Overview

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

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

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

Our Critical Accounting Policies

Our unaudited condensed consolidated financial statements and the notes to our unaudited condensed consolidated financial statements contain information that is pertinent to management's discussion and analysis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. On a continual basis, management reviews its estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such reviews, and if deemed appropriate, those estimates are adjusted accordingly. Actual results may vary from these estimates and assumptions under different and/or future circumstances. Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-KSB for the year ended December 31, 2007. A discussion of our critical accounting policies and estimates are included in Management's Discussion and Analysis or Plan of Operation in our Annual Report on Form 10-KSB for the year ended December 31, 2007. Management has discussed the development and selection of these policies with the Audit Committee of the Company's Board of Directors, and the Audit Committee of the Board of Directors has reviewed the Company's disclosures of these policies. There have been no material changes to the critical accounting policies or estimates reported in the Management's Discussion and Analysis section of the 10-KSB for the year ended December 31, 2007 as filed with the Securities and Exchange Commission.

Cautionary Statement Regarding Forward-Looking Statements

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe", "expect", "intend", "anticipate", "estimate", "project" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in economic, competitive, governmental, technological and other factors that may affect our business and prospects. Additional factors are discussed below under "Risk Factors" and in

Risk Factors

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

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

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

- the cost of development of our products;

- the mix of products we sell;

- the mix of distribution channels we use;

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

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

- general economic conditions.

We cannot assure that the level of revenues and gross profit, if any, that we achieve in any particular fiscal period will not be significantly lower than in other fiscal periods. Our net revenues for the three months ended September 30, 2008 were $1,283,957 versus $1,049,915 for the three months ended September 30, 2007. Net income for the three months ended September 30, 2008 was $25,289, or $0.00 income per share on a basic and diluted basis, versus net loss of $194,569, or $0.00 loss per share on a basic and diluted basis for the three months ended September 30, 2008. Our revenues for the nine months ended September 30, 2008 were $3,417,848 versus $3,624,931 for the nine months ended September 30, 2007. Net loss for the nine months ended September 30, 2008 was $344,874 or $.01 loss per share on a basic and diluted basis, versus net loss of $313,214, or $.01 loss per share on a basic and diluted basis for the nine months ended September 30, 2007. We continue to explore opportunities to grow sales in other business areas; we are also examining additional opportunities for cost reduction, production efficiencies and further diversification of our business. Although we have improved cash flows by reducing overall expenses, if our revenues decline we may not continue to generate positive cash flows and our operating results may be affected.

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

In order to be a viable entity we need to maintain and increase profitable operations. To achieve profitable operations we need to maintain/increase current net revenues and continue to look for ways to control expenses. We might also need to sell additional assets or raise capital as a means of funding continued operations. We may have to raise capital from external sources. These sources may include private or public financings through the issuance of debt, convertible debt or equity, or collaborative arrangements. Such additional capital and funding may not be available on favorable terms, if at all. Additionally, we may only be able to obtain additional capital or funds through arrangements that require us to relinquish rights to our products, technologies or potential markets, in whole or in part, or result in our sale. As a result of past few years of performance, we believe that we have sufficient liquidity to continue our operations at least through September 2009, provided our net revenues do not continue to decline and our operating expenses do not continue to increase. Although we have revised our business strategies to reduce our expenses and capital expenditures, we cannot assure you that we will be successful in generating positive cash flows or obtaining access to additional sources of funding in amounts necessary to continue our operations. Failure to maintain sufficient access to funding may also result in our inability to continue operations.

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

Sales of a substantial number of shares of our common stock in the public market could have the effect of depressing the prevailing market price of our common stock. Of the 200,000,000 shares of common stock presently authorized, 60,406,945 were outstanding as of November 10, 2008. The number of shares outstanding does not include an aggregate of 28,811,925 shares of common stock that are issuable. This number of issuable common shares is equal to approximately 48% of the 60,406,945 outstanding shares. These issuable common shares are comprised of: a)14,676,820 shares of our common stock reserved for issuance upon exercise of outstanding awards granted under our 1991 Performance Equity Plan, 1998 Stock Plan and 2006 Stock Plan; b) 101,345 shares reserved for future grants under our 2006 Stock Plan; c) 4,103,984 shares of common stock that are issuable upon conversion of the Series C Preferred Stock; d) 4,771,432 shares of common stock issuable upon conversion of the Series D Preferred Stock; and e) 5,158,344 of common stock issuable upon exercise of warrants relating to the Series D Preferred stock.

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

We generate revenues to regions outside the United States, particularly in Asia. For the three months ended September 30, 2008 and 2007, net revenues to customers outside the United States accounted for approximately 6% and 43%, respectively, of our net revenues. For the nine months ended September 30, 2008 and 2007, net revenues to customers outside the United States accounted for approximately 13% and 33%, respectively, of our net sales. International sales and operations are subject to a number of risks, including:

• trade restrictions in the form of license requirements;

• restrictions on exports and imports and other government controls;

• changes in tariffs and taxes;

• difficulties in staffing and managing international operations;

• problems in establishing and managing distributor relationships;

• general economic conditions; and

• political and economic instability or conflict.

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

In addition to the risk factors set forth above and the other information set forth in this report, you should carefully consider the factors discussed in

Results Of Operations

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

Net Revenues



                                For the Three Months                          For the Nine Months
                                 Ended September 30             %             Ended September 30             %
                                 2008            2007          Change         2008            2007          Change
Andrea Anti-Noise Products
net product revenues
Sales of products to an
OEM customer for use with
speech recognition
software                     $   190,143     $         -          100     $   313,243     $   139,821          124   (a)
Sales of gaming headset
products to an OEM
customer                     $         -     $         -            -     $         -     $   183,261         (100 ) (a)
All other Andrea
Anti-Noise net product
revenues                         598,387         428,342           40       1,626,636       1,476,290           10   (b)
Total Andrea Anti-Noise
Products net product
revenues                     $   788,530     $   428,342           84     $ 1,939,879     $ 1,799,372            8

Andrea DSP Microphone and
Audio Software Products
revenues
Sales of array microphone
products to an OEM
customer                               -         359,357         (100 )       107,800         731,467          (85 ) (c)
All other Andrea DSP
Microphone and Audio
product revenues                 158,045         172,264           (8 )       512,454         596,239          (14 ) (d)
License revenues                 337,382          89,952          275         857,715         497,853           72   (e)
Total Andrea DSP
Microphone and Audio
Software Products revenues       495,427         621,573          (20 )     1,477,969       1,825,559          (19 )

Total Revenues               $ 1,283,957     $ 1,049,915           22     $ 3,417,848     $ 3,624,931           (6 )


                                                                              18
--------------------------------------------------------------------------------

(a) The significant increase of revenues of Andrea Anti-Noise Products is directly related to an Original Equipment Manufacturer ("OEM") customer for use with speech recognition software and was a result of the OEM's increased demand for our products associated with the timing of the launch of the OEMs updated software during the three and nine months ended September 30, 2008 as compared to the same periods in 2007. We believe that our annual revenues for 2008 and 2009 associated with this customer will be approximately $313,000 and $250,000, respectively.

(b) The 40% and 10% increases for the nine months and three months ended September 30, 2008, respectively, of all other Andrea Anti-Noise net product revenues is associated with increased sales of products to educational customers for use with their distance learning products.

(c) The significant decreases of revenues of microphone array products to an OEM customer for the three month and nine month periods ending September 30, 2008, relates to the decreased demand from the OEM customer. We believe that this decrease is result of the OEM deciding not to continue including a microphone array with all applicable product models. The revenues in 2007 were a result of the OEM's introduction of the OEM's product and the OEM customers' need to supply all of its customers for the initial launch.

(d) The 8% and 14% decrease in all other Andrea DSP Microphone and Audio product revenues for the three and nine month periods ended September 30, 2008, respectively, are a result of a decreased demand for our in-vehicle auto array. We believe the decline is resulting to the decline of government funding for these types of products.

(e) The majority of the increase in licensing revenues for the three and nine month periods ended September 30, 2008 is a result of licensing revenue from two customer in the PC Audio market. The increase for the three month period was a result of these customers launch of PC's utilizing Intel's new platform. The increase for the nine-month period is a result of one licensing customer's initial implementation of our technology. We expect our licensing revenues for 2008 and 2009 to be approximately $1,100,000.

Cost of Revenues

Cost of revenues as a percentage of net revenues for the three months ended September 30, 2008 decreased to 41% from 54% for the three months ended September 30, 2007. The cost of revenues as a percentage of net revenues for the three months ended September 30, 2008 for Andrea Anti-Noise Products is 61% compared to 54% for the three months ended September 30, 2007. The cost of revenues as a percentage of net revenues for the three months ended September 30, 2008 for Andrea DSP Microphone and Audio Software Products is 10% compared to 54% for the three months ended September 30, 2007. Cost of revenues as a percentage of net revenues for the nine months ended September 30, 2008 decreased to 44% from 50% for the nine months ended September 30, 2007. The cost of revenues as a percentage of net revenues for the nine months ended September 30, 2008 for Andrea Anti-Noise Products is 62% compared to 58% for the nine months ended September 30, 2007. The cost of revenues as a percentage of net revenues for the nine months ended September 30, 2008 for Andrea DSP Microphone and Audio Software Products is 19% compared to 43% for the nine months ended September 30, 2007. The changes are primarily the result of the changes in revenue as described under "Net Revenues" above. Specifically the increase in cost of revenues as a percentage of revenues for the Andrea Anti-Noise Products is a result of high volume low margin sales to an OEM customer. The decrease in cost of revenues as a percentage of revenues for the Andrea DSP Microphone and Audio Software is the result of the increase in license revenues partially offset by the decrease in the revenues of high volume low margin microphone array products to an OEM customer.

Research and Development

Research and development expenses for the three months ended September 30, 2008 increased 3% to $179,062 from $173,895 for the three months ended September 30, 2007. This small increase primarily relates to increases in employee related benefit costs. For the three months ended September 30, 2008, the increase in research and development expenses reflects a 6% decrease in our Andrea DSP Microphone and Audio Software Technology efforts to $117,670, or 66% of total research and development expenses and a 25% increase in our Andrea Anti-Noise Headset Product efforts to $61,392, or 34% of total research and development expenses. Research and development expenses for the nine months ended September 30, 2008 increased 11% to $557,807 from $502,755 for the nine months ended September 30, 2007. This increase primarily relates to increases in employee compensation and related benefit costs. For the nine months ended September 30, 2008, the increase in research and development expenses reflects a 4% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $376,240, or 67% of total research and development expenses and a 29% increase in our Andrea Anti-Noise Headset Product efforts to $181,567, or 33% of total research and development expenses. With respect to DSP Microphone and Audio Software technologies, research efforts are primarily focused on the pursuit of commercializing a natural language-driven human/machine interface by developing optimal far-field microphone solutions for various voice-driven interfaces, incorporating Andrea's digital super directional array microphone technology, and certain other related technologies such as noise suppression and stereo acoustic echo cancellation. We believe that continued research and development spending should provide Andrea with a competitive advantage.

General, Administrative and Selling Expenses

General, administrative and selling expenses increased approximately 9% to $555,326 for the three months ended September 30, 2008 from $507,503 for the three months ended September 30, 2007. For the three months ended September 30, 2008, the increase reflects a less than 1% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $298,964, or 54% of total general, administrative and selling expenses and a 23% increase in our Andrea Anti-Noise Headset Product efforts to $256,362, or 46% of total general, administrative and selling expenses. General, administrative and selling expenses increased approximately 8% to $1,721,773 for the nine months ended September 30, 2008 from $1,587,335 for the nine months ended September 30, 2007. For the nine months ended September 30, 2008, the increase reflects an 6% increase in our Andrea DSP Microphone and Audio Software Technology efforts to $980,414, or 57% of total general, administrative and selling expenses and a 12% increase in our Andrea Anti-Noise Headset Product efforts to $741,359, or 43% of total general, administrative and selling expenses. These increases relate to increases in sales and marketing efforts as well as to increases in employee compensation and related benefit costs.

Interest income, net

Interest income, net for the three months ended September 30, 2008 was $2,031 compared to $3,967 for the three months ended September 30, 2007. Interest income, net for the nine months ended September 30, 2008 was $6,602 compared to $4,371 for the nine months ended September 30, 2007.

Provision for Income Taxes

The provision for income taxes is a result of certain licensing revenues that are subject to withholding of income tax as mandated by the foreign jurisdiction in which the revenues are earned. Amounts are based on net revenues and are therefore subject to change.

Net income (loss)

Net income for the three months ended September 30, 2008 was $25,289 compared to a net loss of $194,569 for the three months ended September 30, 2007. Net loss for the nine months ended September 30, 2008 was $344,874 compared to a net loss of $313,214 for the nine months ended September 30, 2007. The net income (loss) for the three and nine month periods ended September 30, 2008 and the net loss for the three months and nine months ended September 30, 2007 principally reflects the factors described above.

Off-Balance Sheet Arrangements

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

Liquidity And Capital Resources

Andrea's principal sources of funds are and are expected to continue to be gross cash flows from operations. At September 30, 2008, we had cash and cash equivalents of $1,156,518 compared with $811,403 at December 31, 2007. The balance of cash and cash equivalents at September 30, 2008 is primarily a result of our cash provided from operations during the nine months ended September 30, 2008.

Working capital balance at September 30, 2008 was $1,993,116 compared to a working capital balance of $1,837,521 at December 31, 2007. The increase in working capital reflects an increase in total current assets of $385,049 coupled with an increase in total current liabilities of $229,454. The increase in total current assets reflects an increase in cash and cash equivalents of $345,115, a decrease in accounts receivable of $267,379, an increase in inventory of $293,581, and an increase in prepaid expenses and other current assets of $13,372. The increase in total current liabilities reflects an increase in trade accounts payable of $165,382, and an increase of $64,072 in other current liabilities. The increase in cash and cash equivalents of $345,115 reflects $415,879 of net cash provided by operating activities, and $70,764 of net cash used in investing activities.

The cash provided by operating activities of $415,879, excluding non-cash charges for the quarter ended September 30, 2008, is attributable to a $267,379 decrease in accounts receivable, a $320,103 increase in inventory, a $13,732 increase in prepaid expenses and other current assets, a $165,382 increase in accounts payable, and a $64,072 increase in other current liabilities. The changes in receivables, inventory and accounts payable primarily reflect differences in the timing related to both the payments for and the acquisition of inventory as well as for other services in connection with ongoing efforts related to Andrea's various product lines.

The cash used by investing activities of $70,764 reflects an increase in property and equipment of $35,512 and an increase in patents and trademarks of $35,252. The increase in property and equipment reflects capital expenditures associated with computer purchases and tooling for some of new products. The increase in patents and trademarks reflects capital expenditures associated with our intellectual property.

We plan to continue to improve our cash flows during 2008 by aggressively pursuing additional licensing opportunities related to our Andrea DSP Audio Software and increasing our Andrea Anti-Noise Headset Products through the introduction of refreshed product line scheduled to be introduced in the second half of 2008 as well as the increased efforts we are putting into our sales and marketing efforts. However, there can be no assurance that we will be able to successfully execute the aforementioned plans. As of November 10, 2008, Andrea has approximately $1,200,000 of cash and cash equivalents. We believe that we have sufficient liquidity available to continue in operation through at least September 2009. To the extent that we do not generate sufficient cash flows from our operations in the next twelve months, additional financing might be required. Although we have improved cash flows by reducing overall expenses, if our revenues decline, these reductions may impede our ability to be cash flow positive and our net income or loss may be disproportionately affected. We have no commitment for additional financing and may experience difficulty in obtaining additional financing on favorable terms, if at all. Any financing we obtain may contain covenants that restrict our freedom to operate our business or may have rights, preferences or privileges senior to our common stock and may dilute our current shareholders' ownership interest in Andrea. We cannot assure that demand will continue for any of our products, including future products related to our Andrea DSP Microphone and Audio Software technologies, or, that if such demand does exist, that we will be able to obtain the necessary working capital to increase production and provide marketing resources to meet such demand on favorable terms, or at all.

. . .