable relative to all deliverables and payment terms in the arrangement.
No bifurcation of an individual milestone is allowed and there can be more than
one milestone in an arrangement. The new standard is effective for interim and
annual periods beginning on or after June 15, 2010. Early adoption is
permitted. The adoption of this standard did not have any material impact on
the Companys consolidated financial position and results of operations.

In February
2010, the FASB issued ASU 2010-09, Subsequent
Events (Topic 855) - Amendments to Certain Recognition and Disclosure
Requirements. ASU 2010-09 requires an entity that is an SEC filer
to evaluate subsequent events through the date that the financial statements
are issued and removes the requirement that an SEC filer disclose the date through
which subsequent events have been evaluated. ASC 2010-09 was effective upon
issuance. The adoption of this standard had no effect on our consolidated
financial position or results of operations.

The FASB has
issued Accounting Standards Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820):
Improving Disclosures about Fair Value Measurements. This ASU
requires some new disclosures and clarifies some existing disclosure
requirements about fair value measurement as set forth in Codification Subtopic
820-10. ASU 2010-06 amends Codification Subtopic 820-10 and now requires a
reporting entity to use judgment in determining the appropriate classes of
assets and liabilities and to provide disclosures about the valuation
techniques and inputs used to measure fair value for both recurring and
nonrecurring fair value measurements.ASU
2010-06 is effective for interim and annual reporting periods beginning after
December 15, 2009, As this standard relates specifically to disclosures, the adoption
will not have an impact on the Companys consolidated financial position and
results of operations.

Use of Estimates

The
preparation of the consolidated 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 consolidated 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

F-10

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

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.

Subsequent Events

The Company
evaluates events that occurred after the balance sheet date but before the
financial statements are issued. Based upon the evaluation, the Company did not
identify any recognized or non-recognized subsequent events that would have
required adjustment or disclosure in the consolidated financial statements.

3. INTANGIBLE ASSETS

Intangible
assets, net, consists of the following:

|                               |  |              |            |      |   |            |  
|------------------------------ |  | ------------ | ---------- | ---- | - | ---------- | -
|                               |  | December 31, |           
|                               |  |              |           
|                               |  | 2010         |            | 2009 |  
|                               |  |              |            |      |  
|Core Technology                |  | $            | 8,567,448  |      | $ | 8,567,448  |  
|Trademarks and Patents         |  |              | 631,975    |      |   | 612,157    |  
|                               |  |              |            |      |   |            |  
|                               |  |              | 9,199,423  |      |   | 9,179,605  |  
|Less: accumulated amortization |  |              | (7,550,560 | )    |   | (7,073,098 | )
|                               |  |              |            |      |   |            |  
|                               |  | $            | 1,648,863  |      | $ | 2,106,507  |  
|                               |  |              |            |      |   |            |  

The changes in the carrying
amount of intangible assets during the years ended December 31, 2010 and 2009
were as follows:

|                                |  |                   |           |                         |   |         |   |   |           |  
|------------------------------- |  | ----------------- | --------- | ----------------------- | - | ------- | - | - | --------- | -
|                                |  | Core 
 Technology |           | Trademarks
 and Patents |   | Totals  |  
|                                |  |                   |           |                         |   |         |  
|Balance as of January 1, 2009   |  | $                 | 2,207,106 |                         | $ | 336,675 |   | $ | 2,543,781 |  
|Additions during the period     |  |                   |          |                         |   | 39,264  |   |   | 39,264    |  
|Amortization                    |  |                   | (441,422  | )                       |   | (35,116 | ) |   | (476,538  | )
|                                |  |                   |           |                         |   |         |   |   |           |  
|Balance as of December 31, 2009 |  | $                 | 1,765,684 |                         | $ | 340,823 |   | $ | 2,106,507 |  
|                                |  |                   |           |                         |   |         |   |   |           |  
|Additions during the period     |  |                   |          |                         |   | 19,818  |   |   | 19,818    |  
|Amortization                    |  |                   | (441,421  | )                       |   | (36,041 | ) |   | (477,462  | )
|                                |  |                   |           |                         |   |         |   |   |           |  
|Balance as of December 31, 2010 |  | $                 | 1,324,263 |                         | $ | 324,600 |   | $ | 1,648,863 |  
|                                |  |                   |           |                         |   |         |   |   |           |  

Andrea
accounts for its long-lived assets in accordance with ASC 360 Property, Plant
and Equipment for purposes of determining and measuring impairment of its
long-lived assets (primarily intangible assets) other than goodwill. Andreas
policy is to periodically review the value assigned to its long-lived assets to
determine if they have been permanently impaired by adverse conditions which
may affect Andrea. If Andrea identifies a permanent impairment such that the
carrying amount of Andreas long lived assets are not recoverable using the sum
of an undiscounted cash flow projection (gross margin dollars from product
revenues), a new cost basis for the impaired asset will be established. If
required, an impairment charge is recorded based on an estimate of future
discounted cash flows. This new cost basis will be net of any recorded
impairment. At December 31, 2010 and 2009, Andrea concluded that the Andrea DSP
Microphone and Audio Software Products business segment was not required to be
tested for recoverability.

Amortization
expense was $477,462 and $476,538 for the years ended December 31, 2010 and
2009, respectively. Amortization of core technology is expected to be
approximately $441,421 per year for the next three 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 $478,125, $478,125, $478,125, $36,704 and $36,704 per year.

4. INVENTORIES, net

Inventories,
net, consist of the following:

|                               |  |              |           |      |   |           |  
|------------------------------ |  | ------------ | --------- | ---- | - | --------- | -
|                               |  | December 31, |          
|                               |  |              |          
|                               |  | 2010         |           | 2009 |  
|                               |  |              |           |      |  
|Raw materials                  |  | $            | 36,821    |      | $ | 54,351    |  
|Finished goods                 |  |              | 1,415,104 |      |   | 1,441,085 |  
|                               |  |              |           |      |   |           |  
|                               |  |              | 1,451,925 |      |   | 1,495,436 |  
|Less: reserve for obsolescence |  |              | (678,251  | )    |   | (653,008  | )
|                               |  |              |           |      |   |           |  
|                               |  | $            | 773,674   |      | $ | 842,428   |  
|                               |  |              |           |      |   |           |  

F-11

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

5. PROPERTY AND EQUIPMENT, net

Property and equipment, net,
consists of the following:

|                                                 |  |              |          |      |   |          |  
|------------------------------------------------ |  | ------------ | -------- | ---- | - | -------- | -
|                                                 |  | December 31, |         
|                                                 |  |              |         
|                                                 |  | 2010         |          | 2009 |  
|                                                 |  |              |          |      |  
|Leasehold
 Improvements                          |  | $            | 13,423   |      | $ | 13,423   |  
|Information
 Technology Equipment                |  |              | 363,151  |      |   | 283,164  |  
|Furniture
 and fixtures                          |  |              | 108,878  |      |   | 108,878  |  
|Tools, molds
 and testing equipment              |  |              | 339,113  |      |   | 319,292  |  
|                                                 |  |              |          |      |   |          |  
|                                                 |  |              | 824,565  |      |   | 724,757  |  
|Less:
 accumulated depreciation and amortization |  |              | (575,538 | )    |   | (508,783 | )
|                                                 |  |              |          |      |   |          |  
|                                                 |  | $            | 249,027  |      | $ | 215,974  |  
|                                                 |  |              |          |      |   |          |  

Depreciation
and amortization of property and equipment was $66,755 and $41,187 for the
years ended December 31, 2010 and 2009, respectively.

6. OTHER CURRENT LIABILITIES

Other current
liabilities consist of the following:

|                                             |  |              |         |      |   |         | 
|-------------------------------------------- |  | ------------ | ------- | ---- | - | ------- | 
|                                             |  | December 31, |        
|                                             |  |              |        
|                                             |  | 2010         |         | 2009 |  
|                                             |  |              |         |      |  
|Accrued
 payroll and related expenses        |  | $            | 94,133  |      | $ | 82,477  | 
|Accrued
 professional and other service fees |  |              | 77,996  |      |   | 72,496  | 
|Accrued
 other                               |  |              | 1,743   |      |   | 1,530   | 
|                                             |  |              |         |      |   |         | 
|                                             |  | $            | 173,872 |      | $ | 156,503 | 
|                                             |  |              |         |      |   |         | 

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 a $1,671 increase in the stated value,
which sum is convertible into Common Stock at a conversion price of
$0.2551. On February 17, 2004, Andrea
announced that it had entered into an Exchange and Termination Agreement and an
Acknowledgment and Waiver Agreement, which eliminated the dividend of 5% per
annum on the stated value. The
additional amount of $1,671 represents the 5% per annum from October 10, 2000
through February 17, 2004. The shares
of Series C Preferred Stock are subject to antidilution provisions, which are
triggered in the event of certain stock splits, recapitalizations, or other
dilutive transactions. In addition,
issuances of common stock at a price below the conversion price then in effect
(currently $0.2551), or the issuance of warrants, options, rights, or
convertible securities which have an exercise price or conversion price less
than that conversion price, other than for certain previously outstanding
securities and certain excluded securities (as defined in the certificate of
amendment), require the adjustment of the conversion price to that lower price
at which shares of common stock have been issued or may be acquired. In the event that Andrea issues securities
in the future which have a conversion price or exercise price which varies with
the market price and the terms of such variable price are more favorable than
the conversion price in the Series C Preferred Stock, the purchasers may elect
to substitute the more favorable variable price when making conversions of the
Series C Preferred Stock.

In accordance
with Sub Topic 815-40, Andrea evaluated the Series C Preferred Stock and
concluded that it is not indexed to the Companys stock because of the
conversion price adjustment feature described above. Accordingly, under the provisions of ASC 815, Derivatives and
Hedging (ASC 815), Andrea evaluated the Series C Preferred Stock embedded
conversion feature. The Company has
concluded that the embedded conversion feature would be classified in
shareholders equity if it were a freestanding instrument as the Series C
Preferred Stock is more akin to equity and as such it should not be bifurcated
from the Series C instrument and accounted for separately.

On July 17,
2009, 37.47 shares of Series C Preferred Stock, together with related accrued
dividends, were converted into 1,714,314 shares of Common Stock at a conversion
price of $0.2551. On September 8, 2009, 4.0 shares of Series C Preferred Stock,
together with related accrued dividends, were converted into 183,006 shares of
Common Stock at a conversion price of $0.2551.

On July 16,
2010, 4 shares of Series C Preferred Stock, together with related accrued
dividends, were converted into 183,006 shares of Common Stock at a conversion
price of $0.2551.

As of December
31, 2010, there were 44.231432 shares of Series C Preferred Stock outstanding,
which were convertible into 2,023,658 shares of Common Stock and remaining
accrued dividends of $73,921.

F-12

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

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. These warrants
were exercisable at any time after August 17, 2004, at an exercise price of
$0.38 per share. On February 23, 2009,
these warrants expired without being exercised.

In addition,
on June 4, 2004, the Buyers purchased for an additional $1,250,000, an additional
1,250,000 shares of Series D Preferred Stock convertible into 5,000,000 shares
of Common Stock (an effective conversion price of $0.25 per share) and Common
Stock warrants exercisable for an aggregate of 2,500,000 shares of Common
Stock. The warrants were exercisable at
any time after December 4, 2004 and before June 4, 2009 at an exercise price of
$0.17 per share. On June 4, 2009, these
warrants expired without being exercised.

The shares of
Series D Preferred Stock are also subject to antidilution provisions, which are
triggered in the event of certain stock splits, recapitalizations, or other
dilutive transactions. In addition, issuances of common stock at a price below
the conversion price then in effect (currently $0.25), or the issuance of warrants,
options, rights, or convertible securities which have an exercise price or
conversion price less than that conversion price, other than for certain
previously outstanding securities and certain excluded securities (as defined
in the certificate of amendment), require the adjustment of the conversion
price to that lower price at which shares of common stock have been issued or
may be acquired. In the event that Andrea issues securities in the future which
have a conversion price or exercise price which varies with the market price
and the terms of such variable price are more favorable than the conversion
price in the Series D Preferred Stock, the purchasers may elect to substitute
the more favorable variable price when making conversions of the Series D
Preferred Stock. In addition, the
Company is required to use its best efforts to secure the inclusion for
quotation on the Over the Counter Bulletin Board for the common stock issuable
under the Series D Preferred Stock and to arrange for at least two market
makers to register with the Financial Industry Regulatory Authority. In the event that the holder of the Series D
Preferred Stock and related warrants is unable to convert these securities into
Andrea Common Stock, the Company shall pay to each such holder 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).

In accordance
with Sub Topic 815-40, Andrea evaluated the Series D Preferred Stock and
concluded that it is not considered to be indexed to the Companys stock
because of the conversion price adjustment feature described above. Accordingly, under the provisions of ASC
815, Andrea evaluated the Series D Preferred Stock embedded conversion
feature. The Company has concluded that
the embedded conversion feature would be classified in shareholders equity if
it were a freestanding instrument as the Series D Preferred Stock is more akin
to equity and as such it should not be bifurcated from the Series D instrument
and accounted for separately.

Additionally,
Andrea reviewed the Series D Preferred Stock warrants and concluded that they
are considered to be indexed to the Companys stock within the provisions of
ASC 815-40 and were properly classified.

On July 17,
2009, 142,857 shares of Series D Preferred Stock were converted into 571,428
shares of Common Stock at a conversion price of $0.25.

As of December
31, 2010, there were 907,144 shares of Series D Preferred Stock outstanding
which were convertible into 3,628,576 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 two
largest licensing customers accounted for $250,790 and $1,248,554 of revenues
in 2010 and $132,285 and $947,545 of revenues in 2009.

F-13

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

10. INCOME TAXES

The Company
accounts for income taxes in accordance with ASC 740 which 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. ASC 740 also provides
guidance on de-recognition, classification, interest and penalties, accounting
in interim period, disclosure and transition.
There were no unrecognized tax benefits as of January 1, 2009 and during
the years ended December 31, 2010 and 2009.

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 it is more
likely than not 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 ASC 740. Based on the Company's evaluation, it has been concluded that
there are no significant uncertain tax positions requiring recognition in the
Company's consolidated financial statements.
The Company's evaluation was performed for tax years ended 2007 through
2010. 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
consolidated financial position.

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, 2010.
For the years ended December 31, 2010 and 2009, the Company determined
that, more likely than not, a portion of its previously reserved deferred tax
assets would be realized and, accordingly, reduced the valuation
allowance. The reduction in the
valuation allowance is included in the income tax benefit, net, in the
accompanying consolidated statement of operations for 2010. The determination that the net deferred tax
asset of $173,700 at December 31, 2010 is realizable is based on the Company's
expectations of taxable future earnings.
Management is currently unaware of any issues under review that could
result in significant payments, accruals or material deviations from its
position.

The components
of loss before income taxes are as follows:

|                         |  |                                  |          |      |   |          |  
|------------------------ |  | -------------------------------- | -------- | ---- | - | -------- | -
|                         |  | For the Years Ended December 31, |         
|                         |  | 2010                             |          | 2009 |  
|                         |  |                                  |          |      |  
|Domestic                 |  | $                                | (108,033 | )    | $ | (327,111 | )
|Foreign                  |  |                                  |         |      |   | 19,203   |  
|                         |  |                                  |          |      |   |          |  
|Loss before income taxes |  | $                                | (108,033 | )    | $ | (307,908 | )
|                         |  |                                  |          |      |   |          |  



The benefit for income tax
consists of the following:

|                                                                      |  |                                  |          |      |   |          |  
|--------------------------------------------------------------------- |  | -------------------------------- | -------- | ---- | - | -------- | -
|                                                                      |  | For the Years Ended December 31, |         
|                                                                      |  | 2010                             |          | 2009 |  
|                                                                      |  |                                  |          |      |  
|Current:                                                              |  |                                  |          |      |   |          |  
|Federal                                                               |  | $                                |         |      | $ |         |  
|Foreign                                                               |  |                                  | 56       |      |   | 1,920    |  
|State and Local:                                                      |  |                                  |         |      |   |         |  
|                                                                      |  |                                  |          |      |   |          |  
|Total Current                                                         |  |                                  | 56       |      |   | 1,920    |  
|                                                                      |  |                                  |          |      |   |          |  
|Deferred                                                              |  |                                  |          |      |   |          |  
|Federal                                                               |  |                                  | 195,300  |      |   | 97,600   |  
|Foreign                                                               |  |                                  |         |      |   |         |  
|State and Local:                                                      |  |                                  | 28,700   |      |   | 14,400   |  
|Adjustment to valuation allowance related
 to net deferred tax assets |  |                                  | (254,570 | )    |   | (255,130 | )
|                                                                      |  |                                  |          |      |   |          |  
|Total Deferred                                                        |  |                                  | (30,570  | )    |   | (143,130 | )
|                                                                      |  |                                  |          |      |   |          |  
|Benefit for income taxes                                              |  | $                                | (30,514  | )    | $ | (141,210 | )
|                                                                      |  |                                  |          |      |   |          |  



F-14

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

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 benefit for income taxes is as follows:

|                                                           |  |                                  |      |    |  |      |   
|---------------------------------------------------------- |  | -------------------------------- | ---- | -- |  | ---- | --
|                                                           |  | For the Years Ended December 31, |     
|                                                           |  |                                  |     
|                                                           |  |                                  | 2010 |    |  | 2009 |   
|                                                           |  |                                  |      |    | 
|Tax provision at statutory rate                            |  |                                  | (34  | )% |  | (34  | )%
|State and local taxes                                      |  |                                  | (5   | )% |  | (5   | )%
|Core technology amortization                               |  |                                  | 139  | %  |  | 49   | % 
|Stock Option Expense Related to Incentive
 Stock Options   |  |                                  | 44   | %  |  | 21   | % 
|Foreign income and withholding taxes                       |  |                                  |     |    |  | 1    | % 
|Change in valuation allowance for net
 deferred tax assets |  |                                  | (172 | )% |  | (78  | )%
|                                                           |  |                                  |      |    |  |      |   
|                                                           |  |                                  | (28  | )% |  | (46  | )%
|                                                           |  |                                  |      |    |  |      |   

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, |           
|                                                     |  | 2010                             |            | 2009 |  
|                                                     |  |                                  |            |      |  
|Deferred tax
 assets:                                |  |                                  |            |      |   |            |  
|Accrued expenses                                     |  | $                                | 39,000     |      | $ | 40,000     |  
|Allowance for doubtful accounts                      |  |                                  | 4,000      |      |   | 2,000      |  
|Reserve for obsolescence                             |  |                                  | 265,000    |      |   | 255,000    |  
|Expense associated with non-qualified stock
 options |  |                                  | 78,000     |      |   | 52,000     |  
|Deferred Revenue                                     |  |                                  | 43,000     |      |   | 48,000     |  
|Foreign tax credit                                   |  |                                  | 99,000     |      |   | 99,000     |  
|General business credit                              |  |                                  | 426,000    |      |   | 419,000    |  
|NOL carryforward                                     |  |                                  | 7,244,000  |      |   | 7,507,000  |  
|                                                     |  |                                  |            |      |   |            |  
|                                                     |  |                                  | 8,198,000  |      |   | 8,422,000  |  
|Less:
 valuation allowance                           |  |                                  | (8,024,300 | )    |   | (8,278,870 | )
|                                                     |  |                                  |            |      |   |            |  
|Deferred tax asset, net                              |  | $                                | 173,700    |      | $ | 143,130    |  
|                                                     |  |                                  |            |      |   |            |  

The change in the valuation
allowance for deferred tax assets are summarized as follows:

|                     |  |                                  |           |      |   |           |  
|-------------------- |  | -------------------------------- | --------- | ---- | - | --------- | -
|                     |  | For the Years Ended December 31, |          
|                     |  | 2010                             |           | 2009 |  
|                     |  |                                  |           |      |  
|Beginning
 Balance   |  | $                                | 8,278,870 |      | $ | 8,534,000 |  
|Change in
 Allowance |  |                                  | (254,570  | )    |   | (255,130  | )
|                     |  |                                  |           |      |   |           |  
|Ending
 Balance      |  | $                                | 8,024,300 |      | $ | 8,278,870 |  
|                     |  |                                  |           |      |   |           |  

As of December
31, 2010, Andrea had net operating loss and credit carryforwards of
approximately $18.6 million (net amount after potential Section 382
limitations) expiring in varying amounts beginning in 2011 through 2026. Andrea
has foreign tax credits of approximately $99,000 expiring in varying amounts
beginning 2016 through 2019 and General Business Credits of approximately $1.1
million expiring in varying amounts beginning in 2011 through 2030. 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.

11. LONG TERM DEBT

Long-term debt
consists of the following:

|                                           |  |                                 |        |      |   |         | 
|------------------------------------------ |  | ------------------------------- | ------ | ---- | - | ------- | 
|                                           |  | For the Year Ended December 31, |       
|                                           |  | 2010                            |        | 2009 |  
|                                           |  |                                 |        |      |  
|Long-term debt                             |  | $                               | 39,673 |      | $ | 121,000 | 
|Less: Current Maturities of Long-Term Debt |  |                                 | 26,268 |      |   | 21,214  | 
|                                           |  |                                 |        |      |   |         | 
|Long-Term Debt, net of Current Maturities  |  | $                               | 13,405 |      | $ | 99,786  | 
|                                           |  |                                 |        |      |   |         | 

HSBC unsecured
bank loan, dated December 9, 2009, is due in 60 monthly installments of $2,362
including principal and interest at 6.4%.

F-15

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

As of December
31, 2010, maturities of long term debt are as follows:

|      |  |   |        | 
|----- |  | - | ------ | 
|2011  |  | $ | 26,268 | 
|2012  |  |   | 13,405 | 
|      |  |   |        | 
|Total |  | $ | 39,673 | 
|      |  |   |        | 

12. COMMITMENTS AND CONTINGENCIES

Leases

Andrea leases
its corporate headquarters located in Bohemia, New York. The lease from an
unrelated party, which currently expires in April 2015, is for approximately
11,000 square feet and houses Andreas warehousing, sales and executive
offices. Rent expense under this operating lease was approximately $90,914 and
$86,229 for the year ended December 31, 2010 and 2009, respectively.

As of December
31, 2010, the minimum annual future lease payments, under this lease and all
other noncancellable operating leases, are as follows:

|           |  |   |         | 
|---------- |  | - | ------- | 
|2011       |  |   | 108,974 | 
|2012       |  |   | 105,728 | 
|2013       |  |   | 96,814  | 
|2014       |  |   | 99,718  | 
|Thereafter |  |   | 33,565  | 
|           |  |   |         | 
|Total      |  | $ | 444,799 | 
|           |  |   |         | 

Employment Agreements

In July 2010,
the Company entered into an employment agreement with the President, Chief
Executive Officer and Chairman of the Board, Douglas J Andrea. The effective
date of the employment agreement was August 1, 2010. The employment agreement
expires July 31, 2012 and is subject to renewal as approved by the Compensation
Committee of the Board of Directors. Pursuant to his employment agreement, Mr.
Andrea will receive an annual base salary of $337,500 for the period of August
1, 2010 through July 31, 2011 and for the period of August 1, 2011 through July
31, 2012 Mr. Andrea will receive an annual base salary of $350,000. The
employment agreement provides for quarterly bonuses equal to 25% of the
Companys pre-bonus net after tax quarterly earnings in excess of $25,000 for a
total quarterly bonus amount not to exceed $12,500; and annual bonuses equal to
10% of the Companys annual pre-bonus net after tax earnings in excess of
$300,000. All bonuses shall be payable as soon as the Companys cash flow
permits. All bonus determinations or any additional bonus in excess of the
above will be made in the sole discretion of the Compensation Committee. On
August 1, 2010, the Board granted Mr. Andrea 1,000,000 stock options with an
aggregate fair value of $130,000 (fair value was estimated using the
Black-Scholes option-pricing model). The 1,000,000 stock option grant vests in
three equal annual installments over a three year period commencing August 1,
2011. These 1,000,000 stock options have an exercise price of $0.13 per share,
which was the fair market value of the Companys common stock at the date of
grant, and a term of 10 years. Pursuant to the employment agreement and subject
to the approval of the Board of Directors, the Compensation Committee will
recommend a second grant of 1,000,000 stock options as soon as practical after
August 1, 2011, with an exercise price equal to the per share fair market value
of the Companys common stock on the date of grant. Mr. Andrea is also entitled
to a change in control payment equal to two times his salary with continuation
of health and medical benefits for two years in the event of a change in
control, as defined in the agreement. At December 31, 2010, the future minimum
cash commitments under this agreement aggregate $546,875.

In November
1999, as amended August 2008, the Company entered into a change in control
agreement with the Chief Financial Officer, Corisa L. Guiffre. This agreement
provides for a change in control payment equal to three times her average
annual compensation for the five preceding taxable years, with continuation of
health and medical benefits for three years in the event of a change in control
of the Company, as defined in the agreement, and subsequent termination of
employment other than for cause.

Legal Proceedings

Andrea is
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 any resolution of these matters will not have a
material adverse effect on Andreas consolidated financial position, results of
operations or liquidity.

F-16

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

13. STOCK PLANS AND STOCK-BASED
COMPENSATION

In 1998, the
Board adopted the 1998 Stock Option Plan (1998 Plan), which was subsequently
approved by the shareholders. The 1998 Plan, as amended, authorizes the
granting of awards, the exercise of which would allow up to an aggregate of
6,375,000 shares of Andreas Common Stock to be acquired by the holders of
those awards. The awards can take the form of stock options, stock appreciation
rights, restricted stock, deferred stock, stock reload options or other
stock-based awards. Awards may be granted to key employees, officers, directors
and consultants. No further awards will be granted under the 1998 Plan.

In October
2006, the Board adopted the Andrea Electronics Corporation 2006 Equity
Compensation Plan (2006 Plan), which was subsequently approved by the
shareholders. The 2006 Plan authorizes the granting of awards, the exercise of
which would allow up to an aggregate of 10,000,000 shares of Andreas Common
Stock to be acquired by the holders of those awards. On July 24, 2009,
shareholders approved an amendment to the 2006 Plan to increase the number of
shares issuable under the 2006 Plan to 18,000,000. The awards can take the form
of stock options, stock appreciation rights, restricted stock or other
stock-based awards. Awards may be granted to key employees, officers, directors
and consultants. At December 31, 2010, there were 4,213,936 shares available
for further issuance under the 2006 Plan.

The stock
option awards granted under these plans have been granted with an exercise
price equal to the market price of the Companys stock at the date of grant;
with vesting periods of up to four years and 10-year contractual terms.

The fair
values of each stock option grant is estimated on the date of grant using the
Black-Scholes option-pricing model that uses the weighted-average assumptions
noted in the following table. Expected volatilities are based on implied
volatilities from historical volatility of the Companys stock. The expected
term of options granted represents the period of time that options granted are
expected to be outstanding. The risk-free rate for periods within the
contractual life of the option is based on the U.S. Treasury yield curve in
effect at the time of grant.

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, 2010 and 2009:

|                                                     |  |                   |       |                   |  |       |  
|---------------------------------------------------- |  | ----------------- | ----- | ----------------- |  | ----- | -
|                                                     |  | December 31, 2010 |       | December 31, 2009 | 
|                                                     |  |                   |       |                   | 
|Expected life in years (based on simplified
 method) |  |                   | 6     |                   |  | 6     |  
|Risk-free interest rates                             |  |                   | 1.84  | %                 |  | 2.87  | %
|Volatility (based on historical volatility)          |  |                   | 168.2 | %                 |  | 163.4 | %
|Dividend yield                                       |  |                   | 0     | %                 |  | 0     | %



Option activity during 2010 is
summarized as follows:

|                     |  |                      |            |                                    |   |                                |  |                                                 |      |                      |  |                                    |  |                                |            |                                                 |   |      |  |   |      |  |  |             | 
|-------------------- |  | -------------------- | ---------- | ---------------------------------- | - | ------------------------------ |  | ----------------------------------------------- | ---- | -------------------- |  | ---------------------------------- |  | ------------------------------ | ---------- | ----------------------------------------------- | - | ---- |  | - | ---- |  |  | ----------- | 
|                     |  | Options Outstanding  |            | Options Exercisable                |  
|                     |  |                      |            |                                    |  
|                     |  | Options
 Outstanding |            | Weighted
 Average
 Exercise
 Price |   | Weighted
 Average
 Fair
 Value |  | Weighted
 Average
 Remaining
 Contractual
 Life |      | Options
 Exercisable |  | Weighted
 Average
 Exercise
 Price |  | Weighted
 Average
 Fair
 Value |            | Weighted
 Average
 Remaining
 Contractual
 Life |  
|                     |  |                      |            |                                    |   |                                |  |                                                 |      |                      |  |                                    |  |                                |            |                                                 |  
|At January 1, 2010   |  |                      | 16,141,821 |                                    | $ | 0.20                           |  | $                                               | 0.16 |                      |  | 7.32
 years                        |  |                                | 9,891,470  |                                                 | $ | 0.29 |  | $ | 0.22 |  |  | 6.37
 years | 
|Granted              |  |                      | 2,054,000  |                                    | $ | 0.10                           |  | $                                               | 0.10 |                      |  |                                    |  |                                |            |                                                 |   |      |  |   |      |  |  |             | 
|Cancelled            |  |                      | (255,000   | )                                  | $ | 6.37                           |  | $                                               | 4.45 |                      |  |                                    |  |                                |            |                                                 |   |      |  |   |      |  |  |             | 
|                     |  |                      |            |                                    |   |                                |  |                                                 |      |                      |  |                                    |  |                                |            |                                                 |   |      |  |   |      |  |  |             | 
|At December 31, 2010 |  |                      | 17,940,821 |                                    | $ | 0.10                           |  | $                                               | 0.10 |                      |  | 6.80
 years                        |  |                                | 12,701,641 |                                                 | $ | 0.11 |  | $ | 0.10 |  |  | 6.03
 years | 
|                     |  |                      |            |                                    |   |                                |  |                                                 |      |                      |  |                                    |  |                                |            |                                                 |   |      |  |   |      |  |  |             | 

During the
year ended December 31, 2010, 3,065,171 options vested with a weighted average
exercise price of $0.07 and a weighted average fair value of $0.07 per option.
Based on the December 31, 2010, fair market value of the Companys common stock
of $0.07, the aggregate intrinsic value of the 17,940,821 options outstanding
and 12,701,641 shares exercisable is $198,450 and $141,099. respectively.

Total
compensation expense recognized related to stock option awards was $204,555 and
$215,125 for the year ended December 31, 2010 and 2009, respectively. In the
accompanying consolidated statement of operations for the year ending December
31, 2010, $157,348 of expense is included in general, administrative and
selling expenses, $31,611 is included in research and development

F-17

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

expenses and
$15,596 is included in cost of revenues. In the accompanying consolidated
statement of operations for the year ending December 31, 2009, $168,429 of
expense is included in general, administrative and selling expenses, $41,495 is
included in research and development expenses and $5,201 is included in cost of
revenues.

As of December
31, 2010, there was $231,425 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 ($157,606 in 2011, $59,117 in 2012 and $14,702 in 2013).

14. SEGMENT INFORMATION

Andrea follows
the provisions of ASC 280, Segment Reporting (ASC 280). Reportable
operating segments are determined based on Andreas management approach. The
management approach, as defined by ASC 280, is based on the way that the chief
operating decision-maker organizes the segments within an enterprise for making
operating decisions and assessing performance. While Andreas results of
operations are primarily reviewed on a consolidated basis, the chief operating
decision-maker also manages the enterprise in two segments: (i) Andrea DSP
Microphone and Audio Software Products and (ii) Andrea Anti-Noise Products.
Andrea DSP Microphone and Audio Software Products primarily include products
based on the use of some, or all, of the following technologies: Andrea Digital
Super Directional Array microphone technology (DSDA), Andrea Direction Finding
and Tracking Array microphone technology (DFTA), Andrea PureAudio noise
filtering technology, and Andrea EchoStop, an advanced acoustic echo
cancellation technology. 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, 2010 and 2009:

|                                     |  |                                                     |           |                             |   |            |   |   |           |  
|------------------------------------ |  | --------------------------------------------------- | --------- | --------------------------- | - | ---------- | - | - | --------- | -
|2010 Segment
 Data                   |  | Andrea DSP
 Microphone and
 Audio Software Products |           | Andrea Anti- Noise Products |   | Total 2010 |  
|Net revenues from external customers |  | $                                                   | 827,853   |                             | $ | 2,498,394  |   | $ | 3,326,247 |  
|License revenues                     |  |                                                     | 1,589,266 |                             |   |           |   |   | 1,589,266 |  
|Income (loss) from operations        |  |                                                     | 483,413   |                             |   | (596,828   | ) |   | (113,415  | )
|Depreciation and amortization        |  |                                                     | 470,075   |                             |   | 74,142     |   |   | 544,217   |  
|Purchases of property and equipments |  |                                                     | 34,096    |                             |   | 65,712     |   |   | 99,808    |  
|Purchases of patents and trademarks  |  |                                                     | 12,367    |                             |   | 7,451      |   |   | 19,818    |  
|Assets                               |  |                                                     | 3,635,905 |                             |   | 2,151,748  |   |   | 5,787,653 |  
|Total long lived assets              |  |                                                     | 1,599,741 |                             |   | 311,013    |   |   | 1,910,754 |  



|                                      |  |   |                                                    |   |   |                             |   |   |            |  
|------------------------------------- |  | - | -------------------------------------------------- | - | - | --------------------------- | - | - | ---------- | -
|2009 Segment Data                     |  |   | Andrea DSP
 Microphone and
 Audio SoftwareProducts |   |   | Andrea Anti- Noise Products |   |   | Total 2009 |  
|Net revenues
 from external customers |  | $ | 341,892                                            |   | $ | 3,209,764                   |   | $ | 3,551,656  |  
|License
 revenues                     |  |   | 1,144,033                                          |   |   |                            |   |   | 1,144,033  |  
|Loss from
 operations                 |  |   | (177,358                                           | ) |   | (144,480                    | ) |   | (321,838   | )
|Depreciation
 and Amortization        |  |   | 470,775                                            |   |   | 46,950                      |   |   | 517,725    |  
|Purchases of
 property and equipments |  |   | 86,864                                             |   |   | 109,393                     |   |   | 196,257    |  
|Purchases of
 patents and trademarks  |  |   | 13,542                                             |   |   | 25,722                      |   |   | 39,264     |  
|Assets                                |  |   | 3,555,990                                          |   |   | 2,271,051                   |   |   | 5,827,041  |  
|Total long
 lived assets              |  |   | 2,023,353                                          |   |   | 311,992                     |   |   | 2,335,345  |  

F-18

---



ANDREA ELECTRONICS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2010

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, 2010 and 2009,
and as of each respective year-end, net revenues and accounts receivable by
geographic area are as follows:

|                      |  |      |           |      |   |           | 
|--------------------- |  | ---- | --------- | ---- | - | --------- | 
|Geographic Data       |  | 2010 |           | 2009 |  
|                      |  |      |           |      |  
|Net
 Revenues:        |  |      |           |      |   |           | 
|United States         |  | $    | 4,191,623 |      | $ | 4,301,530 | 
|Foreign(1)            |  |      | 723,890   |      |   | 394,159   | 
|                      |  |      |           |      |   |           | 
|                      |  | $    | 4,915,513 |      | $ | 4,695,689 | 
|                      |  |      |           |      |   |           | 
|Accounts
 receivable: |  |      |           |      |   |           | 
|United States         |  | $    | 427,552   |      | $ | 486,865   | 
|Foreign               |  |      | 77,580    |      |   | 27,462    | 
|                      |  |      |           |      |   |           | 
|                      |  | $    | 505,132   |      | $ | 514,327   | 
|                      |  |      |           |      |   |           | 

|    |                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                              
|(1) | Net revenues
 to any one foreign country did not exceed 10% of total net revenues for year
 ended December 31, 2010 and 2009.

$15,870 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
 CORPORATION        
| |     |                                        
| | By: | /s/ DOUGLAS
 J. ANDREA                 
| |     | Name:Douglas J. Andrea                 
| |     | Title:Chairman of the Board, President,
| |     | Chief Executive Officer and Corporate  
| |     | Secretary                              

Date: March 17, 2011

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 17,
 2011
|Douglas J. Andrea            |  | Officer and
 Corporate Secretary                   |  |                
|                             |  |                                                    |  |                
|/s/     CORISA
 L. GUIFFRE   |  | Vice
 President, Chief Financial Officer and       |  | March 17,
 2011
|Corisa L. Guiffre            |  | Assistant
 Corporate Secretary                     |  |                
|                             |  |                                                    |  |                
|/s/     GARY
 A. JONES       |  | Director                                           |  | March 17,
 2011
|Gary A. Jones                |  |                                                    |  |                
|                             |  |                                                    |  |                
|/s/     LOUIS
 LIBIN         |  | Director                                           |  | March 17,
 2011
|Louis Libin                  |  |                                                    |  |                
|                             |  |                                                    |  |                
|/s/     JOSEPH
 J. MIGLIOZZI |  | Director                                           |  | March 17,
 2011
|Joseph J. Migliozzi          |  |                                                    |  |                
|                             |  |                                                    |  |                
|/s/     JONATHAN
 D. SPAET   |  | Director                                           |  | March 17,
 2011
|Jonathan D. Spaet            |  |                                                    |  |                

---