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 devices, cellular and other wireless communication devices and automotive communication systems. Our Andrea DSP Microphone and Audio Software Products use "far-field" digital signal processing technology to provide high quality transmission of voice where the user is at a distance from the microphone. High quality audio communication technologies will be required for emerging far-field voice applications, ranging from continuous speech dictation, to Internet telephony and multiparty video teleconferencing and collaboration, to natural language-driven interfaces for automobiles, home and office automation and other machines and devices into which voice-controlled microprocessors are expected to be introduced during the next several years.

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

Our Critical Accounting Policies

Our 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-K for the year ended December 31, 2008. 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-K for the year ended December 31, 2008. 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 10K for the year ended December 31, 2008 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 Part I, "Item 1A - Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2008. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

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; 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 three months ended June 30, 2009 were $1,197,561 compared to $1,207,251 for the three months ended June 30, 2008. Net loss for the three months ended June 30, 2009 was $17,712, or $0.00 loss per share on a basic and diluted basis, and $8,891, or $0.00 per share on a basic and diluted basis for the three months ended June 30, 2008. Our revenues for the six months ended June 30, 2009 were $2,109,141 compared to $2,133,891 for the six months ended June 30, 2008. Net loss for the six months ended June 30, 2009 was $301,576 or $.00 loss per share on a basic and diluted basis, compared to net loss of $370,163, or $.01 loss per share on a basic and diluted basis for the six months ended June 30, 2008. We continue to explore opportunities to grow sales in other business areas; we are also examining additional opportunities for cost reduction, production efficiencies and further diversification of our business. Although we have improved cash flows by reducing overall expenses, if our revenues continue to decline we may not continue to generate positive cash flows and our net income or loss may be affected.

If we fail to 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 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 June 2010, provided our net revenues do not materially decline and our operating expenses do not materially 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, 63,355,023 were outstanding as of August 11, 2009. The number of shares outstanding does not include an aggregate of 28,505,503 shares of common stock that are issuable. This number of issuable common shares is equal to approximately 45% of the 63,355,023 outstanding shares. These issuable common shares are comprised of: a) 16,206,821 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) 6,280,436 shares reserved for future grants under our 2006 Stock Plan; c) 2,389,670 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.

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 Part I, "Item 1A - Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2008, which could materially affect our business, financial condition or future results. The risks described in this report and in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Results Of Operations

Quarter and Six Months ended June 30, 2009 compared to Quarter and Six Months ended June 30, 2008

Net Revenues


                                    For the Three Months                         For the Six Months
                                        Ended June 30                               Ended June 30
                                                                    %                                           %
                                    2009            2008         Change         2009            2008          Change

Andrea Anti-Noise Products net
Product revenues
Sales of products to an OEM
customer for use with speech
recognition software             $   204,353     $    98,310         108     $   232,877     $   123,100           89   (a)
Revenues related to LED
headphone products                   137,957           7,325       1,783         155,277          18,013          762   (b)
All other Andrea Anti-Noise
net product revenues                 461,737         514,835         (10 )       963,221       1,010,236           (5 )
Total Andrea Anti-Noise
Products net Product revenues    $   804,047     $   620,470          30     $ 1,351,375     $ 1,151,349           16

Andrea DSP Microphone and
Audio Software Products
revenues
Sales of array microphone
products to an OEM
customer                                   -           9,800        (100 )             -         107,800         (100 ) (c)
Consulting revenue to an OEM
Customer                                   -          75,000        (100 )             -         150,000         (100 ) (d)
All other Andrea DSP
Microphone and Audio product
revenues                             111,507         111,866           -         186,918         204,409           (9 )
License revenues                     282,007         390,115         (28 )       480,848         520,333           (8 ) (e)
Total Andrea DSP Microphone
and Audio Software Products
revenues                             393,514         586,781         (33 )       667,766         982,542          (32 )

Total Revenues                   $ 1,197,561     $ 1,207,251          (1 )   $ 2,019,141     $ 2,133,891           (5 )

(a) The increase of sales of Andrea Anti-Noise Products is directly related to increased purchases by an OEM customer for use with speech recognition software during the three and six months ended June 30, 2009 as compared to the same periods in 2008.

(b) The increases of revenues related to blinking LED earbud products are primarily associated with the initial sales of a custom retail product for an OEM customer.

(c) The significant decreases of revenues of microphone array products to an OEM customer relates to the decreased demand from the OEM customer. We believe that this decrease is the result of the OEM deciding not to continue bundling a microphone array with all applicable product models. We do not expect any revenues from the OEM for this product in 2009.

(d) The decrease in consulting revenue relates to an OEM customer selling the business line for which the consulting revenue related.

(e) The majority of the decreases in licensing revenues for the three and six months ended June 30, 2009 is a result of one of our OEM licensing partner's initial launch of our licensed products in their product line during the three and six months ended June 30, 2008 as compared to the regularly expected licensing revenues for the three and six months ended June 30, 2009. In addition, these decreases are effected by another one of our OEM licensing partners selling the business line which featured our licensed products. Although we have entered into a new license agreement with this second partner's successor, we do not expect the revenues to remain at the level of the predecessor.

Cost of Revenues

Cost of revenues as a percentage of net revenues for the three months ended June 30, 2009 increased to 45% from 39% for the three months ended June 30, 2008. The cost of revenues as a percentage of net revenues for the three months ended June 30, 2009 for Andrea Anti-Noise Products is 59% compared to 63% for the three months ended June 30, 2008. The cost of revenues as a percentage of net revenues for the three months ended June 30, 2009 and June 30, 2008 for Andrea DSP Microphone and Audio Software Products is 15%. Cost of revenues as a percentage of net revenues for the six months ended June 30, 2009 decreased to 43% from 45% for the six months ended June 30, 2008. The cost of revenues as a percentage of net revenues for the six months ended June 30, 2009 for Andrea Anti-Noise Products is 56% compared to 63% for the six months ended June 30, 2008. The cost of revenues as a percentage of net revenues for the six months ended June 30, 2009 for Andrea DSP Microphone and Audio Software Products is 15% compared to 24% for the six months ended June 30, 2008. The decreases for the Andrea Anti-Noise Products are a result of a decrease in factory overhead expenses. The decrease for Andrea DSP Microphone and Audio Software Products for the six months ending June 30, 2009 is a result of the decreased sales of array microphone products to an OEM customer.

Research and Development

Research and development expenses for the three months ended June 30, 2009 decreased 23% to $142,853 from $185,341 for the three months ended June 30, 2008. For the three months ended June 30, 2009, the decrease in research and development expenses reflects a 36% decrease in our Andrea DSP Microphone and Audio Software Technology efforts to $80,858, or 57% of total research and development expenses offset in part by a 4% increase in our Andrea Anti-Noise Headset Product efforts to $61,995, or 43% of total research and development expenses. Research and development expenses for the six months ended June 30, 2009 decreased 23% to $292,366 from $378,745 for the six months ended June 30, 2008. These decreases primarily relate to decreases in employee compensation and related benefit costs. For the six months ended June 30, 2009, the decrease in research and development expenses reflects a 58% decrease in our Andrea DSP Microphone and Audio Software Technology efforts to $163,347, or 56% of total research and development expenses offset in part by a 7% increase in our Andrea Anti-Noise Headset Product efforts to $129,019, or 44% 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 decreased approximately 3% to $538,658 for the three months ended June 30, 2009 from $556,273 for the three months ended June 30, 2008. For the three months ended June 30, 2009, the decrease reflects a 22% decrease in our Andrea DSP Microphone and Audio Software Technology efforts to $259,647, or 48% of total general, administrative and selling expenses and a 24% increase in our Andrea Anti-Noise Headset Product efforts to $279,011, or 52% of total general, administrative and selling expenses. General, administrative and selling expenses remained relative flat, increasing approximately 1% to $1,173,079 for the six months ended June 30, 2009 from $1,166,447 for the six months ended June 30, 2008. For the six months ended June 30, 2009, the increase reflects a 14% decrease in our Andrea DSP Microphone and Audio Software Technology efforts to $600,411, or 51% of total general, administrative and selling expenses and a 15% increase in our Andrea Anti-Noise Headset Product efforts to $572,668, or 49% of total general, administrative and selling expenses.

Interest Income, net

Interest income, net for the three months ended June 30, 2009 was $2,444 compared to $1,697 for the three months ended June 30, 2008. Interest income, net for the six months ended June 30, 2009 was $4,936 compared to $4,571 for the six months ended June 30, 2008. The year to date increase in other income is the result of interest earned on higher cash balances in 2009.

Provision for Income Taxes

The provision for income taxes the three months ended June 30, 2009 was $308 compared to a provision for income taxes of $1,643 for the three months ended June 30, 2008. The provision for income taxes the six months ended June 30, 2009 was $1,565 compared to a provision for income taxes of $3,716 for the six months ended June 30, 2008. The decrease is a result of a decrease of certain licensing revenues that are subject to withholding of income tax as mandated by the foreign jurisdiction in which the revenues are earned.

Net Loss

Net loss for the three months ended June 30, 2009 was $17,712 compared to a net loss of $8,891 for the three months ended June 30, 2008. Net loss for the six months ended June 30, 2009 was $301,576 compared to a net loss of $370,163 for the six months ended June 30, 2008. The net loss for the three and six month periods ended June 30, 2009 and the net loss for the three months and six months ended June 30, 2008 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 be gross cash flows from operations. At June 30, 2009, we had cash of $1,764,606 compared with $1,006,951 at December 31, 2008. The cash balance at June 30, 2009 is primarily a result of our cash provided from operations.

Our working capital balance at June 30, 2009 was $2,220,141 compared to a working capital balance of $2,196,689 at December 31, 2008. The increase in working capital reflects an increase in total current assets of $409,364 coupled with an increase in total current liabilities of $385,912. The increase in total current assets reflects an increase in cash of $757,655, a decrease in accounts receivable of $170,440, a decrease in inventory of $307,011, an increase in short term customer deposit of $130,854 and a decrease in prepaid expenses and other current assets of $1,694. The decrease in accounts receivable is a result of timing of revenues and subsequent collection. The increase in short term customer deposit and short term deferred revenue is related to a deposit for a product for one of our customers. The increase in total current liabilities reflects an increase in trade accounts payable of $251,610, an increase in short-term deferred revenue of $130,854 and an increase of $3,448 in other current liabilities. The increase in cash of $757,655 reflects $808,593 of net cash provided by operating activities, and $50,938 of net cash used in investing activities.

The cash provided by operating activities of $808,593, excluding non-cash charges for the six months ended June 30, 2009, is attributable to a $170,440 decrease in accounts receivable, a $352,335 decrease in inventory, a $130,854 increase in short term customer deposit, a $1,694 decrease in prepaid expenses and other current assets, a $251,610 increase in accounts payable, a $130,854 increase in short-term deferred revenue and a $3,448 increase in other current and long-term liabilities. The changes in receivables, inventory, prepaid expenses 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 in investing activities of $50,938 reflects $27,649 in purchases of property and equipment and $23,289 of payments related to patents and trademarks. The increase in property and equipment reflects capital expenditures associated with information technology purchases as well as molds associated with our Andrea Anti-Noise Headset Products. The increase in patents and trademarks reflects capital expenditures associated with our intellectual property.

We plan to continue to improve our cash flows in 2009 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 a refreshed product line introduced in the latter part of 2008 as well as the increased efforts we are putting into our sales and marketing efforts. However, there can be no assurance that we will be able to successfully execute the aforementioned plans. As of August 11, 2009, Andrea has approximately $1,800,000 of cash deposits. We believe that we have sufficient liquidity available to continue in operation through at least June 2010. 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 condensed consolidated financial statements.