SCHEDULE 14A INFORMATION
                PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

FILED BY THE REGISTRANT [X]
FILED BY A PARTY OTHER THAN THE REGISTRANT [_]

CHECK THE APPROPRIATE BOX:

[_] Preliminary Proxy Statement
[_] Confidential, for Use of the Commission Only (as permitted by Rule
    14a-6(e)(2))
[X] Definitive Proxy Statement
[_] Definitive Additional Materials
[_] Soliciting Material Pursuant Rule 14a-12

                         ANDREA ELECTRONICS CORPORATION
   --------------------------------------------------------------------------
                (NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                                       N/A
   --------------------------------------------------------------------------
    (NAME OF PERSON(S) FILING PROXY STATEMENT, IF OTHER THAN THE REGISTRANT)

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     (1)  Title of each class of securities to which transaction applies:
          ____________________________________________________________________
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          pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
          filing fee is calculated and state how it was determined):
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          ____________________________________________________________________
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          ____________________________________________________________________

[_] Fee paid previously with preliminary materials.
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    0-11(a)(2) and identify the filing for which the offsetting fee was paid
    previously. Identify the previous filing by registration statement number,
    or the Form or Schedule and the date of its filing.

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                         ANDREA ELECTRONICS CORPORATION
                              45 Melville Park Road
                            Melville, New York 11747

                      ------------------------------------

                    NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
                           TO BE HELD JANUARY 31, 2003

                      ------------------------------------

     On Friday, January 31, 2003, Andrea Electronics Corporation will hold a
special meeting of shareholders at the American Stock Exchange, 86 Trinity
Place, New York, New York. The meeting will begin at 9:30 a.m., local time. At
the meeting, shareholders will consider and act on the following:

     1.   The approval of an amendment to the Restated Certificate of
          Incorporation of the Company to increase the authorized shares of
          common stock from 70,000,000 shares to 200,000,000 shares;

     2.   The approval of an amendment to the Restated Certificate of
          Incorporation of the Company to reduce the par value of the Company's
          common stock from $0.50 per share to $0.01 per share; and

     3.   Such other business as may properly come before the meeting.

     Note: As of the date of this notice, the board of directors is not aware of
any other business to come before the meeting.

     Only shareholders of record as the close of business on December 27, 2002,
are entitled to receive notice of the meeting and to vote at the meeting and any
adjournment or postponement of the meeting.

     Please complete and sign the enclosed form of proxy, which is solicited by
the board of directors, and mail it promptly in the enclosed envelope. The proxy
will not be used if you attend the meeting and vote in person.

                                              BY ORDER OF THE BOARD OF DIRECTORS

                                              /s/ Richard A. Maue

                                              Richard A. Maue
                                              Secretary
Melville, New York
January 3, 2003

IMPORTANT: The prompt return of proxies will save the Company the expense of
further requests for proxies in order to ensure a quorum. A self-addressed
envelope is enclosed for your convenience. No postage is required if mailed in
the United States.



                                 SPECIAL MEETING

                         ANDREA ELECTRONICS CORPORATION

                                 PROXY STATEMENT

         This proxy statement is furnished in connection with the solicitation
of proxies by the board of directors of Andrea Electronics Corporation ("Andrea
Electronics" or the "Company") to be used at the special meeting of shareholders
of the Company. The special meeting will be held at the American Stock Exchange,
86 Trinity Place, New York, New York on Friday, January 31, 2003 at 9:30 a.m.,
local time. This proxy statement and the enclosed proxy card are being first
mailed to shareholders on or about January 3, 2003.

                           Voting and Proxy Procedure

Who Can Vote at the Meeting

         You are entitled to vote your Andrea Electronics common stock only if
the records of the Company show that you held your shares as of the close of
business on December 27, 2002. As of the close of business on December 27, 2002,
a total of 21,127,918 shares of Andrea Electronics common stock were
outstanding. Each share of common stock has one vote.

Attending the Meeting

         If you are a beneficial owner of Andrea Electronics common stock held
by a broker, bank or other nominee (i.e., in "street name"), you will need proof
of ownership to be admitted to the meeting. A recent brokerage statement or
letter from a bank or broker are examples of proof of ownership. If you want to
vote your shares of Andrea Electronics common stock held in street name in
person at the meeting, you will have to get a written proxy in your name from
the broker, bank or other nominee who holds your shares.

Vote Required

         The special meeting will be held if a majority of the outstanding
shares of common stock entitled to vote is represented at the meeting. If you
return valid proxy instructions or attend the meeting in person, your shares
will be counted for purposes of determining whether there is a quorum, even if
you abstain from voting. Broker non-votes also will be counted for purposes of
determining the existence of a quorum. A broker non-vote occurs when a broker,
bank or other nominee holding shares for a beneficial owner does not vote on a
particular proposal because the nominee does not have discretionary voting power
with respect to that item and has not received voting instructions from the
beneficial owner.

         In voting on the approval of the amendment to the Restated Certificate
of Incorporation to increase the number of authorized shares, you may vote in
favor of the amendment, vote against the amendment or abstain from voting. In
voting on the approval of the amendment to the Restated Certificate of
Incorporation to reduce the par value, you may vote in favor of the amendment,
vote against the amendment or abstain from voting. Both amendments to the
Restated Certificate of Incorporation will be decided by the affirmative vote of
a majority of the outstanding shares entitled to



vote at the special meeting. On these matters, abstentions and broker non-votes
will have effect of votes against the proposal.

Voting by Proxy

         The board of directors of Andrea Electronics is sending you this proxy
statement for the purpose of requesting that you allow your shares of Andrea
Electronics common stock to be represented at the special meeting by the persons
named in the enclosed proxy card. All shares of Andrea Electronics common stock
represented at the special meeting by properly executed and dated proxies will
be voted according to the instructions indicated on the proxy card. If you sign,
date and return a proxy card without giving voting instructions, your shares
will be voted as recommended by the Company's board of directors. The board of
directors recommends a vote "FOR" the amendment to the Restated Certificate of
Incorporation to increase the number of authorized shares and "FOR" the
amendment to the Restated Certificate of Incorporation to reduce the par value.

         If any matters not described in this proxy statement are properly
presented at the special meeting, the persons named in the proxy card will use
their own best judgment to determine how to vote your shares. This includes a
motion to adjourn or postpone the special meeting in order to solicit additional
proxies. If the special meeting is postponed or adjourned, your Andrea
Electronics common stock may be voted by the persons named in the proxy card on
the new special meeting date as well, unless you have revoked your proxy. The
Company does not know of any other matters to be presented at the special
meeting.

         You may revoke your proxy at any time before the vote is taken at the
meeting. To revoke your proxy you must either advise the Secretary of the
Company in writing before your Company common stock has been voted at the
special meeting, deliver a later dated proxy, or attend the meeting and vote
your shares in person. Attendance at the special meeting will not in itself
constitute revocation of your proxy.

         If your Andrea Electronics common stock is held in street name, you
will receive instructions from your broker, bank or other nominee that you must
follow in order to have your shares voted. Your broker, bank or other nominee
may allow you to deliver your voting instructions via the telephone or the
Internet. Please see the instruction form provided by your broker, bank or other
nominee that accompanies this proxy statement. If you wish to change your voting
instructions after you have returned your voting instruction form to your broker
or bank, you must contact your broker or bank.

Proposal One:

              Amendment of Restated Certificate of Incorporation to
            Increase the Number of Authorized Shares of Common Stock

         The board of directors recommends the adoption by shareholders of an
amendment to Article Third of the Company's Restated Certificate of
Incorporation, to increase the number of shares of common stock that may be
issued. The Restated Certificate of Incorporation currently authorizes the
issuance of 70,000,000 shares of common stock. The board of directors believes
it to be in the best interests of the Company, and has therefore proposed and
declared advisable, that the Restated Certificate of Incorporation be amended to
increase the number of authorized shares of common stock to 200,000,000 shares.


                                       2



         As of December 27, 2002, the Company had available for future issuance
approximately 29,031,447 of its 70,000,000 authorized shares, which were not
outstanding or reserved for possible future issuance. The Company has 21,127,918
shares outstanding and has reserved approximately 19,840,635 shares for future
issuance. These reserved shares relate to the following: 1,268,000 shares and
4,120,625 shares for issuance upon exercise of awards granted under the
Company's 1991 Performance Equity Plan and 1998 Stock Plan, respectively,
992,500 shares for additional awards which may be granted under the 1998 Stock
Plan, 2,569,848 shares for issuance upon conversion of the outstanding Series B
Redeemable Convertible Preferred Stock ("B Preferred Stock") and related
warrant, and 10,889,662 shares for issuance upon conversion of the outstanding
Series C Redeemable Convertible Preferred Stock ("C Preferred Stock").

         Further, the conversion prices of the B Preferred Stock and the C
Preferred Stock fluctuate based on the then-applicable trading price for the
common stock. As a result, if the price of the Company's common stock decreases,
the Company likely will be required by its contractual obligations relating to
the B Preferred Stock and the C Preferred Stock to substantially increase the
number of shares of common stock reserved for possible issuance upon the
conversion of the B Preferred Stock and the C Preferred Stock. Such required
increase in reserved shares could restrict the significant portion of the
currently unissued and unreserved shares and could even exceed the number of
unissued and unreserved shares currently available.

         The following table illustrates the varying amounts of shares of common
stock that would be issuable upon conversion of all outstanding shares of B
Preferred Stock and all outstanding shares of C Preferred Stock at the indicated
conversion prices (without regard to any limitations on conversion) and assuming
that all additional amounts are paid in cash:

                                          Number of Shares
                                          of Common Stock        Percentage of
                         Conversion        Issuable Upon          Outstanding
                           Price        Conversion (1)(2)(3)    Common Stock (4)
                         ----------     --------------------    ----------------
                           $0.10             81,518,759               79%
                            0.15             54,345,840               72%
                            0.20             40,759,380               66%
                            0.25             32,607,504               61%
                            0.30             27,172,920               56%
                            0.35             23,291,074               52%

                  ----------------------
                  (1)      The calculation assumes that the conversion price of
                           the B Preferred Stock and C Preferred Stock are the
                           same at the assumed conversion prices of $0.10,
                           $0.15, $0.20, $0.25 and $0.30.
                  (2)      The calculation assumes that for any conversion of
                           the B Preferred Stock when the prevailing market
                           price is above $0.30, the C Preferred Stock would
                           still be converted at its maximum conversion price of
                           $0.30.
                  (3)      The holder of B Preferred Stock and C Preferred Stock
                           is prohibited from converting the B Preferred Stock
                           or C Preferred Stock or from exercising the warrants
                           issued in connection with the B Preferred Stock, if,
                           after giving effect to such conversion, it would
                           beneficially own in excess of 4.99% or, over the
                           sixty day period prior to the conversion, 9.99% of
                           the outstanding shares of the Company's common stock
                           following such conversion.

                                       3



                  (4)      Based on 21,127,918 shares of common stock
                           outstanding as of December 27, 2002, plus the number
                           of shares of common stock issuable upon conversion of
                           the B Preferred Stock and C Preferred Stock.

         The conversion rate at December 27, 2002 of the B Preferred Stock and
the C Preferred Stock was $0.28. On December 27, 2002, there were 66 shares of B
Preferred Stock outstanding and 749 shares of C Preferred Stock outstanding. If
all of the outstanding shares of the B Preferred Stock and the C Preferred Stock
were converted on December 27, 2002, the Company would have issued a total of
32,345,598 shares of common stock.

         If the Company is not authorized to issue additional shares of common
stock and is unable to deliver common stock upon conversion of the B Preferred
Stock or the C Preferred Stock, the holder of the preferred shares may have the
right to require Andrea Electronics to redeem all or a portion of the preferred
shares. If such redemption rights are triggered and Andrea Electronics has
insufficient funds to satisfy the redemption, which would be the case if a
redemption occurred as of January 3, 2003, Andrea Electronics' ability to
continue its current operations will be materially adversely affected and if the
Company has insufficient funds to redeem either the B Preferred Stock or the C
Preferred Stock, it could result in Andrea Electronics' inability to meet its
operating obligations, and consequently delisting from the American Stock
Exchange.

         The Company believes that this proposed increase in authorized shares
is necessary as a result of its contractual obligations under each of the B
Preferred Stock and C Preferred Stock. Other than the required issuance of
shares upon conversion of the B Preferred Stock or C Preferred Stock, the
Company does not have a specific plan or arrangement to issue any of the
proposed increased authorized shares. However, the board of directors believes
its important for the Company to maintain an authorized capitalization that will
permit certain financing alternatives in the future. If the proposal to amend
the Restated Certificate of Incorporation is approved, the additional shares
will be available for issuance from time to time for the conversion or exercise
of previously or to be issued convertible securities, warrants and options, for
use in obtaining funds for present and future operations, for use in conjunction
with possible acquisitions of businesses or properties, for use in possible
stock dividends and stock splits, or for any other proper corporate purpose. The
board of directors does not intend to seek further shareholder approval prior to
the issuance of any additional shares in future transactions unless required by
law, by the Company's Restated Certificate of Incorporation, or by the rules of
any stock exchange upon which the stock may be listed, or unless the Company
deems it advisable to do so to qualify (or to continue to qualify) an employee
benefit plan under the Securities Exchange Act of 1934. Common stock would be
issued only if the Company believed the issuance favorable to, and in the
interests of, the Company and its shareholders.

         The newly authorized shares of common stock will have voting and other
rights identical to those of the currently authorized shares of common stock,
subject to shareholder approval of Proposal 2.

         Any issuance of additional shares of common stock of the Company would
dilute the equity of the outstanding shares of common stock. In addition, the
board of directors has not proposed the increase in authorized shares of common
stock with the intention of using such shares for anti-takeover purposes
although the availability of such shares may theoretically be utilized to render
more difficult or discourage an attempt to acquire control of Andrea
Electronics.

                                       4



         Under the Restated Certificate of Incorporation of the Company, holders
of common stock do not have preemptive rights.

         Approval of Proposal 1 is not contingent on approval of Proposal 2.

         The Board of Directors recommends a vote "FOR" the adoption of this
proposal.

Proposal Two:

              Amendment of Restated Certificate of Incorporation to
                        Reduce Par Value of Common Stock

         The board of directors recommends the adoption by shareholders of an
amendment to Article Third of the Company's Restated Certificate of
Incorporation, to reduce the par value of the Company's common stock. The
Restated Certificate of Incorporation currently authorizes the issuance of
shares of common stock with a par value of $0.50 per share. The board of
directors believes it to be in the best interests of the Company, and has
therefore proposed and declared advisable, that the Restated Certificate of
Incorporation be amended to reduce the par value of the Company's common stock
to $0.01 per share.

         Under New York corporate law, par value is initially determined by
incorporators of an entity and set forth in the certificate of incorporation.
Many companies who incorporate today use a low par value (e.g., $0.01) or have
no par value. The concept of par value, which dates back to early corporate law,
once served to protect stock purchasers and creditors from the issuance of stock
at prices below par value. The stated par value was presumed to be the
corporation's value and represented an assurance to both stock purchasers and
creditors that the corporation in which they were investing had a certain value.
Today, corporations issue stock at prices which bear no discernible relationship
to par value.

         Although par value generally does not serve the corporate purposes for
which it was originally intended, it remains a factor under New York law in
issuing common stock, upon conversion of preferred stock or otherwise. The
Company is not permitted to issue common stock, upon conversion of preferred
stock or otherwise, below par value. As of December 27, 2002, the price of the
Company's common stock was $0.30 per share, below the $0.50 par value per share.
The Company has recently been able to issue common stock upon conversion of its
B Preferred Stock and C Preferred Stock when its common stock was trading below
par value because New York corporate law permits the Company to allocate capital
surplus to the common stock being issued upon conversion. However, since the
conversion prices of the B Preferred Stock and the C Preferred Stock fluctuate
based on the then-applicable trading price for the common stock, as the price of
the Company's common stock decreases below par value, the more of its capital
surplus the Company will be required to allocate to shares of common stock
issued upon conversion. Since the Company has a limited amount of capital
surplus, the Company may not be able to meet its conversion obligations when the
common stock trades below par value and there is an inadequate amount of capital
surplus to allocate to the common stock issued upon conversion. If the Company
is unable to deliver common stock upon conversion of the B Preferred Stock or
the C Preferred Stock, the holder of the preferred shares may have the right to
require Andrea Electronics to redeem all or a portion of the preferred shares.
If such redemption rights are triggered and Andrea Electronics has insufficient
funds to satisfy the redemption, which would be the case if a redemption
occurred as of December 27, 2002, Andrea Electronics' ability to continue its
current operations will be materially adversely affected and if the Company has
insufficient funds to redeem either the B Preferred Stock or

                                       5



the C Preferred Stock, it could result in Andrea Electronics' inability to meet
its operating obligations, and consequently delisting from the American Stock
Exchange.

         The following table reflects the capitalization of the Company at
September 30, 2002 with the par value of the common stock at $0.50 per share and
$0.01 per share.




                                                                   $0.50 par value       $0.01 par value
                                                                      per share             per share
                                                                   -----------------    -----------------

                                                                                      
Preferred stock, $0.01 par value; authorized: 4,997,500 shares;
   none issued and outstanding ..................................     $         --         $         --

Common stock, $0.50 par value; authorized: 70,000,000
   shares; issued and outstanding: 20,011,948 shares ............       10,005,974              200,119

Additional paid-in capital ......................................       54,479,117           64,284,972

Deferred stock compensation .....................................          (95,857)             (95,857)

Accumulated deficit .............................................      (50,278,117)         (50,278,117)
                                                                      ------------         ------------

         Total shareholders' equity .............................     $ 14,111,117         $ 14,111,117


         The Board believes that the proposed reduction in the par value of the
shares of common stock is desirable to provide the Company with flexibility in
managing its corporate funds. The adoption of the amendment to reduce the par
value of shares of the Company's common stock will substantially increase the
Company's ability to issue shares of common stock upon conversion of the B
Preferred Stock and C Preferred Stock.

         Any issuance of additional shares of common stock of the Company would
dilute the equity of the outstanding shares of common stock. In addition, the
board of directors has not proposed the reduction in the par value with the
intention of declaring dividends on the common stock although the reduction in
the par value, and resulting increase in capital surplus of the Company, may
result in added dividend flexibility since New York corporate law permits a
corporation to declare dividends and other corporate distributions out of
capital surplus only.

         In the event this proposal is approved, certificates representing
shares of the Company's common stock, $0.50 par value per share, issued and
outstanding prior to the effective date of filing of the amendment to the
Company's Restated Articles of Incorporation will be changed to represent the
same number of shares of the Company's common stock, $0.01 par value per share,
as they did prior to the effective date. Existing certificates will not be
exchanged for new certificates. Please do not return any certificates to the
Company.

         Except with respect to added dividend flexibility, the decrease in the
par value of the common stock should have no effect on the Company's
shareholders.

         Andrea Electronics will notify the American Stock Exchange of the
reduction in par value of the common stock in accordance with American Stock
Exchange regulations.

         Approval of Proposal 2 is not contingent on approval of Proposal 1.

                                       6



         The Board of Directors recommends a vote "FOR" the adoption of this
proposal.

                                 Stock Ownership

         The following table sets forth certain information with respect to
beneficial ownership of the Company's common stock, as of December 27, 2002,
for:

         .   each person known to the Company to beneficially own more than 5%
             of its common stock;

         .   each of the Company's directors;

         .   each of the Company's executive officers; and

         .   all of the Company's directors and executive officers as a group.

         A person may be considered to beneficially own any shares of stock over
which he or she has, directly or indirectly, sole or shared voting or investing
power. Unless otherwise indicated, each of the named individuals has sole voting
power and sole investment power with respect to the number of shares shown.




                                                                Number of
                                           Number of           Shares that
                                          Shares Owned       May Be Acquired      Percent of
Name (and Address of                       (excluding       Within 60 Days By    Common Stock
Persons Owning More than 5%)                options)       Exercising Options  Outstanding (1)
----------------------------              ------------     ------------------  ---------------

                                                                      
Douglas J. Andrea ......................      256,088 (2)            832,500             5.0%
     45 Melville Park Road
     Melville, New York  11747
Christopher P. Sauvigne ................      210,000 (3)            687,500             4.1%
Richard A. Maue ........................        2,000                248,750             1.2%
John R. Croteau ........................       15,625                      -                *
James M. Griffin .......................       20,625                 35,000                *
Gary A. Jones ..........................       17,625                 70,000                *
Scott Koondel ..........................       15,625                117,500                *
Jack Lahav .............................       15,625                      -                *
Louis Libin ............................       15,625                 35,000                *
Directors and executive officers as
a group (9 persons) ....................      568,838              2,061,250                *


---------------------------------
* Less than 1% of the shares of Company common stock outstanding.
(1)  Based on 21,127,918 shares of Company common stock outstanding and entitled
     to vote as of December 27, 2002, plus the number of shares that may be
     acquired within 60 days by each individual (or group of individuals) by
     exercising options.
(2)  Includes 11,188 shares owned by Mr. Andrea's spouse and 1,450 shares owned
     by Mr. Andrea's daughter.
(3)  Includes 15,000 shares owned by Mr. Sauvigne's spouse and 5,000 shares
     owned by Mr. Sauvigne's minor children.

                                       7



                              Independent Auditors

Attendance at the Special Meeting

     A representative of Marcum & Kliegman LLP is expected to be present at the
special meeting to respond to appropriate questions from stockholders and will
have the opportunity to make a statement should he or she desire to do so.
Arthur Andersen LLP served as the Company's independent auditors for the fiscal
year ended December 31, 2001. A representative of Arthur Andersen LLP is not
expected to be present at the annual meeting.

Change in Independent Auditors

     On July 1, 2002, the Company's Board of Directors, at the recommendation of
its Audit Committee, determined not to engage Arthur Andersen LLP as the
Company's independent accountants for the fiscal year ending December 31, 2002,
however, no action was taken on this date to formally dismiss Arthur Andersen
LLP as the Company's independent accountants. On July 29, 2002, the Company's
Board of Directors, at the recommendation of its Audit Committee, determined to
engage PricewaterhouseCoopers LLP as the Company's independent accountants,
however no action was taken on this date to formally engage
PricewaterhouseCoopers LLP as the Company's independent accountants. On August
6, 2002, the Securities and Exchange Commission informed the Company that Arthur
Andersen LLP had notified the Securities and Exchange Commission that it was
unable to perform future audit services for the Company and, as a result, its
relationship with the Company was effectively terminated. Arthur Andersen LLP
did not notify the Company of this directly, however, the Securities and
Exchange Commission stated in its letter that Arthur Andersen LLP's notification
was consistent with widely disseminated press reports of the wind-down of Arthur
Andersen's business. As a result, on August 6, 2002, Arthur Andersen LLP was
dismissed as the Company's independent accountant.

     The report of Arthur Andersen LLP on the financial statements of the
Company for each of the years ended December 31, 2001 and 2000 did not contain
an adverse opinion or a disclaimer of opinion and was not qualified or modified
as to uncertainty, audit scope, or accounting principles. During each of the
years ended December 31, 2001 and 2000 and the subsequent interim period
preceding August 6, 2002, the Company was not in disagreement with Arthur
Andersen LLP on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreement, if not
resolved to the satisfaction of Arthur Andersen LLP, would have caused Arthur
Andersen LLP to make reference to the subject matter of the disagreement in
connection with its report.

     On August 6, 2002, the Company's Board of Directors, at the recommendation
of its Audit Committee, engaged PricewaterhouseCoopers LLP as the Company's
independent accountants. During the years ended December 31, 2001 and 2000 and
through the date of the Board's decision, the Company did not consult
PricewaterhouseCoopers LLP with respect to the application of accounting
principles to a specified transaction, either completed or proposed, or the type
of audit opinion that might be rendered on the Company's consolidated financial
statements, or any other matters or reportable events as set forth in Items
304(a)(2)(i) and (ii) of Regulation S-K.

     On August 14, 2002, the Company's Board of Directors, at the recommendation
of its Audit Committee, dismissed PricewaterhouseCoopers LLP as the Company's
independent accountants. During the term of its engagement,
PricewaterhouseCoopers LLP did not audit or review any financial statements of
the Company as of any date or for any period, nor issue any reports relating
thereto.

                                       8



However, PricewaterhouseCoopers LLP did commence, but did not complete a review
of the Company's interim financial statements for the quarter ended June 30,
2002.

     During the term of its engagement, there were no disagreements with
PricewaterhouseCoopers LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP
would have caused it to make reference thereto in any report on any audited
financial statements of the Company.

     During the term of PricewaterhouseCoopers LLP's engagement, there were no
reportable events (as defined in Regulation S-K Item 304(a)(1)(v)), except that
prior to its dismissal, PricewaterhouseCoopers LLP raised questions regarding
the Company's ability to recover its deferred tax assets.

     PricewaterhouseCoopers LLP was dismissed prior to the matter being
resolved. Members of the Board of Directors, one of which is a member of the
Audit Committee, discussed this matter with PricewaterhouseCoopers LLP. The
Company has authorized PricewaterhouseCoopers LLP to respond fully to the
inquiries of the Company's successor accountant concerning this matter.

     On August 15, 2002, the Company's Board of Directors, at the recommendation
of its Audit Committee, engaged Marcum & Kliegman LLP as the Company's
independent accountants. During the years ended December 31, 2001 and 2000 and
through the date of the Board's decision, the Company did not consult Marcum &
Kliegman LLP with respect to the application of accounting principles to a
specified transaction, either completed or proposed, or the type of audit
opinion that might be rendered on the Company's consolidated financial
statements, or any other matters or reportable events as set forth in Items
304(a)(2)(i) and (ii) of Regulation S-K.

                             Solicitation of Proxies

     The Company will pay the cost of this proxy solicitation. The Company will
reimburse brokerage firms and other custodians, nominees and fiduciaries for
reasonable expenses incurred by them in sending proxy materials to the
beneficial owners of Andrea Electronics common stock. In addition to soliciting
proxies by mail, directors, officers and regular employees of the Company may
solicit proxies personally or by telephone without receiving additional
compensation.

                      Shareholder Proposals and Nominations

     Proposals of shareholders intended to be presented at the annual meeting
for the fiscal year 2002 must be received at the Company's offices by May 7,
2003 and must otherwise comply with the requirements of Rule 14a-8 for inclusion
in the proxy materials relating to that meeting.

     The Company's Bylaws provide that in order for a shareholder to make
nominations for the election of Directors or proposals for business to be
brought before the annual meeting, a shareholder must give written notice of
such nominations and/or proposals to the Secretary not less than 90 days prior
to the date of the Annual Meeting. A copy of the Bylaws may be obtained from the
Company.

                                       9



                                  Miscellaneous

     If you and others who share your address own your shares in street name,
your broker or other holder of record may be sending only one proxy statement to
your address. This practice, known as "householding," is designed to reduce our
printing and postage costs. However, if a shareholder residing at such an
address wishes to receive a separate proxy statement in the future, he or she
should contact the broker or other holder of record. If you own your shares in
street name and are receiving multiple copies of the Company's proxy statement,
you can request householding by contacting your broker or other holder of
record.

                       Where You Can Find More Information

     As a public company, Andrea Electronics is obligated to file annually,
quarterly and current reports, proxy statements and other information with the
SEC. You may read and copy any reports, statements or other information that the
Company files at the SEC's public reference rooms in Washington, D.C., New York,
New York, and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for
further information on the public reference rooms. In addition, Andrea
Electronics' public filings are available to the public from commercial document
retrieval services and on the Internet World Wide Website maintained by the SEC
at "http://www.sec.gov."

     This proxy statement incorporates by reference the documents listed below
that we have previously filed with the Securities and Exchange Commission and
have attached to this proxy statement.

     .    Annual Report to Shareholders for the year ended December 31, 2001
          (see Appendix A); and

     .    Quarterly Report on Form 10-Q for the quarter ended September 30,
          2002, as filed on November 14, 2002 (see Appendix B).

     Whether or not you plan to attend the annual meeting, please vote by
marking, signing, dating and promptly returning the enclosed proxy card in the
enclosed envelope.

                                              By Order of the Board of Directors

                                              /s/ Richard A. Maue

                                              Richard A. Maue
                                              Secretary

Melville, New York
January 3, 2003

                                       10



                                                                      Appendix A




                                [PERFECTLY CLEAR]













                                  Andrea [LOGO]

                               2001 Annual Report



[LOGO]

Andrea                                                              The Freedom
Electronics                                                         of Voice (R)

[PICTURE]

An effective, natural communication interface requires clear, noise-free audio
input. By ensuring highly intelligible, low noise audio source input (spoken
words), Andrea Electronics' microphone products and technologies enable more
accurate and reliable communication, as well as high performance speech
recognition, in noisy office and various noisy mobile environments. Our products
and technologies enable a person speaking to be at a distance from the audio
input source, freeing the speaker from having to hold or wear a conventional
"close talking" microphone, while maintaining the same level of performance.
This capability is referred to as untethered, "far-field" microphone operation.

All of our digital, far-field technologies can be tailored and embedded into
various form factors, for example, into the monitor of a PC, a rear view mirror,
or a personal digital assistant, and can be used individually or combined
depending on particular customer requirements. We are currently targeting our
far-field microphone technologies primarily at 1) the desktop computing market
(primarily through our relationship with Analog Devices, Inc., 2) the market for
personal computers designed for use in automobiles, trucks and buses to control
satellite-based navigation systems and other devices within vehicles, 3) the
market for mobile devices, such as personal digital assistants and 4) the
military and commercial aircraft communication systems market.

In addition to our far-field technologies, we also offer a complete line of PC
headsets for voice applications which desire a headset such as with call center
environments.



                               Andrea Electronics Corporation 2001 Annual Report
                                                                          Page 1

Highlights
--------------------------------------------------------------------------------

Andrea Electronics Corporation Generates $5 Million in Licensing Revenues from
Analog Devices

"To date, the industry reaction to SoundMAX Cadenza, which includes Andrea's
PureAudio technology, and Andrea's DSDA microphone has been overwhelming."

                                               John Croteau, Analog Devices Inc.

Andrea Electronics' Array Microphone Demonstrated at Launch of Windows XP "To
showcase some of the important sound quality innovations in Windows XP, we
wanted to include an excellent audio input device, so we turned to Andrea and
its DA-400 2.0 far-field array microphone."

                                                 Mark Lee, Microsoft Corporation

Andrea Electronics Announces Purchase Agreement with Clever Devices

"Clever Devices selected Andrea Electronics' superior microphone technology and
supporting acoustic designs to address the audio intelligibility and safety
issues common in high noise, mass transit environments."

                                              William Long, Clever Devices, Ltd.

Andrea Electronics' Customized USB Laptop Array Microphone Available for Use
with IBM's ThinkPad

"Andrea's customized digital microphone technologies with speech enhancing
software allows us to provide consumers with solutions that make it easier for
people to interact with their PCs--enabling a natural language interface."

                                                                   Rob Pace, IBM

Andrea Electronics Corporation Announces Patents Issued for Its Digital Audio
Technologies

..   Patent issued for Direction Finding and Tracking Array Technology (DFTA)
..   Patent issued for Digital Super Directional Array Technology (DSDA)
..   Patent issued for Adaptive and Nonadaptive Noise Canceling Algorithm process
..   Patent issued for PureAudio Technology



Dear Shareholders
--------------------------------------------------------------------------------

Unfortunately, as a result of the indelible tragic events of September 11th, no
one will ever forget the year 2001. On behalf of the entire Andrea Electronics
team, we pray for those families who lost loved ones, applaud the emergency
workers' tireless rescue efforts and strongly believe our citizens will
collectively prove their resilience to maintain our nation's position as a
worldwide leader.

Similar to our country, our Company's inner strength was put to the test during
2001. Being a recognized leader in the development of noise canceling Digital
Audio Technologies (DATs) has been, and continues to be, the cornerstone of our
corporate strategy. When the commercial application of a new technology is not
accepted as quickly as envisioned and additional investments are required, the
ability to stay the course becomes increasingly difficult. We have stayed the
course, and have created "the" strategic alliance with Analog Devices, Inc., an
industry leader capable of exploiting our DATs in several high growth markets
including PC based speech applications, telematics and hand-held devices. As
such, we are now positioned to be well rewarded for our investments.

Mission Statement
--------------------------------------------------------------------------------

To provide emerging "voice interface" markets with state-of-the-art microphone
technologies that facilitate a natural language communication interface.



                               Andrea Electronics Corporation 2001 Annual Report
                                                                        Page 2/3


--------------------------------------------------------------------------------

Our relationship with Analog Devices not only provides us with $5 million in
royalty revenue/cash flow but also provides us with a technology platform to
deliver our far-field microphone array technology at unprecedented price points.
Equally as important, is the immediate opportunity to leverage Analog's customer
relationships in PC market space, which represents an approximate 70% market
share. Our Company looks forward to an expanding, long-term mutually beneficial
relationship with Analog Devices.

                                    [PICTURE]

                                 Perfectly Clear

To maximize shareholder value during 2002, we will focus on executing the
opportunities created by the Analog Devices' relationship, developing high
margin call center products that leverage our core competencies and critically
reviewing all areas of our business to enhance our capital structure.

On behalf of Team Andrea, while we look forward to the year 2002 with great
enthusiasm and optimism, we thank you for your continued support.

Sincerely,


/s/ Christopher P. Sauvigne

Christopher P. Sauvigne
President and Chief Executive Officer



Superbeam Array Microphone
--------------------------------------------------------------------------------

One of the most significant barriers to speech recognition performance and, as a
result, in speech recognition usage and popularity, is the high sensitivity to
the acoustic environment and, in particular, to the surrounding noise in any
real office or workstation. The only technically acceptable solution, until
recently, was to use a headset; however, this made the user experience annoying,
uncomfortable and inconvenient. Recent noise canceling microphone array product
developments have enabled users to be untethered; however, these solutions are
very expensive and, therefore, less appealing to an average user.

Andrea Electronics, together with Analog Devices, Inc., has developed a
groundbreaking solution: The Andrea Superbeam(R) Array Microphone. Analog
Devices has developed an interface that allows the Superbeam Array to connect to
the PC and run the necessary software instructions on the PC's processor. The
Superbeam Array is a two-microphone device that attaches to the top of any
laptop or PC equipped with Analog Devices' SoundMax(R) Cadenza software. The
SoundMax Cadenza software is integrated with Andrea Electronics' PureAudio(R)
and DSDA(R) noise-cancellation software, thereby removing the high costs
associated with required memory and processing power from the microphone device
(now powered by the PC's host processor).

                                    [PICTURE]

The end result: freeing a speaker from having to hold, or wear, a conventional
microphone with a very high-tech, low cost, sleek hardware accessory.

          5                                              Selected Financial Data
          6-17   Management's Discussion and Analysis of Financial Condition and
                                                           Results of Operations
         17          Quantitative and Qualitative Disclosures About Market Risk
         18                                          Consolidated Balance Sheets
         19                                Consolidated Statements of Operations
         20                      Consolidated Statements of Shareholders' Equity
         21                                Consolidated Statements of Cash Flows
         22-35                        Notes to Consolidated Financial Statements
         36                             Report of Independent Public Accountants



                               Andrea Electronics Corporation 2001 Annual Report
                                                                        Page 4/5

Selected Financial Data
--------------------------------------------------------------------------------
December 31,



                                                                 2001            2000            1999           1998           1997
        ---------------------------------------------------------------------------------------------------------------------------
                                                                                                         
        Income Statement Data
           Net Sales--Operating                         $  10,258,875    $ 15,567,664    $ 17,112,487   $ 21,304,570   $ 26,429,804
           Sales Reserve--Restructuring/(1)/                 (337,499)             --              --             --             --
        Net Sales                                           9,921,376      15,567,664      17,112,487     21,304,570     26,429,804
        Cost of Sales
           Cost of Sales--Operating                         7,401,605      11,279,649      11,908,751     14,178,871     16,077,801
           Cost of Sales--Restructuring/(1)/                2,573,339              --              --             --             --
        Total Cost of Sales                                 9,974,944      11,279,649      11,908,751     14,178,871     16,077,801
        Gross Profit                                         (53,568)       4,288,015       5,203,736      7,125,699     10,352,003
        Research and Development                            3,462,340       4,694,116       3,399,666      2,016,684      1,106,880
        Restructuring Charges/(1)/                          1,552,892              --              --             --             --
        General, Administrative and Selling Expenses        8,724,784       9,373,025       8,954,805     13,002,959      5,753,130
        Income (Loss) from Operations                     (13,793,584)     (9,779,126)     (7,150,735)    (7,893,944)     3,491,993
        Other Income (Expense)                                163,475         204,774         (26,258)     1,447,989         76,864
        Income (Loss) Before Provision (Benefit)
           for Income Taxes                               (13,630,109)     (9,574,352)     (7,176,993)    (6,445,955)     3,568,857
        Provision (Benefit) for Income Taxes                       --              --              --             --        154,461
        Net Income (Loss)                                 (13,630,109)     (9,574,352)     (7,176,993)    (6,445,955)     3,414,396
        Preferred Stock Dividends                             564,604         351,209         195,843             --             --
        Non-Cash Charge Attributable to Beneficial
           Conversion Feature/(2)/                          7,500,000              --              --             --             --
        Net Income (Loss) Attributable to
           Common Shareholders                          $ (21,694,713)   $ (9,925,561)   $ (7,372,836)  $ (6,445,955)  $  3,414,396
        Earnings (Loss) Per Share
           Basic                                        $       (1.43)   $       (.72)   $       (.56)  $       (.61)  $        .42
           Diluted                                      $       (1.43)   $       (.72)   $       (.56)  $       (.61)  $        .39

        Balance Sheet Data
        Current Assets                                  $   9,755,897    $ 19,161,845    $ 19,315,415   $ 18,818,190   $ 14,430,645
        Total Assets                                    $  34,019,659    $ 47,272,866    $ 49,853,402   $ 50,681,940   $ 17,789,184
        Current Liabilities                             $   4,124,982    $  4,126,794    $  5,293,930   $  4,481,074   $  2,643,986
        Total Liabilities                               $   4,945,889    $  4,322,661    $  6,001,769   $  7,103,040   $  2,682,486
        Redeemable Securities                           $   9,785,020    $ 12,162,725    $  7,187,077   $         --   $         --
        Total Equity                                    $  19,288,750    $ 30,787,480    $ 36,664,556   $ 43,578,900   $ 15,106,698
        ---------------------------------------------------------------------------------------------------------------------------


         (1) Restructuring Charges--The net loss applicable to Common
             Shareholders reflects the impact of restructuring charges
             associated with exiting a specific PC headset customer type, or
             channel, within the Anti-Noise Product business segment as follows:

               Sales returns                            $         337
               Cost of sales                            $       2,573
               Restructuring charges                    $       1,553
             --------------------------------------------------------
                 Total                                  $       4,463
             ========================================================

         (2) Non-cash charge attributable to beneficial conversion feature--The
             net loss applicable to Common Shareholders reflects the intrinsic
             value of the realization, during the third quarter of 2001, of a
             contingent beneficial conversion feature related to the Company's
             Series C Redeemable Convertible Preferred Stock.



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
Software Products and Andrea Anti-Noise(R) 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; military and commercial aircraft communications; 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, military and commercial aircraft systems, cellular
and other wireless communication devices and automotive communication systems.
Our Andrea DSP Microphone and 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.

In order to complement our internal efforts to develop digital signal processing
technology, in May 1998, we acquired Lamar Signal Processing, Ltd., an Israeli
corporation engaged in the development of DSP noise cancellation microphone
solutions for voice-driven interfaces covering a wide range of audio and
acoustic applications. This acquisition resulted in a substantial amount of
goodwill and other intangible assets. The amortization of the goodwill and other
intangible assets has a significant, negative, non-cash impact on our results of
operations. See Note 3 to our Consolidated Financial Statements.

We outsource the assembly of most of our Andrea Anti-Noise(R) Products from
purchased components, and we are currently assembling our Andrea DSP Microphone
and Software Products from purchased components at our New York and Israeli
facilities. We manufacture our Aircraft Communications Products at our New York
facility.

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,
2001 and other items set forth in this 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. In order to obtain the benefits of these "safe harbor" provisions for
any such forward-looking statements, we wish to caution investors and
prospective investors about the following significant factors, which, among
others, have in some cases affected our actual results and are in the future
likely to affect our actual results and could cause them to differ materially
from those expressed in any such forward-looking statements. These factors
include:

Because 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 under our collaborative
        development arrangements;
     .  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.



                               Andrea Electronics Corporation 2001 Annual Report
                                                                        Page 6/7



--------------------------------------------------------------------------------

We cannot assure that the level of sales and gross profit, if any, that we
achieve in any particular fiscal period will not be significantly lower than in
other fiscal periods. Our revenues for the year ended December 31, 2001, were
approximately $9.9 million versus $15.6 million in the prior year. Net loss
applicable to common shareholders for the year ended December 31, 2001 was
approximately $21.7 million, or $1.43 per share on a diluted basis, versus net
loss applicable to common shareholders of approximately $9.9 million, or $0.72
per share on a diluted basis, for the year ended December 31, 2000. We continued
to experience a significant decline in our sales of Andrea Anti-Noise Products
as a result of increased competition with respect to a specific customer
channel. In response to this decline, as well as our overall shift in strategic
direction to deliver digital, far-field microphone solutions, during the fourth
quarter of 2001, we incurred restructuring charges of approximately $4.5
million. This restructuring is expected to result in a further decrease in sales
during fiscal 2002. We are examining additional opportunities for
cost-reduction, production efficiencies and further diversification of our
business. But to remain competitive, we intend to continue incurring substantial
research and development, marketing and general and administrative expenses. We
may not be able to easily and quickly reduce these expenses if our sales revenue
falls below our expectations and, therefore, our net income or loss may be
disproportionately affected by any reduction in sales revenue. Furthermore, our
acquisition in 1998 of Lamar Signal Processing, Ltd. resulted in a substantial
amount of goodwill and other intangible assets. The amortization of these
intangible assets has had, and will continue to have, a negative, non-cash
impact on our results of operations (other than goodwill). As a result of these
factors, we expect to continue to accumulate losses and the market price of our
common stock could decline.

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, and could result in our
delisting on the American Stock Exchange or inability to continue operations.

In recent years, we have sustained significant operating losses. We have been
unable to generate sufficient cash flow from operations to meet our operating
needs and, correspondingly, from time to time during the past several years, we
have raised additional capital from external sources. We expect to continue to
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. 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 the sale of Andrea. Additionally, Andrea's
funding and capital raising efforts could trigger change in control payments due
to certain executive officers of Andrea under their employment contracts or
redemptions of the Company's Series B and Series C Redeemable Convertible
Preferred Stock. Given our current financial condition and market conditions, it
may be difficult to attract additional financings on favorable terms, or at all,
as compared to prior periods. We have revised our business strategies to reduce
our expenses and capital expenditures, but we cannot assure you that we will be
successful in obtaining financings or 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 delisting from the American Stock
Exchange.

We face the risk that Andrea could be required to redeem the Series C Redeemable
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"). The Series C Preferred Stock is convertible or redeemable at maturity
by the Company, based upon certain circumstances at that time, and is redeemable
by the holder upon certain events, including the announcement of a major
transaction, as defined in the Certificate of Amendment, or upon certain other
triggering events. On March 25, 2002, Andrea announced that a triggering event
had occurred and that Andrea was seeking a waiver from the Series C Preferred
Stock holders. A final agreement regarding the waiver arrangement was reached on
March 28, 2002. The waiver related to the existing triggering event, as well as
certain possible future triggering events, however, the waiver will be null and
void upon the earlier of April 7, 2007, the first date on which Andrea fails to
comply in any material respect with the terms of the waiver and related
documents, and the first date on which Andrea is insolvent.

As consideration for the Series C Preferred Stock holder's agreement to waive
its current and, in certain circumstances, any future right to receive the
aggregate Triggering Event Redemption Price for the Series C Preferred Stock,
Andrea agreed to grant a security interest in all of Andrea's assets. However,
the Series C Preferred Stock holder agreed to have its lien on Andrea's assets



Management's Discussion and Analysis of
Financial Condition and Results of Operations
--------------------------------------------------------------------------------
(Continued)

subordinated to (1) any lien granted in the future to a non-affiliated third
party in connection with a strategic transaction with a financing component,
provided that such third-party lien relates only to the amount of the financing
component of such transactions, and (2) any lien granted in the future to a bank
or other similar institution pursuant to any asset based financing transaction.
In addition, the Series C Preferred Stock holder agreed to release its lien in
connection with any sale of any assets subject to its lien, provided they
receive a lien on the proceeds of the sale. The Series C Preferred Stock holder
acknowledged that its lien in any portion of Andrea's intellectual property is
effectively subordinate to the interest of any current or future licensee of
such intellectual property, as any interest the investor may have in such
intellectual property cannot be greater than Andrea's interest therein.

Given that the waiver granted by the Series C Preferred Stock holder does not
cover all triggering events that could require the redemption of the Series C
Preferred Stock, and that the waiver will be null and void in the event Andrea
fails to comply in any material respect with the terms of the agreements
relating to the waiver, among other things, there is a risk that the Series C
Preferred Stock holder could declare a triggering event that would trigger the
redemption rights. If such redemption rights are triggered and Andrea has
insufficient funds to satisfy the redemption, Andrea will be requested to obtain
a new waiver from the holder of the Series C Preferred Stock. If no such waiver
can be obtained, Andrea's ability to continue its current operations will be
materially adversely affected and if Andrea has insufficient funds to redeem the
Series C Preferred Stock, it could result in Andrea's inability to meet its
operating obligations and, consequently, delisting from the American Stock
Exchange.

Shares eligible for future sale may have an adverse effect on market price; you
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 70,000,000 shares of common stock presently authorized, 17,861,700
were outstanding as of March 27, 2002. This does not include 5,732,375 shares of
our common stock reserved for issuance upon exercise of outstanding awards
granted under our 1991 Performance Equity Plan and 1998 Stock Plan, and shares
of our common stock reserved for further awards under the 1998 Stock Plan. In
addition, this does not include 20,496,848 shares of common stock reserved for
issuance upon conversion of the Series B and Series C Convertible Preferred
Stock and exercise of related warrants. Furthermore, in May 1998, we issued
1,800,000 shares of common stock as part of the consideration for our
acquisition of Lamar Signal Processing, Ltd. Trading restrictions on these
1,800,000 shares have expired and are subject to demand and piggyback
registration rights. To date, 920,880 of the 1,800,000 shares have been
registered for sale under the Securities Act of 1933.

Conversions of our Series B Convertible Preferred Stock and Series C Convertible
Preferred Stock may result in substantial dilution to other holders of our
common stock.

As of March 27, 2002, we had 172 shares of Series B Convertible Preferred Stock
and 750 shares of Series C Convertible Preferred Stock outstanding. Both the
Series B Convertible Preferred Stock and the Series C Convertible Preferred
Stock are convertible into shares of common stock, subject to ownership
limitations that prohibit the holders of the preferred stock from owning more
than 4.99% of the outstanding shares of common stock at the time of conversion
or 9.99% over the sixty day period prior to the conversion. These restrictions
do not prevent purchasers from converting and selling some of their holdings and
then later converting the rest of their holdings.

As the price of our common stock decreases, the number of shares of common stock
issuable upon conversion of our Series B Convertible Preferred Stock and Series
C Convertible Preferred Stock increases.

The variable conversion price of the Series B Convertible Preferred Stock and
any reset of the conversion price of the Series C Convertible Preferred Stock
are functions of the market price of our common stock. If the price of our
common stock decreases over time, the number of shares of common stock issuable
upon conversion of each series will increase.

The following table illustrates the varying amounts of shares of common stock
issuable upon conversion of all 172 shares of Series B Convertible Preferred
Stock at the indicated conversion



                               Andrea Electronics Corporation 2001 Annual Report
                                                                        Page 8/9


--------------------------------------------------------------------------------

prices (without regard to any limitations on conversion) and assuming that the
4% additional amount is paid in cash:

                    Number of Shares
                    of Common Stock         Percentage of
 Conversion          Issuable Upon           Outstanding
   Price            Conversion/(1)/        Common Stock/(2)/
------------------------------------------------------------
   $0.50             3,440,000                  16%
   $1.50             1,146,667                   6%
   $2.50               688,000                   4%
   $3.50               491,429                   3%
   $4.50               382,222                   2%
   $5.50               312,727                   2%
   $6.50               264,615                   1%
   $7.50               229,333                   1%

(1) The Series B Holder is prohibited from converting its holdings of the
    Series B Convertible Preferred Stock if after giving effect to such
    conversion it would beneficially own in excess of 4.99% or, over the sixty
    day period prior to the conversion, 9.99% of the outstanding shares of our
    Common Stock following such conversion. The numbers in this column do not
    reflect these limitations.

(2) Based on 17,861,700 shares of common stock outstanding as of March 27, 2002.

The following table illustrates, as of any reset date and assuming the
conversion price indicated is lower than the then applicable conversion price on
that date, the varying amounts of shares of common stock that would be issuable
upon conversion of all outstanding 750 shares of Series C Convertible Preferred
Stock at the indicated conversion prices (without regard to any limitations on
conversion) and assuming that the 5% additional amount is paid in cash:

                   Number of Shares
                    of Common Stock         Percentage of
 Conversion          Issuable Upon           Outstanding
   Price            Conversion/(1)         Common Stock/(2)/
------------------------------------------------------------
   $0.40             18,750,000                 51%
   $0.50             15,000,000                 46%
   $0.60             12,500,000                 41%
   $0.65             11,538,462                 39%
   $0.70             10,714,286                 37%
   $0.75             10,000,000                 36%
   $0.765             9,803,922                 35%

(1) The Series C Holder is prohibited from converting its holdings of the Series
    C Convertible Preferred Stock if after giving effect to such conversion it
    would beneficially own in excess of 4.99% or, over the sixty day period
    prior to the conversion, 9.99% of the outstanding shares of our common
    stock following such conversion. The numbers in this column do not reflect
    these limitations.

(2) Based on 17,861,700 shares of common stock outstanding as of March 27, 2002.

The following table illustrates the varying amounts of shares of Common Stock
that would be issuable upon conversion of all 172 outstanding shares of Series B
Convertible Preferred Stock and all 750 outstanding shares of Series C
Convertible Preferred Stock at the indicated conversion prices (without regard
to any limitations on conversion) and assuming that all additional amounts are
paid in cash:

                    Number of Shares
                     of Common Stock           Percentage of
 Conversion           Issuable Upon            Outstanding
   Price         Conversion/(1)/(2)/(3)/     Common Stock/(4)/
---------------------------------------------------------------
   $0.50             18,440,000                 51%
   $0.65             14,184,615                 44%
   $0.765            12,052,288                 40%
   $1.50             10,950,588                 38%
   $2.50             10,491,922                 37%
   $3.50             10,295,350                 37%
   $4.50             10,186,144                 36%
   $5.50             10,116,649                 36%
   $6.50             10,068,537                 36%

(1) The calculation assumes that the conversion price of the Series B and Series
    C Convertible Preferred Stock are the same at the assumed conversion prices
    of $.50, $.65 and $.765. This could only occur if the market price of
    Andrea's Common Stock declines, and at a future reset date, the conversion
    price of the Series C adjusts to the then prevailing market price (the
    current fixed conversion price of the Series C is $.765, and such conversion
    price is fixed unless adjusted downward at a future reset date).

(2) The calculation assumes that for any conversion of the Series B Convertible
    Preferred Stock when the prevailing market price is above $.765, the Series
    C would still be converted at its maximum conversion price of $.765.

(3) The Series B and Series C holder is prohibited from converting the Series C
    or Series B Convertible Preferred Stock, or from exercising the warrants
    issued in connection with the Series B Convertible Preferred Stock, if
    after giving effect to such conversion it would beneficially own in excess
    of 4.99% or, over the sixty day period prior to the conversion, 9.99% of
    the outstanding shares of our Common Stock following such conversion.

(4) Based on 17,861,700 shares of common stock outstanding as of March 27,
    2002.

Sales of an increased number of shares of common stock issued
upon conversion of the Series B Convertible Preferred Stock and the Series C
Convertible Preferred Stock resulting from a declining market price for our
common stock can cause the market price of our common stock to decline further.

Disregarding the manner in which the shares of common stock issued upon
conversion of the Series B Convertible Preferred Stock and the Series C
Convertible Preferred Stock are sold as



Management's Discussion and Analysis of
Financial Condition and Results of Operations
--------------------------------------------------------------------------------
(Continued)

well as any other factors such as reactions to our operating results and general
market conditions which may be operative in the market at such time, an increase
in the number of shares of common stock eligible for sale can cause a decrease
in the market price of our common stock. This decrease could reduce the
conversion prices of the Series B Convertible Preferred Stock and the Series C
Convertible Preferred Stock, leading to a further increase in the number of
shares of common stock issuable upon future conversions and a further decline in
our stock price.

Short sales of our common stock may be attracted by or accompany conversions of
Series B Convertible Preferred Stock and Series C Convertible 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. The result of conversions
of the Series B and Series C Convertible Preferred Stock at declining conversion
prices would be increasing and substantial dilution of the interests of the
other holders of common stock.

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

Our business, results of operations and financial condition depend on successful
commercialization of our Andrea DSP Microphone and Software and Andrea
Anti-Noise products and technologies. Since we began sales of the initial Andrea
Anti-Noise products in 1995, we have been expanding the number of products in
this line. We introduced our first Andrea Digital Super Directional Array
products in 1998 and we are initially targeting these and our other Andrea DSP
Microphone and Software products at the desktop computer market, the market for
computer-based automobile monitoring and control systems for use by drivers and
passengers, and the mobile device market. 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
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 Anti-Noise, Andrea DSP Microphone and
Software and our Aircraft Communication Products are highly competitive. We may
not compete successfully with any of our competitors. Most of our current and
potential competitors have significantly greater financial, technology
development, marketing, technical support and other resources than we do.
Consequently, these competitors may be able to respond more quickly to new or
emerging technologies and changes in customer requirements, or devote greater
resources to the development, marketing, and sale of their products than we can.
One or more of these competitors may independently develop technologies that are
substantially equivalent or superior to our technology. The introduction of
products incorporating new technologies could render our products obsolete and
unmarketable and could exert price pressures on existing products.

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

In the markets for Aircraft Communications Products, we often compete with major
defense electronics corporations as well as smaller manufacturing firms, which
specialize in supplying products and technologies for specific military
initiatives.



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 10/11



--------------------------------------------------------------------------------

Further, the markets for our products and technologies are characterized by
evolving industry standards and specifications that may require us to devote
substantial time and expense to adapt our products and technologies. 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 those of their products
with which our products are included or incorporated, our sales growth could be
adversely affected.

We have entered into several collaborative and distribution arrangements with
software publishers and computer hardware manufacturers relating to the
marketing and sale of Andrea Anti-Noise products and Andrea DSP Microphone and
Software products through inclusion or incorporation with the products of our
collaborators. Our success will therefore be dependent to a substantial degree
on the efforts of these collaborators to market those of their products with
which our products are included or incorporated. 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.

If we fail to maintain sales of Aircraft Communication Products to the U.S.
Government, we would experience a material adverse effect on our business,
results of operations and financial condition.

We are substantially dependent on product sales to the U.S. Government. During
the years ended December 31, 2001, 2000 and 1999, the U.S. Government accounted
for 17%, 18% and 23%, respectively, of our net sales before sales
returns--restructuring. The U.S. Government is not obligated to continue to
purchase these products and is free to purchase similar products from our
competitors. Our failure to maintain sales of Aircraft Communication Products to
the U.S. Government would have a material adverse effect on our business,
results of operations and financial condition.

Shortages of, or interruptions in, the supply of more specialized components for
our Andrea Anti-Noise products and Andrea DSP Microphone products could have a
material adverse effect on our sales of these products.

We conduct assembly operations at our facilities in New York and Israel and
through subcontractors using purchased components. Some specialized components
for the Andrea Anti-Noise and Andrea DSP Microphone products, such as
microphones and digital signal processing boards, are available from a limited
number of suppliers and subject to long lead times. We may not be able to
continue to obtain sufficient supplies of these more specialized components,
particularly if our sales of Andrea Anti-Noise and Andrea DSP microphone
products increase substantially or market demand for these components otherwise
increases.

If our subcontractor fails to meet our production and shipment schedules, our
business, results of operations and financial condition would be materially and
adversely affected.

We conduct assembly operations at our facilities in New York and Israel and
through subcontracting. During initial production runs of Andrea Anti-Noise and
Andrea DSP Microphone products, we perform assembly operations at our New York
facility from purchased components. As sales of any particular product increase,
assembly operations are primarily transferred to a subcontractor in Asia.

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, nondisclosure agreements with our employees, 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



Management's Discussion and Analysis of
Financial Condition and Results of Operations
--------------------------------------------------------------------------------
(Continued)

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.

We are presently engaged in a lawsuit filed in the U.S. District Court for the
Eastern District of New York by NCT Group, Inc. ("NCT") and its subsidiary NCT
Hearing Products, Inc. NCT alleges that we: engaged in unfair competition by
misrepresenting the scope our patents, specifically, U.S. Pat. Nos. 5,732,143,
5,825,897 and 6,061,456 thereby tortuously interfering with prospective
contractual rights between NCT and its existing and potential customers; made
false and disparaging statements about NCT and its products; and falsely
advertised Andrea's ANR products. The complaint requests a declaration that
these patents are invalid and unenforceable and that NCT's products do not
infringe upon these patents and seeks to enjoin Andrea from engaging in these
alleged activities and seeks compensatory damages of not less than $5 million,
punitive damages of not less than $50 million and plaintiffs' costs and
attorneys' fees.

We have filed and served an answer to the NCT complaint, denying the allegations
and asserting affirmative defenses and counterclaims. Our counterclaims, as
amended, allege that NCT has willfully infringed the above mentioned patents,
and that NCT has engaged in trademark infringement, false designation of origin,
and unfair competition. The counterclaims seek injunctive relief with respect to
the allegations of patent infringement, trademark infringement, false
designation of origin and unfair competition. We are also seeking exemplary and
punitive damages, prejudgment interest on all damages, costs, reasonable
attorneys' fees and expenses.

During the third quarter of 2001, the court held a "Markman Hearing" to
determine the meaning of the claims in the three Andrea patents. We are unable
to anticipate when the Court will issue a decision on this question. If this
suit is ultimately resolved in favor of NCT, we could be materially adversely
effected. We believe, however, that NCT's allegations are without merit and we
intend to vigorously defend Andrea and to assert against NCT the claims
described above.

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

We have been seeking to increase our sales to regions outside the United States,
particularly in Europe and areas in the Americas and Asia. For the year ended
December 31, 2001, sales to customers outside the United States accounted for
approximately 17% 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 sales in U.S. dollars, and have not
engaged in any foreign exchange or hedging transactions. We may not continue to
be able to invoice all our sales in U.S. dollars and to avoid engaging in
foreign exchange or hedging transactions. If we are required to invoice any
material amount of international sales 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.

We Face Risk From Operating in Israel

Our principal research and development facility is located in the State of
Israel and, as a result, as of December 31, 2001, certain of our key research
and development employees were located in Israel. Although substantially all of
our sales currently are being made to customers outside Israel, we are
nonetheless directly influenced by the political, economic and military
conditions affecting Israel. Since the establishment of the State of Israel in
1948, a state of hostility has existed, varying in degree and



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 12/13



--------------------------------------------------------------------------------

intensity, between Israel and Arab countries. Although Israel has entered into
various agreements with certain Arab countries and the Palestinian Authority,
and various declarations have been signed in connection with efforts to resolve
some of the economic and political problems in the Middle East, we cannot
predict whether or in what manner these problems will be resolved.

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 additional 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.

RESULTS OF OPERATIONS

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

Sales

Excluding the impact of restructuring charges, sales for the year ended December
31, 2001, were $10,258,875, a decrease of 34% from sales of $15,567,664 for the
year ended December 31, 2000. This decrease in sales reflects an approximate 61%
decrease in sales of Andrea Anti-Noise Products to $4,656,078, or 45% of total
sales , offset by an approximate 68% increase in sales of our Aircraft
Communications Products, to $4,916,616, or 48% of total sales, and an
approximate 2% increase in sales of Andrea DSP Microphone and Software Products,
to $686,181, or 7% of total sales.

The primary reason for the decrease of Andrea Anti-Noise Product sales during
2001 was a significant decline in headset unit shipments to IBM which was
primarily a result of increased competition in the PC headset market, coupled
with unfavorable economic conditions which continues to negatively impact the
technology sector. In response, during the fourth quarter 2001, we formulated a
plan to exit from an increasingly unprofitable PC headset channel within
Andrea's Anti-Noise Headset product segment. This customer channel included IBM.
For the year ended December 31, 2001, excluding the impact of restructuring
charges, sales to IBM and certain of IBM's affiliates accounted for
approximately 25% of our total sales, or $2,515,819. This reflects an
approximate 63% decrease from $6,809,575 for the year ended December 31, 2000.

The increase in our Aircraft Communication Product revenues is primarily a
result of increased sales and marketing activities.

Sales of Andrea DSP Microphone and Software Products were primarily comprised of
shipments of Andrea's far-field microphone products for use with business
videoconferencing  systems, in-vehicle communications systems, and
desktop speech dictation applications. During the fourth quarter of 2001, we
recorded deferred revenues of $1 million related to a license agreement for
certain of our Andrea DSP Microphone and Software technologies. The deferred
revenue will be recognized over a period of three years beginning March 22,
2002.

Cost of Sales

Excluding the impact of restructuring charges, cost of sales as a percentage of
sales for the year ended December 31, 2001 remained consistent from the year
ended December 31, 2000.

Research and Development

Research and development expenses for the year ended December 31, 2001 decreased
26% to $3,462,340 from $4,694,116 for the year ending December 31, 2000. This
decrease is due primarily to a reduction in expenses associated with research
efforts that were determined not to be integral to Andrea's core portfolio of
digital microphone software and hardware technologies. DSP Microphone and
Software Technology efforts were $2,770,491, or 80% of total research and
development expenses, Aircraft Communications technology efforts were $388,757,
or 11% of total research and development expenses and Andrea Anti-Noise Product
efforts were $303,092, or 9% of total research and development expenses. With
respect to DSP Microphone and 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 our digital super directional
array microphone technology ("DSDA") and certain other related technologies
obtained through the acquisition of Lamar in May 1998. We believe that the
acquisition of Lamar significantly reinforces its position in digital signal
processing by extending our marketing programs to other high-growth industries,
including automotive telematics, mobile device markets, the business
videoconferencing market and Internet telephony, among others. Specifically, the
core technology acquired produces noise filtering capabilities that management
believes is preferred to other known DSP-based technologies in the market, and
is unattainable in products using traditional mechanical solutions. In addition,
the nature of a



Management's Discussion and Analysis of
Financial Condition and Results of Operations
--------------------------------------------------------------------------------
(Continued)

DSP-based solution, together with the people acquired supporting our technology,
offers a solution that is highly scalable and embeddable, and therefore enables
the technology to be integrated into many different applications and form
factors. We believe that continued research and development spending will
provide us with a competitive advantage. For 2002, we expect total research and
development spending to approach levels similar to that of 2001.

General, Administrative and Selling Expenses

Excluding the impact of restructuring charges, general, administrative and
selling expenses decreased approximately 7%  to $8,724,784 for the
year ended December 31, 2001 from $9,373,025 for the year ended December 31,
2000. This decrease is primarily due to our cost reduction efforts which are
aimed at cutting costs that are not integral to the execution of Andrea's
overall strategy, and to ensure conservative spending during the current period
of economic uncertainty. Included in our cost reduction initiatives was a
reduction in workforce which was implemented during February of 2001,
representing a reduction of approximately 25% of Andrea's then total workforce.

Restructuring Charges

During the fourth quarter 2001, we committed to a defined plan of action and
recorded restructuring charges relating to repositioning our business plan for
our Anti-Noise Product business segment as part of our overall effort to drive
high margin product sales and become profitable. The restructuring focused on
exiting from an increasingly unprofitable PC headset channel within Andrea's
Anti-Noise Headset product segment. This was primarily a result of the
increasing competitive nature of the PC headset market, coupled with Andrea's
ongoing strategic efforts to focus on being primarily a leading supplier of
high-end, digital-based, far-field microphone technologies. This channel
primarily purchased our lower-end, low margin headset products, and required
substantial support which, when combined with decreasing volumes realized during
2001, became unprofitable. The plan resulted in an aggregate restructuring
charge of approximately $4.5 million, and included the following:

     1.Sales returns--restructuring reserve--This charge, approximating $340
       thousand, reflects estimated sales returns activity related to exiting
       this customer channel.

     2.Cost of sales--This charge, approximating $2.6 million, relates to
       inventory obsolescence for products that we do not expect to sell as a
       result of exiting this activity.

     3.Other charges--These charges, approximating $1.6 million, relate to costs
       associated with exiting certain agreements, as well as impairment charges
       associated with abandoning related assets.

Other Income (Expense)

Other income for the year ended December 31, 2001 was $163,475 compared to
$204,774 for the year ended December 31, 2000. This decrease is due to lower
cash balances coupled with unfavorable market conditions for those invested cash
balances during 2001.

Provision for Income Taxes

We did not record income tax expense for the year ending December 31, 2001 in
light of the net loss recorded for the period. Furthermore, the realization of a
portion of our reserved deferred tax assets, if and when realized, will not
result in a tax benefit in the consolidated statement of operations, but will
result in an increase in additional paid in capital as they are related to tax
benefits associated with the exercise of stock options. We will be continually
re-assessing its reserves on deferred income tax assets in future periods on a
quarterly basis. The determination as to the realization of additional reserves
is, and will be, based on Andrea's expectations of future earnings. To the
extent we believe that, more likely than not, previously reserved deferred tax
assets will be realized, we will reduce the reserve accordingly. See Note 12 to
our Consolidated Financial  Statements.

Net Loss

Net loss for the year ended December 31, 2001 was $13,630,109 compared to a net
loss of $9,574,352 for the year ended December 31, 2000. The net loss for the
year ended December 31, 2001 principally reflects the factors described above.

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

Sales

Sales for the year ended December 31, 2000 were $15,567,664, a decrease of 9%
from sales of $17,112,487 for the year ended December 31, 1999. The decrease in
sales for the year ended December 31, 2000 reflects an approximate 10% decrease
in sales of Andrea Anti-Noise Products to $11,974,410, or 77% of total sales and
an approximate 23% decrease in sales of our Aircraft Communications Products, to
$2,923,031, or 19% of total sales, both offset by initial sales of Andrea DSP
Microphone and Software Products of $670,223, or 4% of total sales. The primary
reasons for the decrease of Andrea Anti-Noise Product sales during 2000 were a
significant decline in headset unit shipments to IBM and, to a lesser extent,
continued price pressures from IBM. In addition, the decrease from 1999 reflects
a decline in Aircraft Communication Product sales as a result of a product
transformation required to meet future demand for printed circuit and
digital-based intercom systems. Initial sales of Andrea DSP Microphone and
Software Products were primarily comprised of



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 14/15



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shipments of Andrea's far-field microphone products for use with business
videoconferencing systems, professional audio microphones and desktop speech
dictation applications. For the year ended December 31, 2000, sales of our
computer headsets to one customer and certain of that customer's affiliates,
distributors, licensees and integrators accounted for approximately 44% of our
total sales.

Cost of Sales

Cost of sales as a percentage of sales for the year ended December 31, 2000
increased to 72% from 70% for the year ended December 31, 1999. This increase in
cost of sales percentage is primarily a result of lower than expected Andrea
Anti-Noise and Aircraft Communications production and sales (described above
under "Sales") over which to spread our pool of fixed overhead costs.

Research and Development

Research and development expenses for the year ended December 31, 2000 increased
38% to $4,694,116 from $3,399,666 for the year ending December 31, 1999. This
increase is due to our continuing efforts to develop its digital signal
processing microphone and software technologies, coupled with, to a lesser
extent, efforts in Aircraft Communication technologies. Research and development
in DSP-based technology at Andrea is 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
array microphone technologies obtained through the acquisition of Lamar Signal
Processing, Ltd. ("Lamar") in May 1998. Correspondingly, the activities of Lamar
accounted for approximately 28% of the total  research and development expenses
during 2000. We believe that the acquisition of Lamar significantly reinforces
its position in digital signal processing by extending our marketing programs to
other high-growth industries, including automotive telematics, mobile device
markets, the business videoconferencing market and Internet telephony, among
others. Specifically, the core technology acquired produces noise filtering
capabilities that management believes is superior to other known DSP-based
technologies in the marketplace, and is unattainable in products using
traditional mechanical solutions. In addition, the nature of a DSP-based
solution, together with the people acquired supporting our technology, offers a
solution that is highly scalable and embeddable, and therefore enablesthe
technology to be integrated into many different applications and form factors.
We believe that continued research and development spending will provide us with
a significant competitive advantage. For 2001, we expect total research and
development spending to approach levels similar to that of 2000.

General, Administrative and Selling Expenses

General, administrative and selling expenses increased approximately 5% to
$9,373,025 for the year ended December 31, 2000 from $8,954,805 for the year
ended December 31, 1999. The slight increase was due to an increase in sales and
marketing expenses during the second half of the year associated with sales
efforts in the automotive telematics market, as well as increases in overall
sales and marketing salaries. We implemented a cost reduction plan aimed at
cutting costs that are not integral to the execution of Andrea's overall
strategy, and to ensure conservative spending during the current period of
economic uncertainty. Included in our cost reduction initiatives was a reduction
in work-force which was implemented during February of 2001, representing a
reduction of approximately 25% of Andrea's then total workforce.

Other Income (Expense)

Other income for the year ended December 31, 2000 was $204,774 compared to other
expense of $26,258 for the year ended December 31, 1999. The increase is due to
interest earned on higher cash balances throughout 2000, coupled with other
miscellaneous income generated during 2000.

Provision for Income Taxes

We did not record income tax expense for the year ending December 31, 2000 in
light of the net loss recorded for the period. Furthermore, the realization of a
portion of our reserved deferred tax assets, if and when realized, will not
result in a tax benefit in the consolidated statement of operations, but will
result in an increase in additional paid in capital as they are related to tax
benefits associated with the exercise of stock options. We will be continually
re-assessing its reserves on deferred income tax assets in future periods on a
quarterly basis. The determination as to the realization of additional reserves
is, and will be, based on Andrea's expectations of future earnings. To the
extent Andrea's management believes that, more likely than not, previously
reserved deferred tax assets will be realized, Andrea will reduce the reserve
accordingly. See Note 12 to our Consolidated Financial Statements.

Net Loss

Net loss for the year ended December 31, 2000 was $9,574,352 compared to a net
loss of $7,176,993 for the year ended December 31,1999. The net loss for the
year ended December 31, 2000 principally reflects the factors described above.



Management's Discussion and Analysis of
Financial Condition and Results of Operations
--------------------------------------------------------------------------------
(Continued)

LIQUIDITY AND CAPITAL RESOURCES

Andrea's principal sources of funds have historically been, and are expected to
continue to be, gross cash flows from operations and proceeds from the sale of
convertible notes, preferred stock or other securities to certain financial
institutions or potential industry partners. At December 31, 2001, we had cash
and cash equivalents of $3,724,130 compared with $9,151,835 at December 31,
2000. The balance of cash and cash equivalents at December 31, 2001, is
primarily a result of Andrea's issuance and sale in a private placement of
$7,500,000 of its Series C Redeemable Convertible Preferred Stock (the "Series C
Preferred Stock") in October 2000. Andrea is using the net proceeds from the
issuance of the Series C Preferred Stock primarily for costs associated with:

     1. research and development,
     2. creating and maintaining strategic alliances, which includes, among
        other things, sales and marketing salaries, substantial travel costs to
        market our products and technologies, product fulfillment costs and
        technical assistance, and other general support costs for existing and
        potential partners,
     3. payment of certain debt obligations,
     4. professional fees, and
     5. general working capital requirements.

In connection with the acquisition of Lamar, of the aggregate cash consideration
to be paid by Andrea, $1,000,000 was paid on May 5, 1998, the closing date, and
$500,000 was paid on each of the six, twelve, twenty-four and thirty-six month
anniversaries of the closing date. The final payment was paid on May 5, 2001.

Working capital at December 31, 2001 was $5,630,915 compared to $15,035,051 at
December 31, 2000. The decrease in working capital reflects decreases in total
current assets and total current liabilities of $9,405,948, and $1,812,
respectively. The decrease in total current assets reflects decreases in cash
and cash equivalents of $5,427,705, a decrease in accounts receivable of
$1,409,567, and a decrease in inventory of $2,895,309 partially offset by
increase in prepaid expenses and other current assets of $326,633. The decrease
in current liabilities primarily reflects a decrease in accounts payable of
$960,500 and a decrease in our current portion of long-term debt of $517,244,
partially offset by an increase in other current liabilities of $976,208
($258,221 of this amount relates to deferred revenue charges) and an increase in
accrued restructuring charges of $499,724.

The decrease in cash of $5,427,705 reflects $4,544,799 of net cash used in
operating activities, $203,893 of net cash used in investing activities and
$679,013 of net cash used in financing activities.

The cash used in operating activities, excluding non-cash charges, is primarily
attributable to the $13,630,109 net loss for the year ended December 31, 2001, a
$1,203,147 increase in prepaid expenses and other current assets, a $238,677
increase in other assets, and a $960,500 decrease in accounts payables partially
offset by a $1,409,567 decrease in accounts receivable, a $321,970 decrease in
inventory, a $595,516 increase in other current liabilities and a $783,288
increase in other liabilities.  The increase in prepaid expenses
and other current assets primarily includes the recognition of increased
premiums for prepaid property taxes and insurance, as well as increases in other
service costs. The increase in other current liabilities and other liabilities
reflects $1,000,000 of deferred revenue charges, which will be recognized over a
three-year period beginning in March 2002. The decrease in accounts receivable
primarily reflects the level of sales during the year ending December 31, 2001,
as well as the timing of collection of such sales. The decrease in accounts
payable as well as the decrease in inventory primarily reflect differences in
the timing related to both the payments for and the acquisition of raw materials
as well as for other services in connection with ongoing efforts related to our
various product lines.

The cash used in investing activities is attributable to capital expenditures
consisting of manufacturing dies and molds and, to a lesser extent, upgrades in
our existing computer systems.

The net cash used in financing activities reflects the payment of the final
installment payment to the former shareholders of Lamar as well as payments to
the debt we assumed in connection with the acquisition of Lamar, partially
offset by the exercises of employee stock options.

We believe that it will be necessary to raise additional working capital to
support operations. In December 1995, April 1996, August 1996 and June 1998,
Andrea raised working capital through the issuance of convertible subordinated
debentures. In June 1999, Andrea raised $7.5 million through the issuance and
sale of Series B Preferred Stock. In October 2000, Andrea raised $7.5 million
through the issuance and sale of Series C Preferred Stock. Furthermore, in
accordance with EITF Issue 00-27, "Application of EITF Issue No. 98-5 to Certain
Convertible Instruments," Andrea recorded a one time non-cash charge of
$7,500,000 to accumulated deficit. This pronouncement values the economic
benefit of the contingent beneficial conversion feature that the holders of the
Series C Preferred Stock received when the conversion price of the Series C
Preferred Stock was reset from $7.0565 to $1.44 in July 2001. This charge
represents the maximum charge under this standard and, accordingly, there will
be no additional charges to equity at later reset dates. Andrea has incurred
significant losses in each of the last three



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 16/17



--------------------------------------------------------------------------------

fiscal years. In the year ended December 31, 2001, Andrea incurred losses from
operations, excluding the impact of restructuring charges, of $9.3 million, and
used $4.5 million in cash from its operating activities. Management expects that
operating losses and negative cash flows will continue at least through Fiscal
2002 as Andrea continues to market its Andrea Anti-Noise products, Aircraft
Communication products and Andrea DSP Microphone and Software Technologies.
Notwithstanding, in December 2001 and March 2002, we entered into two agreements
with Analog Devices, Inc. whereby Analog Devices is obligated to pay us a total
of $5 million in license fees during calendar 2002. Through the date of this
Form 10-K, and in accordance with our agreements, we have received
$1 million of these license fees. If Andrea fails to develop revenues from sales
of its products to generate adequate funding from operations or fails to obtain
additional financing through capital or funding, it will be required to either
further reduce its operating expenses and/or operations or may result it
relinquishing its products, technologies or markets. Such financing may not be
available on acceptable terms, or at all. We cannot assure that demand will
continue for any of our products, including future products related to our
Andrea Digital Signal Processing Microphone and Software Technologies, or, that
if such demand does exist, that we will be able to obtain the necessary working
capital to increase production and marketing resources to meet such demand on
favorable terms, or at all.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Goodwill and Other Intangible Assets

In July 2001, the FASB issued Statements of Financial Accounting Standards No.
141, "Business Combinations" and No. 142, "Goodwill and other Intangible
Assets." SFAS No. 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. Under SFAS No. 142,
goodwill and intangible assets with indefinite lives are no longer amortized but
are reviewed annually (or more frequently, if impairment indicators arise) for
impairment. Separable intangible assets that are not deemed to have indefinite
lives will continue to be amortized over their useful lives (but with no maximum
life).

Andrea has adopted this standard effective January 1, 2002, and, accordingly,
those intangible assets that will continue to be classified as goodwill or as
other intangibles with indefinite lives will no longer be amortized. Other
intangible assets, which do not have indefinite lives (such as core
technology--Note 4), will continue to be amortized. Andrea has made a
preliminary assessment of its intangible assets to identify goodwill separately
from other identifiable intangibles. No adjustment was deemed necessary,
although the intangible asset "Workforce in Place" will be reclassified as
goodwill pursuant to SFAS No. 142. In accordance with the SFAS No. 142,
intangible assets, including purchased goodwill, will be evaluated periodically
for impairment. Based upon the results of Andrea's transitional impairment
testing, there will be no material impact on the combined financial results
related to Andrea's intangible assets or purchased goodwill. Amortization of
goodwill and other intangible assets, relating to the assets that will no longer
be amortized, was approximately $1,128,186 for the year ended December 31, 2001.

Long-Lived Assets

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and Accounting Principles Board Opinion No. 30, "Reporting
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The Statement retains the fundamental provisions of SFAS No. 121
for recognition and measurement of impairment, but amends the accounting and
reporting standards for segments of a business to be disposed of. The provisions
of this statement are required to be adopted no later than fiscal years
beginning after December 31, 2001, with early adoption encouraged. Andrea is
currently evaluating the impact of the adoption of SFAS No. 144, which Andrea
expects will not be material.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our principal source of financing activities is the issuance of convertible
debt with financial institutions. We are affected by market risk exposure
primarily through any amounts payable in stock, or cash by us under convertible
securities. A significant rise in interest rates could materially adversely
affect our financial condition and results of operations. We do not utilize
derivative financial instruments to hedge against changes in interest rates or
for any other purpose. In addition, substantially all transactions 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.



Consolidated Balance Sheets
--------------------------------------------------------------------------------
December 31,



                                                                                                         2001                2000
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                               
ASSETS
CURRENT ASSETS:
   Cash and cash equivalents                                                                     $  3,724,130        $  9,151,835
   Accounts receivable, net of allowance for doubtful
     accounts of $176,292 and $186,121, respectively                                                2,094,146           3,503,713
   Inventories, net                                                                                 3,389,729           6,285,038
   Prepaid expenses and other current assets                                                          547,892             221,259
----------------------------------------------------------------------------------------------------------------------------------
        Total current assets                                                                        9,755,897          19,161,845
PROPERTY AND EQUIPMENT, net                                                                           811,392           1,393,760
DEFERRED INCOME TAXES                                                                               1,806,615           1,806,615
GOODWILL, net (Note 4)                                                                             12,317,843          13,403,836
OTHER INTANGIBLE ASSETS, net (Note 4)                                                               8,467,616           9,243,917
OTHER ASSETS, net                                                                                     860,296           2,262,893
----------------------------------------------------------------------------------------------------------------------------------
Total assets                                                                                     $ 34,019,659        $ 47,272,866
----------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHARE HOLDERS' EQUITY
CURRENT LIABILITIES:
   Trade accounts payable                                                                        $  1,147,160        $  2,107,660
   Current portion of long-term debt (Note 9)                                                         158,802             676,046
   Accrued restructuring charges (Note 3)                                                             499,724                  --
   Other current liabilities (Note 8)                                                               2,319,296           1,343,088
----------------------------------------------------------------------------------------------------------------------------------
        Total current liabilities                                                                   4,124,982           4,126,794
LONG-TERM DEBT (Note 9)                                                                                37,619             195,867
OTHER LIABILITIES                                                                                     783,288                  --
----------------------------------------------------------------------------------------------------------------------------------
        Total liabilities                                                                           4,945,889           4,322,661
----------------------------------------------------------------------------------------------------------------------------------
SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01 par value; authorized:
   1,000 shares; issued and outstanding: 249 and 500 shares, respectively (Notes 10 and 19);
   liquidation value: $2,490,000 and $5,000,000, respectively                                       2,421,009           4,830,060
----------------------------------------------------------------------------------------------------------------------------------
SERIES C REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01 par value; authorized:
   1,500 shares; issued and outstanding: 750 and 750 shares, respectively (Note 11);
   liquidation value:  $7,500,000                                                                   7,364,011           7,332,665
----------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Note 15)

SHAREHOLDERS' EQUITY:
   Preferred stock, $.01 par value; authorized: 4,997,500 shares; none issued and outstanding             --                   --
   Common stock, $.50 par value; authorized: 70,000,000 shares; issued and outstanding:
     16,308,968 and 13,897,572 shares, respectively                                                 8,154,484           6,948,786
   Additional paid-in capital                                                                      55,754,228          46,711,609
   Deferred stock compensation                                                                        (52,334)                 --
   Accumulated deficit                                                                            (44,567,628)        (22,872,915)
----------------------------------------------------------------------------------------------------------------------------------
        Total shareholders' equity                                                                 19,288,750          30,787,480
----------------------------------------------------------------------------------------------------------------------------------
        Total liabilities and shareholders' equity                                               $ 34,019,659        $ 47,272,866
==================================================================================================================================


The accompanying notes are an integral part of these consolidated balance
sheets.



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 18/19

Consolidated Statements of Operations
--------------------------------------------------------------------------------
For the Years Ended December 31,




                                                                             2001           2000           1999
----------------------------------------------------------------------------------------------------------------
                                                                                           
NET SALES--OPERATING                                                 $ 10,258,875    $15,567,664    $17,112,487
SALES RETURNS--RESTRUCTURING (Note 3)                                    (337,499)            --             --
----------------------------------------------------------------------------------------------------------------
     Net sales                                                          9,921,376     15,567,664     17,112,487
COST OF SALES--OPERATING                                                7,401,605     11,279,649     11,908,751
COST OF SALES--RESTRUCTURING (Note 3)                                   2,573,339             --             --
----------------------------------------------------------------------------------------------------------------
     Cost of sales                                                      9,974,944     11,279,649     11,908,751
     Gross (deficit) margin                                              (53,568)      4,288,015      5,203,736
RESEARCH AND DEVELOPMENT EXPENSES                                       3,462,340      4,694,116      3,399,666
RESTRUCTURING CHARGES (Note 3)                                          1,552,892             --             --
GENERAL, ADMINISTRATIVE AND SELLING EXPENSES                            8,724,784      9,373,025      8,954,805
----------------------------------------------------------------------------------------------------------------
     Loss from operations                                             (13,793,584)    (9,779,126)    (7,150,735)
----------------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE):
   Interest income                                                        193,087        416,393        246,882
   Interest expense                                                       (51,746)      (233,880)      (306,843)
   Rent and miscellaneous income                                           22,134         22,261         33,703
----------------------------------------------------------------------------------------------------------------
                                                                          163,475        204,774       (26,258)
----------------------------------------------------------------------------------------------------------------
LOSS BEFORE PROVISION FOR INCOME TAXES                                (13,630,109)    (9,574,352)    (7,176,993)
PROVISION FOR INCOME TAXES (Note 14)                                           --             --             --
----------------------------------------------------------------------------------------------------------------
     Net loss                                                         (13,630,109)    (9,574,352)    (7,176,993)
NON-CASH CHARGE ATTRIBUTABLE TO PREFERRED STOCK
   BENEFICIAL CONVERSION FEATURE (Note 11)                              7,500,000             --             --
PREFERRED STOCK DIVIDENDS                                                 564,604        351,209        195,843
----------------------------------------------------------------------------------------------------------------
     Net loss attributable to common shareholders                    $(21,694,713)   $(9,925,561)   $(7,372,836)
================================================================================================================
PER SHARE INFORMATION (Note 5):
   Net Loss Per Share--Basic and Diluted                             $      (1.43)   $      (.72)   $      (.56)
================================================================================================================
Shares used in computing net loss per share--Basic and Diluted         15,190,834     13,748,945     13,229,559
================================================================================================================


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



Consolidated Statements of Shareholders' Equity
--------------------------------------------------------------------------------
For the Three Years Ended December 31, 2001



                                                                          Additional                                     Total
                                                    Shares       Common    Paid-In   Deferred Stock  Accumulated     Shareholders'
                                                  Outstanding    Stock     Capital    Compensation     Deficit          Equity
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                  
BALANCE, December 31, 1998                         13,210,038 $6,605,019 $42,548,399  $       --    $ (5,574,518)   $ 43,578,900
  Exercise of stock options, net of related costs      32,500     16,250      93,785          --              --         110,035
  Issuance of warrants in connection with
    Series B Redeemable Convertible
    Preferred Stock (Note 10)                              --         --     348,457          --              --         348,457
  Preferred stock dividends                                --         --          --          --        (195,843)       (195,843)
  Net loss                                                 --         --          --          --      (7,176,993)     (7,176,993)
------------------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1999                         13,242,538  6,621,269  42,990,641          --     (12,947,354)     36,664,556
  Conversion of Series B Redeemable
    Convertible Preferred Stock                       371,909    185,955   2,231,447          --              --       2,417,402
  Exercise of stock options, net of related costs     283,125    141,562   1,489,521          --              --       1,631,083
  Preferred stock dividends                                --         --          --          --        (351,209)       (351,209)
  Net loss                                                 --         --          --          --      (9,574,352)     (9,574,352)
------------------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 2000                         13,897,572  6,948,786  46,711,609          --     (22,872,915)     30,787,480
  Conversions of Series B Redeemable
    Convertible Preferred Stock                     2,308,896  1,154,448   1,411,636          --              --       2,566,084
  Exercise of stock options, net of related costs      27,500     13,750       2,733          --              --          16,483
  Preferred stock dividends                                --         --          --          --        (564,604)       (564,604)
  Restricted stock grant, net of related
    current year amortization                          75,000     37,500      96,000     (28,529)             --         104,971
  Stock option grant to consultant, net of
    related current year amortization                      --         --      32,250     (23,805)             --           8,445
  Beneficial conversion charge attributable
    to Series C Redeemable Convertible
    Preferred Stock (Note 11)                              --         --   7,500,000          --      (7,500,000)             --
  Net loss                                                 --         --          --          --     (13,630,109)    (13,630,109)
------------------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 2001                         16,308,968 $8,154,484 $55,754,228  $  (52,334)   $(44,567,628)   $ 19,288,750
====================================================================================================================================


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



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 20/21



Consolidated Statements of Cash Flows
--------------------------------------------------------------------------------
For the Years Ended December 31,



                                                                                             2001          2000           1999
---------------------------------------------------------------------------------------------------------------------------------
                                                                                                          
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss                                                                           $(13,630,109)  $(9,574,352)   $(7,176,993)
  Adjustments to reconcile net loss to net cash used in operating activities:
    Non-cash interest expense                                                                  --        39,964         93,023
    Depreciation and amortization                                                       3,800,147     3,644,392      3,390,987
    Non-cash stock compensation expense                                                   113,416            --             --
    Non-cash charges related to Restructuring (Note 3)                                  4,463,730            --             --
    (Increase) decrease in:
       Accounts receivable, net                                                         1,409,567      (733,010)     2,097,079
       Inventories                                                                        321,970       838,709        890,576
       Prepaid expenses and other current assets                                       (1,203,147)     (287,544)      (242,559)
       Other assets                                                                      (238,677)     (257,657)      (563,619)
    Increase (decrease) in:
       Trade accounts payable                                                            (960,500)      (27,213)       (87,039)
       Other current liabilities                                                          595,516      (323,798)      (947,508)
       Other liabilities                                                                  783,288            --             --
---------------------------------------------------------------------------------------------------------------------------------
         Net cash used in operating activities                                         (4,544,799)   (6,680,509)    (2,546,053)
---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property, plant and equipment                                             (203,893)     (369,970)      (834,135)
---------------------------------------------------------------------------------------------------------------------------------
         Net cash used in investing activities                                           (203,893)     (369,970)      (834,135)
---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Payment of debt obligations (Notes 4 and 9)                                            (695,496)     (596,840)      (514,122)
  Net proceeds from Series B Redeemable Convertible Preferred Stock (Note 10)                  --            --      7,500,000
  Net proceeds from Series C Redeemable Convertible Preferred Stock (Note 11)                  --     7,500,000             --
  Payment of convertible notes                                                                 --    (1,485,077)            --
  Proceeds from issuance of common stock upon exercise of stock options,
    net of related costs                                                                   16,483     1,631,083        110,035
---------------------------------------------------------------------------------------------------------------------------------
         Net cash provided by financing activities                                       (679,013)    7,049,166      7,095,913
---------------------------------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                   (5,427,705)       (1,313)     3,715,725
CASH AND CASH EQUIVALENTS, beginning of year                                            9,151,835     9,153,148      5,437,423
---------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of year                                               $  3,724,130   $ 9,151,835    $ 9,153,148
=================================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Non-cash investing and financing activities:
    Beneficial conversion charge attributable to Series C Redeemable Convertible
       Preferred Stock (Note 11)                                                     $  7,500,000   $        --    $        --
=================================================================================================================================
    Conversion of Series B Redeemable Convertible Preferred Stock into common
       stock (Note 10)                                                               $  2,566,084   $ 2,417,402    $        --
=================================================================================================================================
    Issuance of warrants in connection with Series B Redeemable Convertible
       Preferred Stock                                                               $         --   $        --    $   348,457
=================================================================================================================================
  Cash paid for:
    Interest                                                                         $     31,749   $   212,859    $    49,601
=================================================================================================================================
    Income taxes                                                                     $     33,838   $    47,675    $    29,479
=================================================================================================================================


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



Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
December 31, 2001

1. ORGANIZATION AND BUSINESS

Andrea Electronics Corporation, incorporated in the State of New York in 1934,
(together with its subsidiaries, "Andrea") has been engaged in the electronic
communications industry since its inception. Andrea is presently focused on the
development, manufacture and marketing of its Andrea Anti-Noise family of
electronic headsets and handsets with noise canceling and noise reducing
properties. Noise cancellation enhances voice-activated computing, computerized
speech recognition, and computer and Internet telephony. In addition, Andrea is
currently developing and marketing a new line of digital signal processing
("DSP") products to further its role in technology enhanced communications, and
in May 1998, acquired Lamar Signal Processing, Ltd. ("Lamar"), an Israeli
corporation engaged in the development of DSP, noise cancellation microphone
solutions (Note 4). Prior to Andrea's entry into the voice-activated computing
market in the 1990s, its primary business was selling intercom systems for
military and industrial use. Andrea continues to manufacture these systems and
is seeking to apply its knowledge of the military and industrial markets to
develop applications of its Andrea Anti-Noise technologies for these markets.

As of December 31, 2001, Andrea had working capital of $5,630,915 and cash and
cash equivalents of $3,724,130. During 2001, Andrea's operating activities used
approximately $4,544,799 of cash. Andrea plans to improve its cash flows during
2002, primarily through performance of its current licensing arrangements (see
Note 12). Management believes that with this plan to improve its cash flows,
existing cash and cash equivalents, and cash flows from licensing arrangements
(Note 12), there will be sufficient liquidity to continue operating and meet its
current obligations until at least the end of the first quarter of 2003.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The financial statements include the accounts of Andrea and its subsidiaries.
All intercompany balances and transactions have been eliminated in
consolidation.

Cash and Cash Equivalents

Cash and cash equivalents include cash and highly liquid investments with
original maturities of three months or less.

Concentration of Credit Risk

Andrea is a manufacturer of audio communications equipment for several
industries. Andrea primarily generates sales from its noise canceling and active
noise canceling products as well as through sales to the federal government.
Sales of noise canceling and active noise canceling products were significant to
one customer and its affiliates, accounting for approximately 37% of total
accounts receivable at December 31, 2000, and approximately 22%, 44% and 49% of
the total sales for 2001, 2000 and 1999, respectively. Deferred revenues
relating to a licensing agreement were significant to one customer, accounting
for 48% of total accounts receivable at December 31, 2001. Sales to the federal
government and related subcontractors aggregated approximately 33% and 25% of
total accounts receivable at December 31, 2001 and 2000, respectively, and
approximately 17%, 18% and 23% of the total sales for 2001, 2000 and 1999,
respectively.

Inventories

Inventories are stated at the lower of cost (on a first-in, first-out) or market
basis.

Property and Equipment

Property, plant and equipment is stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are provided using the
straight-line method over the estimated useful lives of the assets, which are as
follows:

Leasehold improvements            shorter of lease term or estimated useful life
Machinery and equipment           3-7 years

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.

Intangible Assets

Patents and trademarks associated with Andrea's proprietary technology are
carried at cost less accumulated amortization, which is calculated on a
straight-line basis over the estimated useful lives of the assets, not to exceed
17 years. The recoverability of carrying values of intangible assets is
evaluated on a recurring basis. Patents and trademarks approximated $500,000 and
$1,286,000, net of accumulated amortization of approximately $44,000 and
$181,000, at December 31, 2001 and 2000, respectively, and are included in other
assets on the accompanying consolidated balance sheets. Goodwill and other
intangible assets associated with Andrea's acquisition (Note 4) are carried at
cost less accumulated amortization, which is calculated on a straight-line basis
over 7-15 years.

Long-Lived Assets

Andrea accounts for its long-lived assets in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 22/23



--------------------------------------------------------------------------------

for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," for purposes of determining and measuring impairment of its long-lived
assets (primarily intangible assets). Andrea's policy is to periodically review
the value assigned to its enterprise level goodwill and other intangible assets,
resulting from its acquisition of Lamar (Note 4) to determine if it has been
permanently impaired by adverse conditions which may affect Andrea or Lamar. If
Andrea identifies a permanent impairment such that the carrying amount of
Andrea's enterprise level goodwill or other intangible assets is not recoverable
using the sum of an undiscounted cash flow projection (gross margin dollars from
product sales), a new cost basis for the impaired asset(s) will be established.
This new cost basis will be net of any recorded impairment. Considerable
management judgment is necessary to estimate undiscounted future operating cash
flows and, accordingly, actual results could vary significantly from such
estimates. As of December 31, 2001, management believes that no impairment
exists for any of its long-lived assets.

Revenue Recognition

Revenue is recognized upon shipment and acceptance of goods. Andrea reports its
sales levels on a net sales basis, with net sales being computed by deducting
from gross sales the amount of actual sales returns and the amount of reserves
established for anticipated sales returns.

Barter Transactions

Andrea records barter transactions at the estimated fair market value of the
services received. Deferred charges relating to a barter transaction
approximated $273,000 and $670,000 as of December 31, 2001 and 2000,
respectively, after giving effect to the restructuring charge (Note 3), and are
included in other assets. The deferred charges are being amortized over the
lesser of the period of benefit or the program period, not to exceed five years.
Andrea did not engage in any barter transactions during 2001, 2000 or 1999.

Income Taxes

Andrea accounts for income taxes in accordance with SFAS No. 109, "Accounting
for Income Taxes." This pronouncement established financial accounting and
reporting standards for the effects of income taxes that result from Andrea's
activities during the current and preceding years. It requires an asset and
liability approach for financial accounting and reporting for income taxes.

The provision for income taxes is based upon income, if any, after adjustment
for those permanent items that are not considered in the determination of
taxable income. Deferred income taxes result when Andrea recognizes revenue or
expenses for income tax purposes in a different year than for financial
reporting purposes (Note 14).

Stock-Based Compensation

Andrea complies with the provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation," by continuing to apply the provisions of Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and
Financial Accounting Standards Board Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation," while providing the required
pro forma disclosures as if the fair value method had been applied (Note 16).

Research and Development

Andrea expenses all research and development costs as incurred.

Advertising Expenses

In accordance with Statement of Position 93-7, "Reporting on Advertising Costs,"
Andrea charges all media costs of newspaper and magazine advertisements as well
as trade show costs to the consolidated statements of operations when
advertisements are run and trade shows are attended. Prepaid advertising at
December 31, 2001 and 2000, which primarily represents costs for media services
purchased but not yet incurred, is included in prepaid expenses and other
current assets in the accompanying consolidated balance sheets. Total
advertising and marketing expenses for the years ended December 31, 2001, 2000
and 1999 approximated $400,000, $500,000 and $500,000, respectively.

Fair Value of Financial Instruments

Andrea calculates the fair value of financial instruments and includes this
additional information in the notes to financial statements when the fair value
is different than the book value of those financial instruments. When the fair
value approximates book 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, 2001 and 2000, the carrying
value of all financial instruments approximated fair value.

Comprehensive Income

Andrea follows the provisions of SFAS No. 130, "Reporting Comprehensive Income,"
which requires companies to report all changes in equity during a period, except
those resulting from investment by owners and distribution to owners, in a
financial statement for the period in which they are recognized. Comprehensive
income is the total of net income and all other non-owner



Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
December 31, 2001 (Continued)

changes in equity (or other comprehensive income) such as unrealized
gains/losses on securities available-for-sale, foreign currency translation
adjustments and minimum pension liability adjustments. Comprehensive and other
comprehensive income must be reported on the face of the annual financial
statements or, in the case of interim reporting, in the footnotes to the
financial statements. Andrea's operations did not give rise to items includible
in comprehensive loss which were not already included in net loss. Accordingly,
Andrea's comprehensive loss is the same as its net loss for all periods
presented.

Derivative Instruments

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. SFAS No. 133, as amended by SFAS No. 137
and SFAS No. 138 is effective for all fiscal years beginning after June 15, 2000
and will not require retroactive restatement of prior period financial
statements. This statement requires the recognition of all derivative
instruments as either assets or liabilities in the balance sheet measured at
fair value. Derivative instruments will be recognized as gains or losses in the
period of change. While Andrea operates in international markets, it does so
presently without the use of derivative instruments or engagement in hedging
activities and, accordingly, the adoption of this standard by Andrea in the
first quarter of 2001 did not have a material effect on its consolidated
financial statements.

Recently Issued Accounting Pronouncements

Goodwill and Other Intangible Assets

In July 2001, the FASB issued Statements of Financial Accounting Standards No.
141, "Business Combinations" and No. 142, "Goodwill and other Intangible
Assets." SFAS No. 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. Under SFAS No. 142,
goodwill and intangible assets with indefinite lives are no longer amortized but
are reviewed annually (or more frequently, if impairment indicators arise) for
impairment. Separable intangible assets that are not deemed to have indefinite
lives will continue to be amortized over their useful lives (but with no maximum
life).

Andrea has adopted this standard effective January 1, 2002, and, accordingly,
those intangible assets that will continue to be classified as goodwill or as
other intangibles with indefinite lives will no longer be amortized. Other
intangible assets, which do not have indefinite lives (such as core
technology--Note 4), will continue to be amortized. Andrea has made a
preliminary assessment of its intangible assets to identify goodwill separately
from other identifiable intangibles. No adjustment was deemed necessary,
although the intangible asset "Workforce in Place," will be reclassified as
goodwill pursuant to SFAS No. 142. In accordance with the SFAS No. 142,
intangible assets, including purchased goodwill, will be evaluated periodically
for impairment. Based upon the results of Andrea's transitional impairment
testing, there will be no material impact on the combined financial results
related to Andrea's intangible assets or purchased goodwill. Amortization of
goodwill and other intangible assets, relating to the assets that will no longer
be amortized, was approximately $1,128,186 for the year ended December 31, 2001.

Long-Lived Assets

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of ," and Accounting Principles Board Opinion No. 30, "Reporting
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The Statement retains the fundamental provisions of SFAS No. 121
for recognition and measurement of impairment, but amends the accounting and
reporting standards for segments of a business to be disposed of. The provisions
of this statement are required to be adopted no later than fiscal years
beginning after December 31, 2001, with early adoption encouraged. Andrea is
currently evaluating the impact of the adoption of SFAS No. 144, which Andrea
expects will not be material.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year
presentation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 24/25



--------------------------------------------------------------------------------

3. RESTRUCTURING

During the fourth quarter of fiscal 2001, Andrea recorded restructuring charges
in connection with exiting a PC headset channel, or customer-type, within the
Anti-Noise Product segment. The restructuring charge is recorded as accrued
restructuring charges or as a reduction of assets, as applicable. Andrea expects
to settle all of its remaining obligations related to the restructuring by the
end of fiscal 2002. Following is a summary of the charges recorded in the
consolidated statement of earnings for fiscal 2001:



                                                                                       Operating
                                                    Net Sales        Cost of Sales      Expenses             Total
---------------------------------------------------------------------------------------------------------------------
                                                                                              
Inventory                                           $     --         $2,573,339/(b)/   $       --         $2,573,339
Trademarks and fixed assets                               --                 --         1,114,190/(c)/     1,114,190
Anticipated sales returns                            337,499/(a)/            --                --            337,499
Reduction of deferred barter costs                        --                 --           276,477/(c)/       276,477
Support services and facility closures                    --                 --           162,225/(c)/       162,225
---------------------------------------------------------------------------------------------------------------------
   Total                                            $337,499         $2,573,339        $1,552,892         $4,463,730
=====================================================================================================================


(a) Represents estimated sales returns activity related to exiting this
    specific customer channel.
(b) Represents the historical cost of inventory to be written-off, which we do
    not expect to sell as a result of exiting this activity.
(c) Represents costs associated with exiting certain agreements, as well as
    impairment charges associated with abandoning related assets as a result of
    exiting this activity and its supporting activities and its supporting
    activities.

4. ACQUISITION OF BUSINESS

On May 5, 1998, Andrea acquired all of the outstanding shares of capital stock
of Lamar (the "Acquisition"). The consideration paid by Andrea for the
Acquisition was approximately 1,800,000 shares of restricted common stock,
$1,000,000 in cash and $2,000,000 in notes payable. The cash was recorded at
stated value. Both the notes payable and the shares issued were discounted to
reflect the appropriate value of the consideration paid taking into account the
underlying restrictions, arriving at the values of $1,615,000 and $23,129,532,
respectively. Of the approximately 1,800,000 shares issued to the sellers,
one-third became freely transferable on the first anniversary of the closing; an
additional one-third became transferable on the second anniversary; and the last
one-third on the third anniversary. Of the aggregate cash consideration to be
paid by Andrea, the last note payment was made by Andrea during 2001. The
Acquisition was accounted for under the purchase method of accounting and,
accordingly, the operating results of Lamar have been included in the
consolidating operating results since the date of acquisition. The purchase, for
aggregate consideration of $27.6 million, including costs associated with the
acquisition of Lamar of $1.4 million, resulted in intangible assets of $27.3
million. The goodwill and other intangibles, together with their respective
useful lives, consist of the following:



                                                             Net Value at            Net Value at         Estimated
                                                           December 31, 2001      December 31, 2000      Useful Life
---------------------------------------------------------------------------------------------------------------------
                                                                                                
Goodwill                                                      $12,317,843            $13,403,836           15 years
Other Intangible Assets:
   Core Technology                                            $ 8,326,586            $ 9,060,694           15 years
   Workforce in Place                                             141,030                183,223            7 years
---------------------------------------------------------------------------------------------------------------------
Total Other Intangible Assets                                 $ 8,467,616            $ 9,243,917
=====================================================================================================================


As described in Note 2, Andrea has adopted the provisions of SFAS No. 141 and
142 effective January 1, 2002. Consequently, the intangible asset "Workforce in
Place" will be reclassified as goodwill, which will no longer amortize, while
the intangible asset "Core Technology" will continue to amortize.




Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
December 31, 2001 (Continued)

5. NET LOSS PER SHARE

Andrea follows the provisions of SFAS No. 128, "Earnings Per Share." In
accordance with this statement, basic net loss per common share is computed by
dividing net loss by the weighted-average number of common shares outstanding.
Diluted net loss per common share is computed by dividing net loss by the
weighted-average number of common shares and dilutive common share equivalents
and convertible securities then outstanding.

The following chart provides a reconciliation of information used in calculating
the per share amounts:



For the Year Ending December 31,                                                         2001            2000           1999
============================================================================================================================
                                                                                                       
Numerator:
   Net loss                                                                     $ (13,630,109)   $ (9,574,352)  $ (7,176,993)
   Less: Non-cash charge attributable to preferred stock beneficial
     conversion feature                                                            (7,500,000)             --             --
        Preferred stock dividends                                                    (564,604)       (351,209)      (195,843)
----------------------------------------------------------------------------------------------------------------------------
     Net loss applicable to common shareholders                                 $ (21,694,713)   $ (9,925,561)  $ (7,372,836)
============================================================================================================================

Denominator:
   Weighted-average common shares outstanding--Basic and Diluted                   15,190,834      13,748,945     13,229,559
============================================================================================================================
Net loss per share--Basic and Diluted                                           $       (1.43)   $       (.72)  $       (.56)
============================================================================================================================


6. INVENTORIES, NET

Inventories, net, consists of the following:



December 31,                                                                                             2001           2000
============================================================================================================================
                                                                                                          
Raw materials                                                                                    $  2,000,375   $  2,476,886
Work-in-process                                                                                       130,167        842,267
Finished goods                                                                                      1,845,720      3,447,896
----------------------------------------------------------------------------------------------------------------------------
                                                                                                    3,976,262      6,767,049
Less: reserve for obsolescence                                                                       (586,533)      (482,011)
----------------------------------------------------------------------------------------------------------------------------
                                                                                                 $  3,389,729   $  6,285,038
============================================================================================================================


7. PROPERTY AND EQUIPMENT, NET

Property and equipment, net, consists of the following:



December 31,                                                                                             2001           2000
============================================================================================================================
                                                                                                         
Leasehold improvements                                                                           $     79,485   $     79,485
Machinery and equipment                                                                             4,303,596      4,377,987
----------------------------------------------------------------------------------------------------------------------------
                                                                                                    4,383,081      4,457,472
Less: accumulated depreciation and amortization                                                    (3,571,689)    (3,063,712)
----------------------------------------------------------------------------------------------------------------------------
                                                                                                 $    811,392   $  1,393,760
============================================================================================================================


Depreciation and amortization of property and equipment was $741,443, $906,719
and $723,705 for the three years ended December 31, 2001, 2000 and 1999,
respectively.



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 26/27



--------------------------------------------------------------------------------

8. OTHER CURRENT LIABILITIES

Other current liabilities consists of the following:



December 31,                                                         2001          2000
========================================================================================
                                                                       
Accrued professional, and other service fees                   $1,164,067    $  857,495
Accrued interest and dividend expense                             721,607       393,015
Deferred revenue--current portion (Note 12)                       258,221            --
Accrued other                                                     175,401        92,578
----------------------------------------------------------------------------------------
                                                               $2,319,296    $1,343,088
========================================================================================


9. LONG - TERM DEBT

Long-term debt consists of the following:



December 31,                                                         2001          2000
========================================================================================
                                                                       
Notes payable to sellers, net/(a)/                             $       --    $  484,997
Bank note/(b)/                                                    196,421       386,916
----------------------------------------------------------------------------------------
                                                                  196,421       871,913
Less: Current portion                                            (158,802)     (676,046)
----------------------------------------------------------------------------------------
                                                               $   37,619    $  195,867
========================================================================================


(a) As part of the aggregate purchase price of the Acquisition (Note 4), Andrea
    issued $2,000,000 in non-interest bearing promissory notes (the "Promissory
    Notes") to the former shareholders of Lamar, which has been fully paid as
    of December 31, 2001.
(b) In connection with the Acquisition (Note 4), Andrea assumed the outstanding
    obligations of Lamar which, at December 31, 2001, includes Israeli
    government-guaranteed loans in the amount of $196,421, bearing interest at
    8.7% per annum. These loans are part of a $1,000,000 government-guaranteed
    credit facility approved for Lamar, which is subject to the implementation
    of an investment program in accordance with Israeli law. The approval
    associated with the investment program requires certain conditions to be
    met, as defined. In the event Lamar fails to meet the conditions, immediate
    repayment may be required. At December 31, 2001, Andrea's management
    believes that Lamar was in compliance with those conditions.

Scheduled maturities of long-term debt are as follows:

2002                                                   $158,802
2003                                                     21,092
2004                                                     16,527
---------------------------------------------------------------
   Total                                               $196,421
===============================================================

10. SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK

On June 22, 1999, Andrea issued and sold in a private placement $7,500,000 of
Series B Redeemable Convertible Preferred Stock (the "Series B Preferred
Stock"), and a warrant covering 75,000 shares of Andrea's common stock. Each of
the 750 shares of Series B Preferred Stock (par value $0.01 per share) has a
stated value of $10,000 plus dividends of 4% per annum, which sum is convertible
into common stock (par value $0.50 per share) at a conversion price equal to the
lower of $8.775 (the "Maximum Conversion Price") and the average of the two
lowest closing bid prices of the common stock during the 15 consecutive trading
days immediately preceding a conversion date (the "Market Price"), subject to
certain adjustments, including anti-dilution. The 4% dividends may, at the
option of Andrea, be paid in cash. The warrant has an exercise price of $8.775
per share and expires on June 18, 2004.

The Series B Preferred Stock becomes convertible into Andrea's common stock
according to a vesting schedule, with 12.5% of the shares having become
convertible on October 17, 1999, 12.5% of the shares having become convertible
on November 17, 1999, 12.5% of the shares having become convertible on December
17, 1999, and an additional 12.5% becoming convertible at the end of next five
succeeding 30-day periods. The vesting schedule will lapse for conversions
occurring at the Maximum Conversion Price and upon the occurrence of certain
extraordinary events, as defined. As of December 31, 2001, Andrea has 6,925,632
shares of its common stock reserved for issuance upon conversion of the shares
of the Series B Preferred Stock.

Upon the announcement of a major transaction, as defined in Andrea's certificate
of incorporation, the investors have the right to require Andrea to redeem all
or a portion of the investor's Preferred Shares at a redemption price equal to
the greater of 120% of the stated value plus any accrued dividends or the



Notes to Consolidated Financial Statements
-------------------------------------------------------------------------------
December 31, 2001 (Continued)

Market Price on the day of announcement. In addition, upon the occurrence of
certain triggering events, as defined, and depending on Andrea's control over
such events, the investor may have the right to require Andrea to i) redeem all
or a portion of the Preferred Shares at a redemption price equal to the greater
of 120% of the stated value plus any accrued dividends or the Market Price on
the day of announcement, or ii) pay a penalty equal to 1% of the remaining
principal amount outstanding for a period not to exceed 20 days in any 365 day
period, and adjust the Maximum Conversion Price, as defined.

Andrea is actively seeking to obtain additional capital and funding which, if
successful, could involve the triggering of the redemption rights. If such
redemption rights are triggered and Andrea has insufficient funds to satisfy the
redemption, Andrea will be required to obtain a waiver from the holders of the
Series B Preferred Stock. If the Series B Preferred Stock holders do not consent
to such a waiver, Andrea's efforts to obtain additional funding and capital will
be materially adversely affected and its ability to continue its current
operations will be materially adversely affected.

For the year ending December 31, 2001, the following number of shares of Series
B Preferred Stock, together with related accrued dividends, were converted:

                           Number of
                            Series B                              Number of
Date of                  Preferred Stock       Conversion          Common
Conversion                  Converted            Price             Shares
============================================================================
January 11, 2001              100                $1.875             566,824
January 18, 2001               52                 1.875             294,961
August 16, 2001                65                  .985             717,029
November 2, 2001               34                  .510             730,082
----------------------------------------                          ----------
   Total                      251                                 2,308,896
========================================                          ==========

The original value of the warrants upon issuance was $348,457. As of December
31, 2001, the Series B Preferred Stock is recorded net of the unaccreted present
value of the warrants of $68,991. Due to the redemption features discussed
above, the Series B Preferred Stock is presented outside of stockholders' equity
in the accompanying consolidated balance sheet. Subsequent to December 31, 2001,
40 and 37 shares of the Series B Preferred Stock, together with related accrued
dividends, were converted into 747,657 and 805,075, respectively, shares of
common stock (Note 19).

11. SERIES C REDEEMABLE 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 the 750 shares of Series C Preferred Stock (par value $0.01 per
share) has a stated value of $10,000 plus dividends of 5% per annum, which sum
is convertible into Common Stock (par value $0.50 per share) at a conversion
price which was initially equal to $7.0565 or 110% of the average of the two
lowest closing bid prices of the Common Stock during the 5 consecutive trading
days immediately preceding the issuance date for the first nine months. The
conversion price will be reset every six months thereafter to the lesser of the
then existing conversion price and the average of the two lowest closing bid
prices of the Common Stock during the 5 consecutive trading days immediately
preceding the six-month reset dates or, for the period beginning on the day two
years after the initial issuance and ending on the maturity of the Series C
Preferred Stock (October 10, 2002), the least of: (i) the then existing
conversion price, (ii) the average of the two lowest closing bid prices of the
Common Stock during the 15 consecutive trading days immediately preceding such
two year date and (iii) the closing bid price on the day of conversion, subject
in each case to certain adjustments. The current conversion price is $0.765. The
5% dividend amount may, at the option of Andrea, be paid in cash or in shares of
Andrea's Common Stock. The Series C Preferred Stock is convertible or redeemable
at maturity by Andrea, based upon certain circumstances at that time, and is
redeemable by the holder upon certain events. As of December 31, 2001, Andrea
has 10,890,411 shares of its common reserved for issuance upon conversion of the
shares of the Series C Preferred Stock. Andrea has the right to require the
conversion of the Series C Preferred Stock after one year upon the satisfaction
of certain conditions. During the 18-month period beginning on October 10, 2000,
the investors may exercise an option to purchase up to an additional $2,500,000
million of Andrea's Series C Preferred Stock, subject to the closing bid price
of Andrea's Common Stock being no less than $7.0565 as of the date of such
exercise. These additional Preferred Shares would be identical in all material
respects to those purchased at Initial Issuance and, consequently, a contingent
beneficial conversion feature exists which may result in the Investor obtaining
a conversion price for such additional Preferred Shares which, at the time of
the exercise of the option, could be less than the market price



                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 28/29



--------------------------------------------------------------------------------

of the Common Stock at such date. In accordance with the provisions of Emerging
Issues Task Force Issue No. 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,"
Andrea may be required to record, at the time of exercise for such additional
Preferred Shares, a charge to accumulated deficit as a result of this beneficial
conversion right.

In accordance with EITF Issue 00-27, "Application of EITF Issue No. 98-5 to
Certain Convertible Instruments," Andrea recorded a one time non-cash charge of
$7,500,000 to accumulated deficit. This pronouncement values the economic
benefit of the contingent beneficial conversion feature that the holders of the
Series C Preferred Stock received when the conversion price of the Series C
Preferred Stock was reset from $7.0565 to $1.44 in July 2001. This charge
represents the maximum charge under this standard and, accordingly, there will
be no additional charges to equity at later reset dates.

The original value of the deal costs upon issuance was $175,000. As of December
31, 2001, the Series C Preferred Stock is recorded net of the unaccreted present
value of the deal costs of $135,989. Due to the redemption features discussed
above, the Series C Preferred Stock is presented outside of stockholders' equity
in the accompanying consolidated balance sheet.

Upon the announcement of a major transaction or upon certain triggering events,
as defined, the investor has the right to require Andrea to redeem all or a
portion of the investor's Series C Preferred Shares at a redemption price equal
to the greater of (i) 120% of the Liquidation Value, as defined, or (ii) the
product of the applicable conversion rate in effect on the date of the major
transaction or the triggering event and the closing bid price of Common Stock of
Andrea on the trading day immediately preceding the major transaction or
triggering event or the closing bid price of Andrea's Common Stock on the date
the holder's delivery to Andrea of notice. In addition, if Andrea is unable to
effect such redemption (i) interest will accumulate on the value of the Series C
Preferred Shares that Andrea is unable to redeem at the rate of 2% per month and
(ii) the holders of the Series C Preferred Stock are entitled to void their
redemption notices and receive a reset of their applicable conversion price.

On March 25, 2002, Andrea announced that a triggering event had occurred and
that as a result of the trigger, the investor had the right to require Andrea to
redeem all of the Series C Preferred Shares. The investor has agreed, in a
Waiver Agreement, to waive its right to receive the aggregate Triggering Event
Redemption Price (as defined in a Certificate of Amendment) (together with any
interest and related cash payments or penalties thereon) the investor was
otherwise entitled to as a result of the existing triggering event until April
7, 2007. In addition, the investor agreed to waive, until April 7, 2007, its
right to receive the aggregate Triggering Event Redemption Price, as defined,
(together with any interest and related cash payments or penalties thereon) with
respect to (1) any future Triggering Event relating to additional registration
failures, provided that the existing registration statements remain effective
and available to the investor for the number of shares currently covered by such
registration statements (less any future sales made pursuant to such
registration statements), and (2) any future Triggering Event relating to the
delisting of Andrea's common stock, provided that the Common Stock is thereafter
authorized for trading on the OTC BB. In addition, the investor agreed to waive,
until April 1, 2007, Andrea's obligation to register any additional shares and
Andrea's obligation to make certain cash payments, if any, for its failure to
register any additional shares. Finally, the investor acknowledged that no
Maturity Date Redemption Price (as defined) is due on October 10, 2002. The
investor's waivers described above shall be null and void immediately, however,
upon the earlier of April 7, 2007, if such Triggering Event Redemption Price is
not paid on April 7, 2007, the first date on which Andrea fails to comply in any
material respect with the terms of the Waiver Agreement, and related agreements
entered into between Andrea and the investor (the "Agreements"), and the first
date on which Andrea is insolvent.

As consideration for the Waiver, Andrea agreed to grant the investor a security
interest in all of Andrea's assets; however, the investor agreed to have its
lien on the Andrea's assets subordinated to (1) any lien granted in the future
to a non-affiliated third party in connection with a strategic transaction with
a financing component, provided that such third-party lien relates only to the
amount of the financing component of such transactions, and (2) any lien granted
in the future to a bank or other similar institution pursuant to any asset based
financing transaction. In addition, the investor agreed to release its lien in
connection with any sale of any assets subject to investor's lien, provided the
investor receives a lien on the proceeds of the sale. The investor acknowledged



Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
December 31, 2001 (Continued)

that its lien in any portion of Andrea's intellectual property is
effectively subordinate to the interest of any current or future licensee of
such intellectual property, as any interest the investor may have in such
intellectual property cannot be greater than Andrea's interest therein.

Given that the waiver granted by the investor does not cover all triggering
events set forth in the Certificate of Amendment and that the waiver will be
null and void in the event Andrea fails to comply in any material respect with
the terms of the Agreements, among other things, there is a risk that the
investor could declare a triggering event that would trigger the redemption
rights.

If such redemption rights are triggered and Andrea has insufficient funds to
satisfy the redemption, Andrea will be required to obtain a new waiver from the
holders of the Series C Preferred Stock. If the Series C Preferred Stock holders
do not consent to such a waiver, Andrea's efforts to obtain additional funding
and capital will be materially adversely affected and its ability to continue
its current operations will be materially adversely affected.

12. LICENSING AGREEMENT

In December 2001 and March 2002, we entered into two agreements with Analog
Devices, Inc to be their provider of noise canceling technologies for use with
certain of their computer audio product offerings. These license agreements
relate to Andrea Electronics' high performance noise canceling technologies that
enable clear voice communications and high-performance audio in small
home-office and regular office environments. Under our agreements with Analog
Devices, they are obligated to pay us a total of $5 million in license fees
during calendar 2002. Through March 2002, and in accordance with our agreements,
we have received $1 million of these license fees. The license agreement
executed in December 2001, as amended, was for $1 million of the aforementioned
license fees, and is recorded as an account receivable and deferred revenue
($258,221 of which is classified as current and $741,779 classified as
long-term) in the accompanying consolidated balance sheets. All license revenues
will be recognized on a straight-line basis over their respective three-year
periods.

13. RETIREMENT PLAN

Andrea has a defined contribution profit sharing plan that is qualified under
Section 401(k) of the Internal Revenue Code and is available to substantially
all of its employees. Andrea's contributions, which serve to match a portion of
participant contributions, were $0, $67,118 and $153,360 for the years ended
December 31, 2001, 2000 and 1999, respectively.

14. INCOME TAXES

Income tax provision (benefit) consists of the following:



Year Ended December 31,                                                                 2001            2000            1999
============================================================================================================================
                                                                                                        
Federal:
   Current                                                                       $        --    $         --     $        --
   Deferred                                                                       (3,258,874)     (2,940,564)     (2,447,011)
State and Local:
   Current                                                                                --              --              --
   Deferred                                                                         (479,246)       (432,436)       (359,855)
   Adjustment to valuation allowance related to net deferred tax assets            3,738,120       3,373,000       2,806,866
----------------------------------------------------------------------------------------------------------------------------
                                                                                 $        --    $         --     $        --
============================================================================================================================


A reconciliation between the effective rate for income taxes and the amount
computed by applying the statutory Federal income tax rate to loss before income
taxes is as follows:



Year Ended December 31,                                                  2001    2000    1999
===============================================================================================
                                                                                
Tax provision at statutory rate                                            34%     34%     34%
State and local taxes                                                       5%      5%      5%
Change in valuation allowance for net deferred tax assets                 (39%)   (39%)   (39%)
-----------------------------------------------------------------------------------------------
                                                                           --      --      --
===============================================================================================




                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 30/31



--------------------------------------------------------------------------------

The tax effects of temporary differences that give rise to significant portions
of the deferred tax asset, net, at December 31, 2001 and 2000, are as follows:



                                                                   2001             2000
========================================================================================
                                                                      
Long-term deferred tax assets:
   Reserve for accrued expenses and trade credit           $    866,000     $    490,000
   Allowance for doubtful accounts                               69,000           73,000
   Reserve for restructuring charges                            303,000          188,000
   Reserve for obsolescence                                     229,000          188,000
   NOL carryforward                                          15,937,000       12,386,000
----------------------------------------------------------------------------------------
                                                             17,404,000       13,137,000
Less: valuation allowance                                   (15,597,385)     (11,330,385)
----------------------------------------------------------------------------------------
   Deferred tax asset, net                                 $  1,806,615     $  1,806,615
========================================================================================


As of December 31, 2001, Andrea had net operating loss and credit carryforwards
of approximately $43,000,000 expiring in varying amounts beginning in 2006
through 2021. The determination that the net deferred tax asset of $1,806,615 at
December 31, 2001 and 2000 is realizable, is based on Andrea's expectations of
future earnings. Included in the remaining fully reserved deferred tax asset of
approximately $15.6 million, is approximately $4.9 million related to tax
benefits associated with the exercise of stock options, which will not result in
a tax benefit in the consolidated statement of operations in future periods but,
rather, will result in further increases to additional paid-in capital, if and
when realized.

15. COMMITMENTS AND CONTINGENCIES

Leases

Andrea's corporate headquarters is located in Melville, New York, where Andrea
leases space for manufacturing, research and development, sales and executive
offices from an unrelated party. The lease is for approximately 40,000 square
feet and expires in June 2008. Rent expense under this operating lease was
approximately $562,000, $540,000 and $507,000 for the years ended December 31,
2001, 2000 and 1999, respectively. As of December 31, 2001, the minimum future
lease commitments, under this lease and all other noncancellable operating
leases, are as follows:


                                                   
2002                                                  $  778,306
2003                                                     776,487
2004                                                     769,311
2005                                                     683,832
2006                                                     711,185
Thereafter                                               339,190
----------------------------------------------------------------
   Total                                              $4,058,311
================================================================


Employment Agreements

Andrea has entered into employment agreements with the officers and Chairman of
the Company. During 2002, Andrea will be negotiating terms to employment
contracts that expire at the end of 2002 and in the first half of 2003. The
future minimum cash commitments under these agreements are as follows:

                                  Number of                          Aggregate
Fiscal Year                      Individuals                       Annual Amount
================================================================================
2002                                  3                               $525,000
2003                                  3                                116,000

Legal Proceedings

Andrea is presently engaged in a lawsuit filed in the U.S. District Court for
the Eastern District of New York by NCT Group, Inc. ("NCT") and its subsidiary
NCT Hearing Products, Inc. NCT alleges that we: engaged in unfair competition by
misrepresenting the scope our patents, specifically, U.S. Pat. Nos. 5,732,143,
5,825,897 and 6,061,456 thereby tortuously interfering with prospective
contractual rights between NCT and its existing and potential customers; made
false and disparaging statements about NCT and its products; and falsely
advertised Andrea's ANR products. The complaint requests a declaration that
these patents are invalid and unenforceable and that NCT's products do not
infringe upon these patents and seeks to enjoin Andrea from engaging in these
alleged activities and seeks compensatory damages of not less than $5 million,
punitive damages of not less than $50 million and plaintiffs' costs and
attorneys' fees.

Andrea has filed and served an answer to the NCT complaint, denying the
allegations and asserting affirmative defenses and counterclaims. Our
counterclaims, as amended, allege that NCT has willfully infringed the above
mentioned patents, and that NCT has engaged in trademark infringement, false
designation of origin, and unfair competition. The counterclaims seek injunctive



Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
December 31, 2001 (Continued)

relief with respect to the allegations of patent infringement, trademark
infringement, false designation of origin and unfair competition. Andrea is also
seeking exemplary and punitive damages, prejudgment interest on all damages,
costs, reasonable attorneys' fees and expenses.

During the third quarter of 2001, the court held a "Markman Hearing" to
determine the meaning of the claims in the three Andrea patents. Andrea is
unable to anticipate when the Court will issue a decision on this question. If
this suit is ultimately resolved in favor of NCT, Andrea could be materially
adversely affected. Andrea believes, however, that NCT's allegations are without
merit and intend to vigorously defend itself and to assert against NCT the
claims described above. This litigation has been dormant from its inception
until the present time.

In addition to the litigation noted above, Andrea is from time to time subject
to routine litigation incidental to its business. While it is not feasible to
predict or determine the final outcome of the claims against Andrea, management
believes that the results of the above noted litigation and other pending legal
proceedings will not have a material adverse effect on Andrea`s financial
condition, results of operations or liquidity.

16. STOCK PLANS

In 1991, the Board of Directors of Andrea (the "Board") adopted the 1991
Performance Equity Plan ("1991 Plan"), which was approved by the shareholders.
The 1991 Plan, as amended, authorizes the granting of awards, the exercise of
which would allow up to an aggregate of 4,000,000 shares of Andrea's common
stock to be acquired by the holders of those awards. 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. Stock options granted to
employees and directors under the 1991 Plan were granted for terms of up to 10
years at an exercise price equal to the market value at the date of grant and
are exercisable in whole or in part at stated times from the date of grant up to
four years from the date of grant.

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
4,375,000 shares of Andrea's common stock to be acquired by the holders of those
awards. Similar to the 1991 Plan, 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.

During the year ended December 31, 2001, Andrea awarded 75,000 shares of
restricted stock under the 1991 Plan, with a weighted-average fair market value
at the date of grant of $1.82 per share. These restricted shares vest one year
from the date of grant. Compensation expense related to these awards was
$104,971 for the year ended December 31, 2001.

Andrea accounts for stock-based awards granted to employees and directors under
APB Opinion No. 25, under which no compensation cost has been recognized for
stock options granted at market value (Note 2). Had compensation cost for these
stock options been determined consistent with SFAS No. 123, Andrea's net loss
and net loss per share would have been as follows:



Year Ended December 31,                                               2001           2000             1999
===========================================================================================================
                                                                                    
Net loss attributable to common shareholders:
   As Reported                                                $(21,694,713)  $ (9,925,561)    $ (7,372,836)
   Pro Forma                                                   (22,592,192)   (11,954,665)     (11,338,178)
Basic and diluted net loss per share:
   As Reported                                                $      (1.43)  $       (.72)    $       (.56)
   Pro Forma                                                         (1.49)          (.87)            (.86)




                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 32/33

--------------------------------------------------------------------------------



The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. Option activity during 2001, 2000 and 1999 is
summarized as follows:



      Year Ended December 31,                                 2001                        2000                       1999
      ==============================================================================================================================
                                                                 Weighted-                   Weighted-                  Weighted-
                                                                  Average                     Average                    Average
                                                     Shares    Exercise Price    Shares    Exercise Price   Shares    Exercise Price
      ------------------------------------------------------------------------------------------------------------------------------
                                                                                                       
      Outstanding at beginning of period           4,964,875      $   7.57     4,300,000      $   8.04    3,082,500      $   9.06
         Granted                                     622,000          1.27     1,233,000          6.27    1,345,000          5.42
         Exercised                                   (27,500)         0.68      (283,125)         5.82      (32,500)         5.67
         Forfeited                                  (578,375)         7.97      (225,625)        12.01      (65,000)        10.93
         Cancelled                                  (767,875)        11.37       (59,375)         9.92      (30,000)         9.52
      ------------------------------------------------------                  ----------                 ----------
      Outstanding at end of period                 4,213,125          6.36     4,964,875          7.57    4,300,000          8.04
      ======================================================                  ==========                 ==========
      Exercisable at end of period                 2,381,375          7.70     2,157,250          7.85    1,439,750          7.34
      ======================================================                  ==========                 ==========
      Weighted-average fair value of options
        granted                                                   $   1.13                    $   4.39                   $   4.14
      ====================================================================                    ========                   ========


      The fair values of the stock options granted were estimated on the date of
      grant using the Black-Scholes option-pricing model with the following
      weighted-average assumptions:



                                                                                                          2001     2000       1999
      ==============================================================================================================================
                                                                                                                    
      Expected life in years                                                                                 3        5          6
      Risk-free interest rates                                                                            4.16%    6.19%      5.92%
      Volatility                                                                                           153%      83%        77%
      Dividend yield                                                                                         0%       0%         0%
      ==============================================================================================================================


The following table summarizes information about stock options outstanding at
December 31, 2001:



                                             Options Outstanding                           Options Exercisable
      ------------------------------------------------------------------------------------------------------------------------------
                                              Weighted-Average
      Range of                    Number         Remaining     Weighted-Average     Number            Weighted-Average
      Exercise Prices          Outstanding   Contractual Life   Exercise Price    Exercisable          Exercise Price
      ==============================================================================================================================
                                                                                      
      $ 0.68 to $ 1.01            320,000          6.35             $ 0.69           120,000               $ 0.68
        1.02 to   1.53              2,000          9.52               1.51                --                   --
        1.54 to   2.32            385,000          9.23               1.77                --                   --
        2.33 to   3.49             10,000          8.93               3.30             2,500                 3.30
        3.50 to   5.25             15,000          4.58               5.00            15,000                 5.00
        5.26 to   7.89          2,583,500          7.12               5.98         1,346,250                 5.83
        7.90 to  11.84            457,625          6.52               8.87           457,625                 8.87
       11.85 to  17.78            440,000          6.36              14.26           440,000                14.26
                                ----------------------------------------------------------------------------------------------------
      $ 0.68 to $17.78          4,213,125          7.10             $ 6.36         2,381,375               $ 7.70
                                ====================================================================================================




Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
December 31, 2001 (Continued)

17. SEGMENT INFORMATION

Andrea follows the provisions of SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." Reportable operating segments are
determined based on Andrea's management approach. The management approach, as
defined by SFAS No. 131, is based on the way that the chief operating
decision-maker organizes the segments within an enterprise for making operating
decisions and assessing performance. While Andrea's results of operations are
primarily reviewed on a consolidated basis, the chief operating decision-maker
also manages the enterprise in three segments: (i) Andrea Anti-Noise Products,
(ii) Aircraft Communication Products, and (iii) Andrea DSP Microphone and
Software Products. Our Andrea Anti-Noise Products include our noise cancellation
and active noise cancellation computer headset products and related computer
peripheral products. Our Andrea DSP Microphone and 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. For the year ended December 31,
2001, our Andrea Anti-Noise Products segment reflects the inclusion of
restructuring charges of approximately $4.5 million (Note 3). The following
represents selected consolidated financial information for Andrea's segments for
the years ended December 31, 2001, 2000 and 1999:



                                                                             Aircraft          Andrea DSP
                                                          Andrea Anti-    Communication      Microphone and
Segment Data                                             Noise Products      Products       Software Products       Total
=============================================================================================================================
                                                                                                  
2001                                                      $  4,318,579    $   4,916,616        $   686,181      $   9,921,376
Income (loss) from operations                               (6,905,641)       1,572,596         (8,460,539)       (13,793,584)
Depreciation                                                   399,739          127,051            214,653            741,443
-----------------------------------------------------------------------------------------------------------------------------
2000
Net sales                                                 $ 11,974,410    $   2,923,031        $   670,223      $  15,567,664
Income (loss) from operations                                  636,060         (426,947)        (9,988,239)        (9,779,126)
Depreciation                                                   409,541          193,197            275,426            878,164
-----------------------------------------------------------------------------------------------------------------------------
1999
Net sales                                                 $ 13,310,138    $   3,802,349        $        --      $  17,112,487
Income (loss) from operations                                1,312,588          591,502         (9,054,825)        (7,150,735)
Depreciation                                                   274,058          123,503            486,165            883,726
=============================================================================================================================


Management of Andrea assesses assets and non-operating income statement data on
a consolidated basis only, and Andrea has not restated any other prior period
information, as it would be impracticable. International revenues are based on
the country in which the end-user is located. For the years ended December 31,
2001, 2000 and 1999, and as of each respective year-end, sales and accounts
receivable by geographic area are as follows:



Geographic Data                                                                           2001           2000            1999
=============================================================================================================================
                                                                                                        
Sales:
   United States                                                                  $  8,198,267   $ 10,877,234   $  11,187,773
   Europe                                                                              486,063      1,788,065       3,803,160
   Other foreign                                                                     1,237,046      2,902,365       2,121,554
-----------------------------------------------------------------------------------------------------------------------------
                                                                                  $  9,921,376   $ 15,567,664   $  17,112,487
=============================================================================================================================
Accounts receivable:
   United States                                                                  $  1,994,022   $  2,055,056   $   1,975,971
   Europe                                                                               11,735        754,155         529,052
   Other foreign                                                                        88,389        694,502         265,680
-----------------------------------------------------------------------------------------------------------------------------
                                                                                  $  2,094,146   $  3,503,713   $   2,770,703
=============================================================================================================================




                               Andrea Electronics Corporation 2001 Annual Report
                                                                      Page 34/35



--------------------------------------------------------------------------------

18. QUARTERLY RESULTS (UNAUDITED)

The following table sets forth unaudited financial data for each of Andrea's
last eight fiscal quarters:



                                               Year Ended December 31, 2001                    Year Ended December 31, 2000
====================================================================================================================================
                                        First       Second      Third       Fourth      First       Second      Third       Fourth
                                       Quarter     Quarter     Quarter     Quarter     Quarter     Quarter     Quarter     Quarter
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                     
Income Statement Data:
 Sales--Operating                   $ 2,615,639 $ 2,617,929 $ 2,937,199 $ 2,088,108 $ 3,201,484 $ 3,181,268 $ 5,318,936 $ 3,865,976
 Sales Reserve--Restructuring/(1)/           --          --          --    (337,499)         --          --          --          --
 Net Sales                            2,615,639   2,617,929   2,937,199   1,750,609   3,201,484   3,181,268   5,318,936   3,865,976
 Cost of Sales--Operating             1,919,354   1,872,758   2,105,848   1,503,645   2,399,175   2,366,353   3,772,311   2,741,810
 Cost of Sales--Restructuring/(1)/           --          --          --   2,573,339          --          --          --          --
 Total Cost of Sales                  1,919,354   1,872,758   2,105,848   4,076,984   2,399,175   2,366,353   3,772,311   2,741,810
 Gross Profit                           696,285     745,171     831,351  (2,326,375)    802,309     814,915   1,546,625   1,124,166
 Restructuring Charges, not
   included above/(1)/                       --          --          --   1,552,892          --          --          --          --
 Loss from Operations                (2,615,958) (2,444,968) (2,060,117) (6,672,541) (2,489,467) (2,527,636) (2,092,278) (2,669,745)
 Net Loss                            (2,546,487) (2,367,680) (2,069,151) (6,646,791) (2,484,621) (2,476,013) (2,045,438) (2,568,280)
 Preferred Stock Dividends              146,285     143,613     140,755     133,951      91,377      60,410      60,577     138,845
 Non-Cash Charge Attributable to
   Beneficial Conversion                     --          --   7,500,000          --          --          --          --          --
   Feature/(2)/
 Net Loss Attributable to
   Common Shareholders               (2,692,772) (2,511,293) (9,709,906) (6,780,742) (2,575,998) (2,536,423) (2,106,015) (2,707,125)
 Basic and Diluted Loss per Share         (0.18)      (0.17)      (0.64)      (0.42)      (0.19)      (0.18)      (0.15)      (0.19)


(1) Restructuring Charges (Note 3)--The net loss applicable to Common
    Shareholders reflects the impact of restructuring charges associated with
    exiting a specific PC headset customer type, or channel, within the
    Anti-Noise Product business segment as follows:

  Sales returns              $    337
  Cost of sales              $  2,573
  Restructuring charges      $  1,553
-------------------------------------
     Total                   $  4,463
=====================================

(2) Non-cash charge attributable to beneficial conversion feature--The net loss
    applicable to Common Shareholders reflects the intrinsic value of the
    realization, during the third quarter of 2001, of a contingent beneficial
    conversion feature related to the Company's Series C Redeemable Convertible
    Preferred Stock.

19. SUBSEQUENT EVENT--CONVERSION OF SERIES B REDEEMABLE SECURITIES

Subsequent to December 31, 2001, 77 shares of Series B Redeemable Convertible
Preferred Stock (Note 10), with aggregate net book value of $749,149, were
converted into 1,552,732 shares of common stock at an average conversion price
of $0.55 per share.



Report of Independent Public Accountants
--------------------------------------------------------------------------------

To Andrea Electronics Corporation:

We have audited the accompanying consolidated balance sheets of Andrea
Electronics Corporation (a New York corporation) and subsidiaries as of December
31, 2001 and 2000, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Andrea Electronics Corporation
and subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States.


/S/ Arthur Andersen LLP

Melville, New York
March 28, 2002



Corporate Information
--------------------------------------------------------------------------------

     BOARD OF DIRECTORS:
     Douglas J. Andrea
     Chairman of the Board of Directors

     Christopher P. Sauvigne
     President & Chief Executive Officer

     Gary A. Jones
     Director

     James M. Griffin
     Director

     Jack Lahav
     Director

     John R. Croteau
     Director

     Louis Libin
     Director

     Scott Koondel
     Director

     CORPORATE OFFICERS:
     Christopher P. Sauvigne
     President & Chief Executive Officer

     Richard A. Maue
     Executive Vice President,
     Chief Financial Officer &
     Corporate Secretary

     INDEPENDENT PUBLIC ACCOUNTANTS:
     Marcum & Kliegman LLP
     130 Crossways Park Drive
     Woodbury, NY 11797

     GENERAL COUNSEL:
     Muldoon, Murphy & Faucette LLP
     5101 Wisconsin Avenue, N.W.
     Washington DC 20016

     INTELLECTUAL PROPERTY COUNSEL:
     Frommer Lawrence & Haug LLP
     745 Fifth Avenue
     New York, NY 10151

     TRANSFER AGENT:
     Continental Stock Transfer & Trust Co.
     2 Broadway
     New York, NY 10004

     MARKET FOR ANDREA ELECTRONICS COMMON EQUITY AND RELATED STOCKHOLDER
     MATTERS:
     Andrea's common stock is listed on the American Stock Exchange under the
     symbol "AND." The table below sets forth the high and low sales prices for
     Andrea's Common Stock as reported by the American Stock Exchange. On March
     27, 2002, there were approximately 534 holders of record of Andrea's
     Common Stock.

     Quarter Ended                        High       Low
     =======================================================
     March 31, 2000                      17.75      7.00
     June 30, 2000                       11.63      5.75
     September 30, 2000                   9.25      5.31
     December 31, 2000                    7.65      1.80

     March 31, 2001                       3.90      1.52
     June 30, 2001                        2.29      1.36
     September 30, 2001                   1.70       .46
     December 31, 2001                    1.00       .50
     =======================================================

     No common stock dividends were paid in 2001 or 2000.






                           WWW.ANDREAELECTRONICS.COM




                           Andrea Electronics Corporation Worldwide Headquarters

                                                           45 Melville Park Road
                                                              Melville, NY 11747
                                                             phone/ 631.719.1800
                                                               fax/ 631.719.1824


                                               Andrea Digital Technologies, Inc.

                                                            1382 West State Road
                                                        Pleasant Grove, UT 84062


[LOGO] ANDREA                                      Lamar Signal Processing, Ltd.

                                                                    P.O. Box 273
                                                              Yoqneam Ilit 20692
                                                                          Israel



                                                                      Appendix B






                 UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON, D.C. 20549

                                      FORM 10-Q


(Mark One)


(X)      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002


                                          OR

(  )     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 (NO FEE REQUIRED) 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                     (I.R.S. employer identification no.)
   incorporation or organization)

45 Melville Park Road, Melville, New York                              11747
------------------------------------------                      --------------------
 (Address of principal executive offices)                            (Zip Code)

Registrant's telephone number, including area code:                 631-719-1800
                                                    --------------------------------------




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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).  Yes __ No X

Indicate the number of shares outstanding of each of the registrant's classes of
common equity, as of the latest practicable date: As of November 12, 2002, there
are 20,043,864 common shares outstanding.





ITEM 1.  FINANCIAL STATEMENTS


                   ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
                        CONDENSED CONSOLIDATED BALANCE SHEETS



                                                                                          September 30,           December 31,


                                                                                              2002                   2001

                                                                                        -----------------      -----------------
                                                                                           (unaudited)             (audited)
                                       ASSETS
                                                                                                             
CURRENT ASSETS:

     Cash and cash equivalents                                                               $  4,711,370          $  3,724,130
     Accounts receivable, net of allowance for doubtful accounts of $70,848 and
     $176,292                                                                                     558,858             2,094,146
     Inventories                                                                                3,617,130             3,389,729
     Prepaid expenses and other current assets                                                    398,737               547,892
                                                                                             ------------          ------------
              Total current assets                                                              9,286,095             9,755,897
PROPERTY AND EQUIPMENT, net                                                                       586,152               811,392
DEFERRED INCOME TAXES                                                                               -                 1,806,615
GOODWILL                                                                                       12,458,872            12,317,843
INTANGIBLE ASSETS                                                                               8,397,648             8,969,950
OTHER ASSETS                                                                                      285,811               357,962
                                                                                             ------------          ------------
              Total assets                                                                   $ 31,014,578          $ 34,019,659
                                                                                             ============          ============
                       LIABILITIES, REDEEMABLE SECURITIES,
                             AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:

     Trade accounts payable                                                                  $    959,765          $  1,147,160
     Current portion of long-term debt                                                             31,364               158,802
     Accrued restructuring charges                                                                388,593               499,724
     Deferred revenue                                                                           1,666,680               258,221
     Other current liabilities                                                                  2,780,712             2,061,075
                                                                                             ------------          ------------
              Total current liabilities                                                         5,827,114             4,124,982
LONG-TERM DEBT                                                                                     21,681                37,619
DEFERRED REVENUE                                                                                2,796,634               741,779
OTHER LIABILITIES                                                                                  34,871                41,509
                                                                                             ------------          ------------
              Total liabilities                                                                 8,680,300             4,945,889
                                                                                             ------------          ------------
COMMITMENTS AND CONTIGENCIES                                                                        -                     -
SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01 par value; authorized:
   1,000 shares; issued and outstanding: 86 and 249 shares, respectively;
   liquidation value:  $860,000 and $2,490,000, respectively                                      839,546             2,421,009
                                                                                             ------------          ------------
SERIES C REDEEMABLE CONVERTIBLE PREFERRED STOCK, net, $.01 par value; authorized:
   1,500 shares; issued and outstanding: 750 shares; liquidation value:
   $7,500,000                                                                                   7,383,615             7,364,011

                                                                                             ------------          ------------
SHAREHOLDERS' EQUITY:
     Preferred stock, $.01 par value; authorized: 4,997,500 shares; none issued
         and outstanding                                                                            -                     -
     Common stock, $.50 par value; authorized: 70,000,000 shares; issued and
         outstanding: 20,011,948 and 16,308,968 shares, respectively                           10,005,974             8,154,484
     Additional paid-in capital                                                                54,479,117            54,642,571
     Deferred stock compensation                                                                  (95,857)              (52,334)
     Accumulated deficit                                                                      (50,278,117)          (43,455,971)
                                                                                             -------------         -------------
              Total shareholders' equity                                                       14,111,117            19,288,750
                                                                                             ------------          ------------
              Total liabilities, redeemable securities, and shareholders' equity             $ 31,014,578          $ 34,019,659
                                                                                             ============          ============


              See Notes to Condensed Consolidated Financial Statements





                   ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
                   CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                    (UNAUDITED)



                                                       For the Three Months Ended                   For the Nine Months Ended

                                                   ------------------------------------        ------------------------------------

                                                              September 30,                               September 30,
                                                        2002                  2001                  2002                   2001
                                                   --------------        --------------        -------------           ------------
                                                                                                            
REVENUES
     Net product revenues                             $1,009,676            $2,937,199            $4,402,993            $8,170,767
     License revenues                                    360,353                -                    536,686                -
                                                     -----------           -----------           -----------           -----------

             Total revenues, net                      $1,370,029            $2,937,199            $4,939,679            $8,170,767

COST OF SALES                                            671,631             2,105,848             2,984,500             5,897,960
                                                     -----------           -----------           -----------           -----------

              Gross profit                               698,398               831,351             1,955,179             2,272,807

RESEARCH AND DEVELOPMENT EXPENSES                        884,772               774,108             2,677,128             2,654,392

GENERAL, ADMINISTRATIVE AND SELLING EXPENSES           1,391,966             2,117,360             4,314,416             6,739,458
                                                     -----------           -----------           -----------           -----------
              Loss from operations                    (1,578,340)           (2,060,117)           (5,036,365)           (7,121,043)
                                                     ------------          ------------          ------------          ------------
OTHER (EXPENSE) INCOME:
     Interest (expense) income, net                      (30,756)               (3,365)              (13,538)              117,505
     Other                                                14,809                (5,669)               34,372                20,220
                                                     -----------           -----------           -----------           -----------
                                                         (15,947)               (9,034)               20,834               137,725
                                                     ------------          ------------          -----------           -----------

LOSS BEFORE PROVISION FOR INCOME TAXES                (1,594,287)           (2,069,151)           (5,015,531)           (6,983,318)

PROVISION FOR INCOME TAXES                             1,806,615                 -                 1,806,615                 -
                                                     -----------           -----------           -----------           -----------
              Net loss                               $(3,400,902)          $(2,069,151)          $(6,822,146)          $(6,983,318)
                                                     ============          ============          ============          ============

PREFERRED STOCK DIVIDENDS                                115,328               140,755               357,854               430,653

NON-CASH CHARGE ATTRIBUTABLE TO BENEFICIAL
CONVERSION FEATURE                                        -                  7,500,000                 -                 7,500,000
                                                     -----------           -----------           -----------           -----------
              Net loss attributable to
                common shareholders                  $(3,516,230)          $(9,709,906)          $(7,180,000)         $(14,913,971)
                                                     ============          ============          ============         =============

PER SHARE INFORMATION:

Net Loss Per Share:
     Basic and Diluted                                     $(.18)                $(.64)                $(.39)               $(1.00)
                                                     ============          ============          ============         =============

Shares used in computing net loss per share:
     Basic and Diluted                                19,216,925            15,137,578            18,356,233            14,848,707
                                                     ===========           ===========           ===========          ============


              See Notes to Condensed Consolidated Financial Statements


                                     -2-




                  ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES

             CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

                  For the Nine Months Ended September 30, 2002

                                  (UNAUDITED)



                                                         Shares                          Additional      Deferred Stock
                                                      Outstanding     Common Stock    Paid-In Capital    Compensation
                                                      -----------     ------------    ---------------    --------------
                                                                                                
BALANCE, January 1, 2002                               16,308,968       $8,154,484      $54,642,571         $(52,334)
  Conversions of Series B Redeemable
      Convertible Preferred Stock, net
      of related costs                                  3,365,480        1,682,740           91,450             -

  Preferred stock dividends                                 -                -             (357,854)            -
  Employee Stock Grant                                    337,500          168,750           60,750         (229,500)
  Option Grant to Consultants                               -                -               42,200          (42,200)
  Amortization of deferred stock compensation               -                -               -               200,589
  Amortization of Option Grant to Consultants               -                -               -                27,588
  Net loss                                                  -                -               -                  -
                                                      -----------     ------------    --------------     -------------
BALANCE, September 30, 2002                            20,011,948      $10,005,974      $54,479,117         $(95,857)

                                                      ===========     ============    ==============     =============




                                                                          Total
                                                       Accumulated    Shareholders'
                                                         Deficit         Equity
                                                      -------------   ------------
                                                                
BALANCE, January 1, 2002                              $(43,455,971)   $19,288,750
  Conversions of Series B Redeemable
      Convertible Preferred Stock, net
      of related costs                                      -           1,774,190

  Preferred stock dividends                                 -            (357,854)
  Employee Stock Grant                                      -               -
  Option Grant to Consultants                               -               -
  Amortization of deferred stock compensation               -             200,589
  Amortization of Option Grant to Consultants               -              27,588
  Net loss                                              (6,822,146)    (6,822,146)
                                                      -------------   ------------
BALANCE, September 30, 2002                           $(50,278,117)    14,111,117
                                                      =============   ============



              See Notes to Condensed Consolidated Financial Statements


                                     -3-




                ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (UNAUDITED)





                                                                                        For the Nine Months Ended
                                                                                              September 30,

                                                                                    ----------------------------------

                                                                                        2002                  2001

                                                                                    ------------          ------------
                                                                                                     
CASH FLOWS FROM OPERATING ACTIVITIES:

   Net loss                                                                          $(6,822,146)          $(6,983,318)
     Adjustments to reconcile net loss to net cash provided by (used in)
          operating activities:

             Non-cash stock compensation expense                                         228,177                 5,760
             Depreciation and amortization                                               936,081             2,048,841
             Deferred income taxes                                                     1,806,615                 -
             Change in:
               Accounts receivable, net                                                1,535,288             1,729,912
               Inventories, net                                                         (227,401)              156,714
               Prepaid expenses and other current assets                                 149,155              (209,062)
               Other assets                                                               72,151                62,183
               Trade accounts payable                                                   (187,395)             (370,386)
               Accrued restructuring charges                                            (111,131)                -
               Deferred revenue                                                        3,463,314                 -
               Other current and long-term liabilities                                   567,476               245,143
                                                                                     -----------           -----------
                  Net cash provided by (used in) operating activities                  1,410,184            (3,314,213)
                                                                                     -----------           ------------


CASH FLOWS FROM INVESTING ACTIVITIES:

   Purchases of property and equipment                                                  (132,686)             (108,313)
   Patents and trademarks                                                               (146,882)             (361,661)
                                                                                     ------------          ------------
                  Net cash used in investing activities                                 (279,568)             (469,974)
                                                                                     ------------          ------------


CASH FLOWS FROM FINANCING ACTIVITIES:

   Payments of debt obligations                                                         (143,376)             (601,717)
   Proceeds from issuance of common stock upon exercise of stock options,
       net of related costs                                                                -                    16,483
                                                                                     -----------           -----------
                  Net cash used in financing activities                                 (143,376)             (585,234)
                                                                                     ------------          ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                     987,240            (4,369,421)

CASH AND CASH EQUIVALENTS, beginning of period                                         3,724,130             9,151,835
                                                                                     -----------           -----------
CASH AND CASH EQUIVALENTS, end of period                                             $ 4,711,370           $ 4,782,414
                                                                                     ===========           ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Non-cash investing and financing activities:

     Conversion of Series B Redeemable Convertible Preferred Stock and

         related accrued dividends into common stock                                 $ 1,774,190            $2,204,740
                                                                                     ===========            ==========
     Stock grant to employees                                                        $   229,500            $   32,250
                                                                                     ===========            ==========
     Option grant to consultant                                                      $    42,400            $    -
                                                                                     ===========            ==========


              See Notes to Condensed Consolidated Financial Statements


                                     -4-



                      ANDREA ELECTRONICS CORPORATION AND SUBSIDIARIES


                    NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Basis of Presentation - The accompanying condensed consolidated financial
     statements include the accounts of Andrea Electronics Corporation and its
     subsidiaries ("Andrea"). All intercompany balances and transactions have
     been eliminated in consolidation.

     These unaudited, condensed consolidated financial statements have been
     prepared in accordance with the instructions for Form 10-Q and accordingly,
     they do not include all of the information and footnotes normally provided
     in annual financial statements.

     The preparation of financial statements in conformity with accounting
     principles generally accepted in the United States of America, requires
     management to make estimates and assumptions that affect the reported
     amounts of assets, liabilities, revenues and expenses reported in those
     financial statements. In the opinion of management, all adjustments
     (consisting of normal recurring accruals) considered necessary for a fair
     presentation have been included.

     Management Estimates - Among other things, estimates are used in accounting
     for allowances for bad debts, inventory obsolescence, restructuring
     reserves, product warranty, depreciation, deferred income taxes, expected
     realizable values for assets (primarily goodwill and intangible assets),
     contingencies, revenue recognition as well as the recording and
     presentation of our 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.

     Andrea believes that adequate disclosures are made to keep the information
     fairly presented. The results of operations for any interim period are not
     necessarily indicative of the results to be expected for the fiscal year.
     For further information, refer to the consolidated financial statements and
     accompanying footnotes included in Andrea's annual report on Form 10-K for
     the year ended December 31, 2001.

     Reclassifications - Certain prior year amounts have been reclassified to
     conform to the current year presentation.

     Revenue Recognition - Non software-related revenue is recognized upon
     shipment. Andrea reports such sales levels on a net sales basis, with net
     sales being computed by deducting from gross sales, the amount of actual
     sales returns and the amount of reserves established for anticipated
     returns. With respect to license revenues, Andrea recognizes revenue in
     accordance with Statement of Position ("SOP") 97-2, "Software Revenue
     Recognition," as amended, and Staff Accounting Bulletin ("SAB") No. 101
     "Revenue Recognition in Financial Statements." License revenue is
     recognized based on the terms and conditions of individual contracts (see
     Note 10). In addition, fee-based services are performed on a
     time-and-material basis or on a fixed-fee basis, under separate service
     arrangements.

2.   Deferred Tax Assets - Statement of Financial Accounting Standards ("SFAS")
     No. 109 "Accounting for Income Taxes" ("FAS 109") requires that a valuation
     allowance be established when it is "more likely than not" that all or a
     portion of deferred tax assets will not be realized. A review of all
     available positive and negative evidence needs to be considered, including
     a company's performance, the market environment in which the company
     operates, the length of carryback and carryforward periods, and
     expectations of future profits, etc.

     FAS 109 further states that forming a conclusion that a valuation allowance
     is not needed is difficult when there is negative evidence such as
     cumulative losses in recent years. Therefore, cumulative losses weigh
     heavily in the overall assessment. Pursuant to a change in circumstances
     during the third quarter, which caused a change in our judgment regarding
     the realizability of deferred tax assets, and after considering all other
     positive and negative evidence (including, in particular, cumulative losses
     in recent years) available to us at September 30, 2002, we concluded that
     it was appropriate to record a full valuation allowance against our net
     deferred tax assets. As a


                                       -5-



     result, we recorded an additional valuation allowance of $1.8 million for
     the quarter ended September 30, 2002. In addition, we expect to provide a
     full valuation allowance on future tax benefits until we can sustain a
     level of profitability that demonstrates our ability to utilize the assets,
     or other significant positive evidence arises that suggests our ability to
     utilize such assets.

3.   Earnings Per Common Share - Basic net loss per common share is computed by
     dividing net loss attributable to common shareholders by the
     weighted-average number of common shares outstanding. Diluted net loss per
     common share is computed by dividing net loss attributable to common
     shareholders by the weighted-average number of common shares and dilutive
     common share equivalents and convertible securities then outstanding. The
     following chart provides a reconciliation of information used in
     calculating the per share amounts:



                                                For the Three Months Ended                  For the Nine Months Ended
                                                      September 30,                               September 30,

                                             ---------------------------------         ----------------------------------

                                                 2002                 2001                  2002                2001
                                             -------------       -------------         -------------      ---------------
                                                                                               
Numerator:
     Net loss                                 $(3,400,902)        $(2,069,151)          $(6,822,146)       $  (6,983,318)
     Preferred stock dividends                    115,328             140,755               357,854              430,653
       Non-cash charge attributable
         to beneficial conversion
         feature                                   -                7,500,000                -                 7,500,000
                                              ------------        ------------          ------------       -------------
       Net loss attributable to
         common shareholders                  $(3,516,230)        $(9,709,906)          $(7,180,000)        $(14,913,971)
                                              ============        ============          ============        =============
Denominator:
     Weighted-average common shares
     outstanding - Basic and Diluted/*/        19,216,925          15,137,578            18,356,233           14,848,707
                                              ===========         ===========           ===========         ============
Net loss per share - Basic and
Diluted                                             $(.18)              $(.64)                $(.39)              $(1.00)
                                              ============        ============          ============         ============


*The effect of dilutive securities (stock options, Redeemable Convertible
Preferred Stock and warrants) have not been included herein as their inclusion
would be anti-dilutive.

4.  In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
    No. 141, "Business Combinations" ("FAS 141") and No. 142, "Goodwill and
    Other Intangible Assets" ("FAS 142"). FAS 141 requires all business
    combinations initiated after September 30, 2001 to be accounted for using
    the purchase method. Under FAS 142, goodwill and intangible assets with
    indefinite lives are no longer amortized but are reviewed annually (or more
    frequently if impairment indicators arise) for impairment. Separable
    intangible assets that are not deemed to have indefinite lives will continue
    to be amortized over their useful lives (but with no maximum life). Andrea
    has adopted FAS 142 effective January 1, 2002, and accordingly, those
    intangible assets that continue to be classified as goodwill or as other
    intangibles with indefinite lives are no longer amortized. Other intangible
    assets, which do not have indefinite lives (such as core technology),
    continue to be amortized. As of January 1, 2002, we made an assessment of
    our intangible assets to identify goodwill separately from other
    identifiable intangibles. No adjustment was deemed necessary, although

                                     -6-



    the intangible asset "Workforce in Place", which amounted to $141,029, was
    reclassified as goodwill. In accordance with FAS 142, intangible assets,
    including purchased goodwill, is evaluated annually for impairment, or more
    often if circumstances warrant. We performed initial transitional
    impairment testing of goodwill and intangible assets during the first
    quarter of fiscal 2002. That effort, and preliminary assessments of our
    identifiable intangible assets, indicated that little or no adjustment would
    be required upon adoption of this pronouncement. The impairment testing is
    performed in two steps: (step one) the determination of impairment, based
    upon the fair value of a reporting unit as compared to its carrying value,
    and (step two) if there is an impairment, this step measures the amount of
    impairment loss by comparing the implied fair value of goodwill with the
    carrying amount of that goodwill.  FAS 142 required that an entity
    complete step one of the transitional goodwill impairment test within six
    months of adoption, and that if there is an indication that the carrying
    amount of the net assets of a reporting unit exceeds its fair value, step
    two must be completed by the end of the fiscal year.  In the second
    quarter of fiscal 2002, we determined that the carrying
    value of this unit might be greater that its fair value. In order to
    finalize our determination of fair value, we will require the assistance of
    a third-party valuation firm.  We anticipate completing this analysis during
    the fourth quarter of 2002.

    The following table presents adjusted net loss and net loss per share data
    restated to include the pro forma retroactive impact of the adoption of FAS
    142:



                                                                Three Months Ended                 Nine Months Ended
                                                                   September 30,                     September 30,

                                                          -------------------------------- -------------------------------

                                                               2002            2001             2002             2001
                                                          -------------   -------------    ------------    ---------------
                                                                                               
Reported Net Loss attributable to common shareholders     $ (3,516,230)   $ (9,709,906)    $ (7,180,000)   $ (14,913,971)
Goodwill and Workforce in Place Amortization                    -              282,047           -               846,141
                                                          --------------  -------------    ------------    ---------------
Adjusted Net Loss                                         $ (3,516,230)   $ (9,427,859)    $ (7,180,000)   $ (14,067,830)
                                                          ==============  =============    ============    ===============

Net Loss Per Share - Basic and Diluted                           $(.18)          $(.64)           $(.39)          $(1.00)

Goodwill and Workforce in Place Amortization                    -                  .02           -                   .06
                                                          --------------  -------------    ------------    ---------------

Adjusted Net Loss Per Common Share                               $(.18)          $(.62)           $(.39)           $(.94)
                                                          ==============  =============    ============    ===============

Weighted-average common shares outstanding - Basic and
Diluted                                                     19,216,925      15,137,578       18,356,233       14,848,707
                                                          ==============  =============    ============    ===============


The changes in the carrying amount of Goodwill and Intangible assets during the
nine months ended September 30, 2002 were as follows:



                                                                    Core           Trademarks and     Workforce in
                                                 Goodwill        Technology           Patents             Place          Totals
                                                -----------     -------------     ----------------   --------------   ------------
                                                                                                       
Balance as of December 31, 2001                 $12,317,843      $ 8,326,587         $ 502,334          $141,029      $21,287,793
Additions during the period                          -                -                146,882              -             146,882
Reclassifications                                   141,029           -                  -              (141,029)           -
Amortization                                         -              (550,581)          (27,574)             -            (578,155)
                                                -----------      ------------        ----------         ---------     ------------
Balance as of September 30, 2002                $12,458,872      $ 7,776,006         $ 621,642          $   -         $20,856,520
                                                ===========      ===========         =========          =========     ===========



                                     -7-




     Intangible assets as of September 30, 2002 and December 31, 2001 consisted
     of the following:



                                                        September 30,           December 31,
                                                            2002                   2001
                                                       ---------------         -------------
                                                                          
Core Technology                                           $7,776,006            $8,326,587
Trademarks and Patents                                       621,642               502,334
Workforce in Place                                           -                     141,029
                                                          ----------            ----------
Total Intangible Assets                                   $8,397,648            $8,969,950
                                                          ==========            ==========


     Amortization of core technology is expected to be approximately $734,000
     a year for the next 11 years. Trademarks and Patents are amortized
     using the straight-line method over 17 years.

5.   Inventories are stated at the lower of cost (on a first in, first out) or
     market.



                                          September 30,           December 31,
                                              2002                   2001
                                        -----------------      ----------------
                                                         
Raw materials                           $      2,308,079       $      2,000,375
Work-in-process                                  294,381                130,167
Finished goods                                 1,794,629              1,845,720
                                        ----------------       ----------------
                                               4,397,089              3,976,262

Less: reserve for obsolescence                  (779,959)              (586,533)
                                        ----------------       ----------------
                                        $      3,617,130       $      3,389,729
                                        ================       ================




6.   New Accounting Pronouncements - In August
     2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
     Disposal of Long-Lived Assets." This statement supersedes SFAS No. 121
     "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
     Assets to Be Disposed Of" and Accounting Principles Board Opinion No. 30
     "Reporting Results of Operations - Reporting the Effects of Disposal of a
     Segment of a Business, and Extraordinary, Unusual and Infrequently
     Occurring Events and Transactions." The Statement retains the fundamental
     provisions of SFAS No. 121 for recognition and measurement of impairment,
     but amends the accounting and reporting standards for segments of a
     business to be disposed of. The provisions of this statement are required
     to be adopted no later than fiscal years beginning after December 31, 2001.
     The impact of adopting this standard was not material to the financial
     statements.

     On April 30, 2002 the FASB issued SFAS No. 145, "Rescission of FASB
     Statements No. 4, 44 and 63, Amendments of FASB Statement No. 13, and
     Technical Corrections" ("FAS 145"). FAS 145 eliminates the requirement that
     gains and losses from the extinguishment of the debt be aggregated and, if
     material, classified as an extraordinary item, net of the related income
     tax effect and eliminates an inconsistency between the accounting for
     sale-leaseback transactions and certain lease modifications that have
     economic effects that are similar to sale-leaseback transactions.
     Generally, FAS 145 is effective for transactions occurring after May 15,
     2002. The adoption of this standard is expected to have no impact to
     Andrea.

     SFAS No. 146, " Accounting for Costs Associated with Exit of Disposal
     Activities" ("FAS 146"), provides guidance on the recognition and
     measurement of liabilities for cost associated with the exit of disposal
     activities. The provisions of this Statement are effective for exit or
     disposal activities that are initiated after December 31, 2002. Andrea is
     currently reviewing FAS 146 to determine the impact upon adoption.

7.   Restructuring Accrual - During the fourth quarter of fiscal 2001, Andrea
     recorded restructuring charges in connection with exiting a PC headset
     channel, or customer-type, within the Anti-Noise Headset Product segment.
     The restructuring charge was recorded as accrued restructuring charges or
     as a reduction of assets, as applicable. During the first nine months of
     fiscal 2002, we made payments of $111,131, which reduced the restructuring

                                     -8-




     liability that had been established during the fourth quarter of fiscal
     2001. As of September 30, 2002, there were no material revisions to the
     plan, exit costs, or the anticipated timing of our plan's execution.

8.   Series B Redeemable Convertible Preferred Stock - On September 22, 1999,
     Andrea issued and sold in a private placement $7,500,000 of Series B
     Redeemable Convertible Preferred Stock (the "Series B Preferred Stock"),
     and a warrant covering 75,000 shares of Andrea's Common Stock. Each of the
     750 shares of Series B Preferred Stock has a stated value of $10,000 plus
     dividends of 4% per annum, which sum is convertible into Common Stock at a
     conversion price equal to the lower of $8.775 (the "Maximum Conversion
     Price") and the average of the two lowest trade prices of the Common Stock
     during the 15 consecutive trading days immediately preceding a conversion
     date (the "Market Price"), subject to certain adjustments, including
     anti-dilution. The 4% dividends may, at the option of Andrea, be paid in
     cash. The warrant has an exercise price of $8.775 per share and expires on
     June 18, 2004.

     All of the Series B Preferred Stock is currently convertible into Andrea's
     Common Stock, and Andrea has reserved 3,560,152 shares of Common Stock for
     issuance upon conversion.

     Upon the announcement of a major transaction, as defined in Andrea's
     Certificate of Incorporation, the holders of the Series B Preferred Stock
     have the right to require Andrea to redeem all or a portion of the holders'
     Series B Preferred Stock at a redemption price equal to the greater of 120%
     of the stated value plus any accrued dividends or the Market Price on the
     day of announcement. In addition, upon the occurrence of certain triggering
     events, and depending on Andrea's control over such events, the holders of
     Series B Preferred Stock may have the right to require Andrea to (i) redeem
     all or a portion of the Series B Preferred Stock at a redemption price
     equal to the greater of 120% of the stated value plus any accrued dividends
     or the Market Price on the day of announcement, or (ii) pay a penalty equal
     to 1% of the remaining principal amount outstanding for a period not to
     exceed 20 days in any 365 day period, and adjust the Maximum Conversion
     Price.

     Andrea is actively seeking to obtain additional capital and funding which,
     if successful, could involve the triggering of the redemption rights. If
     such redemption rights are triggered and Andrea has insufficient funds to
     satisfy the redemption, Andrea will be required to obtain a waiver from the
     holders of the Series B Preferred Stock. If the Series B Preferred Stock
     holders do not consent to such a waiver, Andrea's efforts to obtain
     additional funding and capital will be materially adversely affected and
     its ability to continue its current operations will be materially adversely
     affected.

     In the nine-month period ended September 30, 2002, the following number of
     shares of Series B Preferred Stock, together with related accrued
     dividends, were converted:





                                             Number of Series B                                 Number of
                  Date of Conversion           Preferred Stock           Conversion              Common
                                                  Converted                 Price                Shares
                ------------------------    ----------------------     ----------------    -------------------
                                                                                      
                January 11, 2002                     40                       $0.59               747,657
                March 15, 2002                       37                       $0.51               805,075
                May 22, 2002                         52                       $0.655              886,898
                September 17, 2002                   34                       $0.415              925,850
                                                     --                                           -------

                Total                               163                                         3,365,480
                                                    ===                                         =========



     The original value of the warrants upon issuance was $348,457. As of
     September 30, 2002, the Series B Preferred Stock is recorded net of the
     unaccreted present value of the warrants of $20,454. Due to the redemption
     features described above, the Series B Preferred Stock is presented outside
     of shareholders' equity in the accompanying condensed consolidated balance
     sheets.

                                       -9-



 9.  Series C Redeemable 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 the 750 shares of Series C Preferred Stock (par value $0.01 per
     share) has a stated value of $10,000 plus dividends of 5% per annum, which
     sum is convertible into Common Stock (par value $0.50 per share) at a
     conversion price which was initially equal to $7.0565 or 110% of the
     average of the two lowest closing bid prices of the Common Stock during the
     5 consecutive trading days immediately preceding the issuance date, for the
     first nine months. The conversion price reset every six months thereafter
     to the lesser of the then existing conversion price or the average of the
     two lowest closing bid prices of the Common Stock during the 5 consecutive
     trading days immediately preceding the six-month reset dates or, for the
     period beginning on the day two years after the initial issuance and ending
     on the maturity of the Series C Preferred Stock, the least of: (i) the then
     existing conversion price, (ii) the average of the two lowest closing bid
     prices of the Common Stock during the 15 consecutive trading days
     immediately preceding such two year date or (iii) the closing bid price on
     the day of conversion, subject in each case to certain adjustments. The 5%
     dividend amount may, at the option of Andrea, be paid in cash or in shares
     of Andrea's Common Stock. The Series C Preferred Stock is convertible or
     redeemable at maturity by Andrea, based upon certain circumstances at that
     time, and is redeemable by the holder upon certain events. As of September
     30, 2002, all of the Series C Preferred Stock is currently convertible into
     Andrea's Common Stock, and Andrea has reserved 10,890,411 shares of Common
     Stock for issuance upon conversion of the shares of the Series C Preferred
     Stock. On October 10, 2002, 81.24% of one share of the Series C Preferred
     Stock was converted into 31,916 shares of Common Stock at a conversion
     price of $0.28.

     In accordance with EITF Issue 00-27, "Application of EITF Issue No. 98-5 to
     Certain Convertible Instruments", in the third quarter of 2001, Andrea
     recorded a non-cash charge of $7,500,000 to accumulated deficit. This
     pronouncement values the economic benefit of the contingent beneficial
     conversion feature that the holders of the Series C Preferred Stock
     received when the conversion price of the Series C Preferred Stock was
     reset from $7.0565 to $1.44 in July 2001. This charge represented the
     maximum charge under this standard.

     The original value of the transaction costs upon issuance was $175,000. As
     of September 30, 2002, the Series C Preferred Stock is recorded net of the
     unaccreted present value of the transaction costs of $116,385. Due to the
     redemption features discussed above, the Series C Preferred Stock is
     presented outside of shareholders' equity in the accompanying condensed
     consolidated balance sheet.

     Upon the announcement of a major transaction or upon certain triggering
     events, as defined, the investors have the right to require Andrea to
     redeem all or a portion of the investors' Series C Preferred Stock at a
     redemption price equal to the greater of (i) 120% of the Liquidation Value,
     as defined, or (ii) the product of the applicable conversion rate in effect
     on the date of the major transaction or the triggering event and the
     closing bid price of the Common Stock of Andrea on the trading day
     immediately preceding the major transaction or triggering event or the
     closing bid price of Andrea's Common Stock on the date the holder's
     delivery to Andrea of notice. In addition, if Andrea is unable to effect
     such redemption (i) interest will accumulate on the value of the Series C
     Preferred Stock that Andrea is unable to redeem at the rate of 2% per
     month and (ii) the holders of the Series C Preferred Stock are entitled to
     void their redemption notices and receive a reset of their applicable
     conversion price.

     On March 15, 2002, Andrea announced that a triggering event had occurred
     and that as a result of the trigger, the investor had the right to require
     Andrea to redeem all of the Series C Preferred Stock. The investor has
     agreed, in a Waiver Agreement, to waive its right to receive the aggregate
     Triggering Event Redemption Price (as defined in the Certificate of
     Amendment) (together with any interest and related cash payments or
     penalties thereon) the investor was otherwise entitled to as a result of
     the existing triggering event until April 7, 2007. In addition, the
     investor agreed to waive, until April 7, 2007, its right to receive the
     aggregate triggering event Redemption Price, as defined, (together with any
     interest and related cash payments or penalties thereon) with respect to
     (1) any future triggering event relating to additional registration
     failures, provided that the existing registration statements remain
     effective and available to the investor for the number of shares covered by
     such registration statements as of the date of the waiver (less any future
     sales made pursuant to such registration statements), and (2) any future
     Triggering Event relating to the delisting of Andrea's Common Stock,
     provided that the Common Stock is thereafter authorized for trading on the
     OTC Bulletin Board. In addition, the investor agreed to waive, until April

                                      -10-



     7, 2007, Andrea's obligation to register any additional shares and Andrea's
     obligation to make certain cash payments, if any, for its failure to
     register any additional shares. Finally, the investor acknowledged that no
     Maturity Date Redemption Price (as defined) was due on October 10, 2002.
     The investor's waivers described above shall be null and void immediately,
     however, upon the earlier of April 7, 2007, if such Triggering Event
     Redemption Price is not paid on April 7, 2007, the first date on which
     Andrea fails to comply in any material respect with the terms of the Waiver
     Agreement, and related agreements entered into between Andrea and the
     investor (the "Agreements"), and the first date on which Andrea is
     insolvent.

     As consideration for the Waiver Agreement, Andrea agreed to grant the
     investor a security interest in all of Andrea's assets; however, the
     investor agreed to have its lien on Andrea's assets subordinated to (1) any
     lien granted in the future to a non-affiliated third party in connection
     with a strategic transaction with a financing component, provided that such
     third-party lien relates only to the amount of the financing component of
     such transactions, and (2) any lien granted in the future to a bank or
     other similar institution pursuant to any asset-based financing
     transaction. In addition, the investor agreed to release its lien in
     connection with any sale of any assets subject to the investor's lien,
     provided the investor receives a lien on the proceeds of the sale. The
     investor acknowledged that its lien in any portion of Andrea's intellectual
     property is effectively subordinate to the interest of any current or
     future licensee of such intellectual property, as any interest the investor
     may have in such intellectual property cannot be greater than Andrea's
     interest therein.

     Given that the waiver granted by the investor does not cover all triggering
     events set forth in the Certificate of Amendment and that the Waiver
     Agreement will be null and void in the event Andrea fails to comply in any
     material respect with the terms of the Agreements, among other things,
     there is a risk that the investor could declare a triggering event that
     would trigger the redemption rights.

     If such redemption rights are triggered and Andrea has insufficient funds
     to satisfy the redemption, Andrea will be required to obtain a new waiver
     from the holders of the Series C Preferred Stock. If the Series C Preferred
     Stockholders do not consent to such a waiver, Andrea's efforts to obtain
     additional funding and capital will be materially adversely affected and
     its ability to continue its current operations will be materially adversely
     affected.

10.  In December 2001 and March 2002, Andrea entered into two agreements with
     Analog Devices, Inc. ("Analog Devices"). These license agreements relate to
     Andrea's high performance noise canceling technologies that enable clear
     voice communications and high-performance audio in small home-office and
     regular office environments. Under our agreements with Analog Devices, they
     paid us a total of $5 million in license fees during the first nine months
     of 2002. The unamortized portion of the license agreements, as amended, is
     recorded as deferred revenue ($1,666,680 of which is classified as current
     and $2,796,634 classified as long-term as of September 30, 2002) in the
     accompanying condensed consolidated balance sheets. All license revenues
     are being recognized on a straight-line basis over three-years, $3 million
     of which started to be recognized during the first quarter of 2002, and $2
     million which started in the third quarter of 2002.

11.  Commitments And Contingencies-

     Leases - Andrea's corporate headquarters is located in Melville, New York,
     where Andrea leases space for manufacturing, research and development,
     sales and executive offices from an unrelated party. The lease is for
     approximately 40,000 square feet and expires in June 2008. For the three
     months and nine months ended September 30, 2002, rent expense under this
     operating lease was approximately $148,000 and $435,000, respectively. As
     of September 30, 2002, the minimum future lease commitments, under this
     lease and all other noncancellable operating leases, are as follows:


                                      -11-




         2002 (fourth quarter of 2002)                      $        192,954
         2003                                                        768,195
         2004                                                        744,021
         2005                                                        657,530
         2006                                                        683,832
         Thereafter                                                1,050,375

                                                            ----------------

                               Total                        $      4,096,907
                                                            ================

     Legal Proceedings - As previously reported in Andrea's Annual Report on
     Form 10-K for the year ended December 31, 2001, Andrea was engaged in a
     lawsuit filed in the U.S. District Court for the Eastern District of New
     York by NCT Group, Inc. ("NCT") and its subsidiary NCT Hearing Products,
     Inc. Andrea filed and served an answer to the NCT complaint, denying the
     allegations and asserting affirmative defenses and counterclaims. Effective
     July 29, 2002, Andrea executed a non-cash settlement of the lawsuit with
     NCT which dismissed both NCT's claims and Andrea's counterclaims.


12.  Segment Information- Andrea follows the provisions of SFAS No.  131,
     "Disclosures about Segments of an Enterprise and Related Information"
     ("FAS 131"). Performance measurement and resource allocation for our
     reportable segments are based on many factors. The primary financial
     measure is income (loss) from operations, which includes the
     revenues, costs and expenses directly attributable to each segment,
     as well as an allocation of costs and operating expenses, which are
     not managed at a segment level, but are shared services such as, for
     example, general corporate functions and corresponding costs that are
     determined to be related to the products or services sold for each
     segment.  Income (loss) from operations for our segments excludes any
     provision for income taxes. Reportable operating segments are
     determined based on Andrea's management approach. The management
     approach, as defined by FAS 131, is based on the way that the chief
     operating decision-maker organizes the segments within an enterprise
     for making operating decisions and assessing performance. While our
     results of operations are primarily reviewed on a consolidated basis,
     the chief operating decision-maker also manages the enterprise in
     three segments: (i) Andrea Anti-Noise Headset Products, (ii) Aircraft
     Communications Products, and (iii) Andrea DSP Microphone and Audio
     Software Products. The following represents selected consolidated
     financial information for Andrea's segments for the three months
     ended September 30, 2002, and 2001:



                                                                                Andrea DSP
                                                                                Microphone
                                       Andrea Anti-             Aircraft        and Audio
                                      Noise Headset          Communications      Software          September 30,
          Segment Data                   Products              Products          Products             2002
---------------------------------  --------------------  --------------------  ---------------   ----------------
                                                                                       
Net sales                               $519,254            $347,116             $503,659          $1,370,029
Income (loss) from operations             25,077             (54,685)          (1,548,732)         (1,578,340)
Depreciation                              41,175              23,177               43,631             107,983







                                                                              Andrea DSP
                                                                              Microphone
                                     Andrea Anti-             Aircraft        and Audio
                                    Noise Headset          Communications      Software           September 30,
        Segment Data                   Products              Products          Products              2001
-------------------------------  -------------------   --------------------  ---------------    ----------------
                                                                                       
Net sales                             $1,537,844          $1,201,895           $197,460            $2,937,199
Income (loss) from operations           (365,430)            250,098         (1,944,785)           (2,060,117)
Depreciation                              98,612              27,720             50,756               177,088




                                      -12-



     The following represents selected consolidated financial information for
     Andrea's segments for the nine months ended September 30, 2002, and 2001:



                                                                              Andrea DSP
                                                                              Microphone
                                     Andrea Anti-             Aircraft        and Audio
                                    Noise Headset          Communications      Software           September 30,
        Segment Data                   Products              Products          Products              2002
-------------------------------  --------------------  --------------------  ----------------   ----------------
                                                                                     
Net sales                              $1,772,156           $2,171,450          $996,073         $4,939,679
Income (loss) from operations            (350,312)             320,698        (5,006,751)        (5,036,365)
Depreciation                              132,172               72,103           153,651            357,926







                                                                                Andrea DSP
                                                                                Microphone
                                   Andrea Anti-              Aircraft           and Audio
                                  Noise Headset           Communications         Software        September 30,
        Segment Data                Products                 Products            Products             2001
------------------------------  ---------------------  --------------------  ------------------  ---------------
                                                                                      
Net sales                           $4,030,262                $3,542,012            $598,493      $8,170,767
Income (loss) from operations       (1,861,075)                1,137,319          (6,397,287)     (7,121,043)
Depreciation                           299,982                   100,605             165,835         566,422





     International revenues are based on the country in which the end-user is
     located. For the three months ended September 30, 2002 and 2001, sales and
     accounts receivable by geographic area are as follows:

                                      September 30,         September 30,
              Geographic Data            2002                   2001
            ------------------       ----------------      ---------------


          Sales:

                 United States        $     1,238,137       $     2,513,906
                 Europe                        60,526               136,783
                 Other foreign                 71,366               286,510
                                     -----------------     -----------------
                                     $      1,370,029      $      2,937,199
                                     =================     =================

          Accounts receivable:

                 United States        $       433,492       $     1,576,703
                 Europe                        60,871               102,702
                 Other foreign                 64,495                94,396
                                     -----------------     -----------------
                                     $        558,858      $      1,773,801
                                     =================     =================


For the nine months ended September 30, 2002 and 2001, sales by geographic area
are as follows:

                                       September 30,         September 30,
              Geographic Data             2002                   2001
            ------------------       ------------------     -----------------

        Sales:
             United States            $     4,223,722        $     6,549,833
             Europe                           239,420                506,755
             Other foreign                    476,537              1,114,179
                                     ------------------     -----------------
                                     $      4,939,679       $      8,170,767
                                     ==================     =================

                                      -13-



     The assets and liabilities of Andrea are managed centrally and are reported
     internally in the same manner as the consolidated financial statements,
     thus no additional information is produced for the Chief Executive or
     included herein.

13.  Concentration of Credit Risk - Sales of Andrea Anti-Noise Headset products
     to one customer and its affiliates were approximately 2% and 40% of the
     total sales for the 2002 and 2001 third quarter, respectively, and 7% and
     29% for the 2002 and 2001 first nine months, respectively. Sales to the
     federal government and related subcontractors were approximately 6% and 14%
     of the total sales for the 2002 and 2001 third quarter, respectively, and
     18% and 20% for the 2002 and 2001 first nine months, respectively.

       ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

Overview of Our Products, Technologies and Markets

           We design, develop and manufacture 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.

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

           .   personal computing (primarily for speech recognition applications
               and voice communication over the Internet);

           .   audio and video conferencing;

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

           .   military and commercial aircraft communications systems; and

           .   call centers.

           Our patented and patent-pending digital noise canceling technologies
enable a speaker to be several feet from the microphone, and free the speaker
from having to hold the microphone (we refer to this capability as "far-field"
microphone use). Our DSDA and DFTA microphone products convert sound received
by an array of microphones in a product 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 DFTA, Andrea has developed
and commercialized several other digital, far-field noise canceling
technologies, including, among others, Andrea EchoStop, a high-quality acoustic
echo canceller, and Andrea PureAudio, a leading 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 Pentium) and 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 rear view mirror, or a personal digital assistant, and
can be used individually or combined depending on particular customer
requirements. We are currently targeting our far-field technologies primarily
at 1) the desktop computing market (primarily through our relationship with
Analog Devices, Inc., 2) the market for personal computers designed for use in
automobiles, trucks and buses to control satellite-based navigation systems and
other devices within vehicles, 3) the market for mobile devices, such as a
personal digital assistants and 4) the military and commercial aircraft
communication systems market. Our far-field, digital noise canceling
technologies and related products, together with implementations of other
high-end audio technologies (for example, our Active Noise Reduction
technology), comprise our Andrea Digital Signal Processing (DSP) Microphone and
Audio Software line of business,

                                      -14-



and sales of such technologies and products during the Third Quarter 2002 and
the Third Quarter 2001 approximated 37% and 7%, respectively, of our total net
revenues. We dedicate the majority of our marketing and research and
development resources to this business segment, as we believe that
communication products will increasingly require high performance, untethered
(hands-free and headset-free) microphone technology.

           Our headset microphone products help to ensure clear speech in
personal computer and telephone headset applications. Our Active Noise
Cancellation microphone technology uses electronic circuits that distinguish a
speaker's voice from background noise in the speaker's environment and then
cancels the noise from the signal to be transmitted by the microphone. Our
Active Noise Reduction headphone products use electronic circuits that
distinguish the signal coming through an earphone from background noise in the
listener's environment and then reduces the noise heard by the listener.
Together with our lower-end noise canceling headset products and our call
center headset products that we launched during 2002, these products comprise
our Andrea Anti-Noise Headset line of business. During the fourth quarter 2001,
we recorded restructuring charges relating to repositioning our business plan
for our Andrea Anti-Noise Headset Product business segment as part of our
overall effort to drive high margin product sales and become profitable. The
restructuring focused on exiting from an increasingly unprofitable PC
OEM/retail headset channel within Andrea's Anti-Noise Headset product segment.
This was primarily a result of the increasing competitive nature of the PC
headset market, coupled with Andrea's ongoing strategic efforts to focus on
being primarily a supplier of digital, far-field noise canceling microphone
technologies. This PC OEM/retail headset channel primarily purchased our
lower-end, low margin headset products, and required substantial support which,
when combined with decreasing volumes realized during 2001, became
unprofitable. During the Third Quarter 2002 and the Third Quarter 2001 our
Andrea Anti-Noise Headset Product segment approximated 38% and 52%,
respectively, of our total net revenues.

           For several decades prior to our entry into the voice-activated
computing market in the 1990's, our primary business was selling intercom
systems for military aircraft communications. During 2000 and 2001, we dedicated
development efforts aimed at increasing the manufacturability of certain
intercom products as well as to accommodate future implementation of our
digital, far field noise canceling technologies. We refer to this line of
business as our Aircraft Communications line of business, and sales of such
products during the Third Quarter 2002 and Third Quarter 2001 approximated 25%
and 41%, respectively, of our total net revenues.

           We are incorporated under the laws of the State of New York and have
been engaged in the electronic communications industry since 1934.

           The interim results of operations of Andrea presented in this report
are not necessarily indicative of the actual sales or results of operations to
be realized for the full year.

Our Critical Accounting Policies

           Our condensed consolidated financial statements and the notes to our
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. In addition to the recording and presentation of our
convertible preferred stock, we believe that the following are some of the more
critical judgment areas in the application of our accounting policies that
affect our financial condition and results of operations.  We have discussed
the application of these critical accounting policies with our Audit Committee.

           Revenue Recognition - Non license-related revenue is recognized upon
shipment. Andrea reports such sales levels on a net sales basis, with net sales
being computed by deducting from gross sales the amount of actual sales returns
and the amount of reserves established for anticipated returns. With respect to
license revenues, Andrea recognizes revenue in accordance with Statement of
Position ("SOP") 97-2, "Software Revenue Recognition," as amended, and Staff
Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial
Statement." In addition, fee-based services are performed on a time-and
material basis or on a fixed-fee basis, under separate service arrangements. We
recognize license-related revenues primarily based on an evaluation of the
terms of individual

                                      -15-



contracts (see Note 10 of our condensed consolidated financial statements, for
example) considering, specifically, whether 1) significant obligations remain,
2) evidence of an arrangement exists, 3) the fees are fixed or determinable,
and 4) collectibility is reasonably assured.

           Accounts Receivable - We are required to estimate the collectibility
of our trade receivables. Judgment is required in assessing the realization of
these receivables, including the current creditworthiness of each customer and
related aging of the past due balances. We evaluate specific accounts when we
become aware of a situation where a customer may not be able to meet its
financial obligations due to a deterioration of its financial viability, credit
ratings or bankruptcy. The reserve requirements are based on the best facts
available to us and reevaluated and adjusted as additional information is
received. Our reserves also are determined by using percentages applied to
certain aged receivable categories. At September 30, 2002 our allowance for
doubtful accounts was approximately $71 thousand.

           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 experienced significant inventory charges
in 2001 due to our change in strategic direction resulting, in part, from
declining market conditions. In connection with our restructuring effort, we
incurred inventory charges of approximately $2.6 million during fiscal 2001.
Inventories of approximately $3.6 million at September 30, 2002, are net of
reserves of approximately $780 thousand. It is possible that additional charges
to inventory may occur in the future if there is further declines in market
conditions, or if additional restructuring actions are taken.

           Statement of Financial Accounting Standards, or SFAS, No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS 144")
supersedes SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" ("FAS 121") and Accounting Principles
Board Opinion No. 30 "Reporting Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions". FAS 144 retains the
fundamental provisions of FAS 121 for recognition and measurement of
impairment, but amends the accounting and reporting standards for segments of a
business to be disposed of. The provisions of this statement require management
judgments regarding the future operating and disposition plans for marginally
performing assets, and estimates of expected realizable values for assets to be
sold. The impact of adopting this standard was not material to the financial
statements.

           Under SFAS No. 141, "Business Combinations", and SFAS No. 142,
"Goodwill and Other Intangible Assets" ("FAS 142") requires all business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method. Under FAS 142, goodwill and intangible assets with indefinite
lives are no longer amortized but are reviewed annually (or more frequently if
impairment indicators arise) for impairment. Separable intangible assets that
are not deemed to have indefinite lives will continue to be amortized over
their useful lives (but with no maximum life). Andrea has adopted this standard
effective January 1, 2002, and, accordingly, those intangible assets that
continue to be classified as goodwill or as other intangibles with indefinite
lives are no longer amortized. The adoption of this pronouncement, to date,
resulted in a $846 thousand decrease in amortization expense for the first nine
months of 2002 over the same period in the prior year. Other intangible assets,
which do not have indefinite lives, continue to be amortized. Andrea has made
an assessment of its intangible assets to identify goodwill separately from
other identifiable intangibles. Andrea determined no adjustment was necessary,
although the intangible asset "Workforce in Place" is reclassified as goodwill
pursuant to FAS 142. We performed initial transitional impairment testing of
goodwill and intangible assets during the first quarter of fiscal 2002. That
effort, and preliminary assessments of our identifiable intangible assets,
indicated that little or no adjustment would be required upon adoption of this
pronouncement. The impairment testing is performed in two steps: (step one) the
determination of impairment, based upon the fair value of a reporting unit as
compared to its carrying value, and (step two) if there is an impairment, this
step measures the amount of impairment loss by comparing the implied fair value
of goodwill with the carrying amount of that goodwill. FAS 142 required that an
entity complete step one of the transitional goodwill impairment test within six
months of adoption, and that if there is an indication that the carrying amount
of the net assets of a reporting unit exceeds its fair value, step two must be
completed by the end of the fiscal year. In the second quarter of fiscal 2002,
we determined that the carrying value of our Andrea DSP Microphone and Audio
segment might be

                                      -16-



greater that its fair value. In order to finalize our determination of fair
value, we will require the assistance of a third-party valuation firm. We
anticipate completing this analysis during the fourth quarter of 2002.

           Deferred Tax Assets - We currently have significant deferred tax
assets. SFAS No. 109, "Accounting for Income Taxes"("FAS 109"), requires a
valuation allowance be established when it is more likely than not that all or
a portion of deferred tax assets will not be realized. Furthermore, FAS 109
provides that it is difficult to conclude that a valuation allowance is not
needed when there is negative evidence such as cumulative losses in recent
years. Therefore, cumulative losses weigh heavily in the overall assessment.
Accordingly, and after considering recent changes in existing positive evidence,
we recorded a full valuation allowance against our deferred tax assets during
the third quarter ended September 30, 2002, recognizing a $1.8 million, non-cash
charge. In addition, we expect to provide a full valuation allowance on future
tax benefits until we can sustain a level of profitability that demonstrates our
ability to utilize the assets, or other significant positive evidence arises
that suggests our ability to utilize such assets. The future realization of a
portion of our reserved deferred tax assets related to tax benefits associated
with the exercise of stock options, if and when realized, will not result in a
tax benefit in the consolidated statement of operations, but rather will result
in an increase in additional paid in capital. We will continue to re-assess our
reserves on deferred income tax assets in future periods on a quarterly basis.

           During 2001, we recorded significant charges in connection with a
restructuring program. The related reserves established in that restructuring
reflect various estimates, primarily those pertaining to inventory and
settlements of contractual obligations. We reassess the reserve requirements
under our restructuring program at the end of each reporting period. Actual
experience may be different from our estimates used and, accordingly,
additional charges related to our restructuring may be incurred.

           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' income (loss) from operations. Although any charges related to our
deferred tax assets 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 three months ended
September 30, 2002 (the "2002 Third Quarter") compared to the three months
ended September 30, 2001 (the "2001 Third Quarter") and for the nine months
ended September 30, 2002 (the "2002 First Nine Months") compared to the nine
months ended September 30, 2001 (the "2001 First Nine Months") are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended. The words "anticipates," "believes," "estimates," "expects,"
"intends," "plans," "seeks," variations of such words, and similar expressions
are intended to identify forward-looking statements. We have based these
forward-looking statements on our current expectations, estimates and
projections about our business and industry, our beliefs and certain
assumptions made by our management. Investors are cautioned that matters
subject to forward-looking statements involve risks and uncertainties including
economic, competitive, governmental, technological and other factors that may
affect our business and prospects. These statements are not guarantees of
future performance and are subject to certain risks, uncertainties and
assumptions that are difficult to predict. In order to obtain the benefits of
these "safe harbor" provisions for any such forward-looking statements, we wish
to caution investors and prospective investors about the following significant
factors, which, among others, have in some cases affected our actual results
and are in the future likely to affect our actual results and

                                      -17-



could cause them to differ materially from those expressed in any such
forward-looking statements. These factors include the following:

Because 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;

           -     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;

           -     fluctuations in Department of Defense spending/funding; and

           -     general economic conditions.

           We cannot assure that the level of sales and gross profit, if any,
that we achieve in any particular period will not be significantly lower than in
other periods. Our revenues for the 2002 Third Quarter, were approximately $1.4
million compared to approximately $2.9 million in the 2001 Third Quarter. Net
loss applicable to common shareholders for the 2002 Third Quarter was
approximately $3.5 million, or $0.18 per share on a diluted basis, versus net
loss applicable to common shareholders of approximately $9.7 million, or $0.64
per share on a diluted basis, for the 2001 Third Quarter. In the 2001 Third
Quarter there was a special, one-time, non-cash accumulated deficit charge of
$7.5 million. Our revenues for the 2002 First Nine Months were approximately
$4.9 million compared to approximately $8.2 million in the 2001 First Nine
Months. For the 2002 First Nine Months, we had a net loss attributable to common
shareholders of approximately $7.2 million, or $0.39 per share on a diluted
basis compared to a net loss attributable to common shareholders of $14.9
million, or $1.00 per share on a diluted basis in the 2001 First Nine Months.

Because of increased competition and a shift in business strategy, 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.

           In response to significant declines in our sales of Andrea Anti-Noise
Headset Products as a result of increased competition with respect to a
specific customer channel, as well as our overall shift in strategic direction
to primarily deliver digital, far-field microphone solutions, during the fourth
quarter of 2001, we recorded restructuring charges of approximately $4.5
million. This restructuring is expected to result in further decreases in sales,
on a comparable period basis, during the remainder of fiscal 2002. We are
examining additional opportunities for cost-reduction, production efficiencies
and further diversification of our business. But to remain competitive, we
intend to continue incurring substantial research and development, marketing and
general and administrative expenses. We may not be able to easily and quickly
reduce these expenses if our sales revenue continues to fall below our
expectations and, therefore, our net income or loss may be disproportionately
affected by any further reduction in sales revenue. Furthermore, amortization of
our intangible assets has had, and will continue to have, a negative, non-cash
impact on our results of operations (other than goodwill). As a result of these
factors, we expect to continue to accumulate losses and the market price of our
common stock could decline.

                                      -18-



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, and could result in our
delisting from the American Stock Exchange or inability to continue operations.

           In recent years, we have sustained significant operating losses. We
have been unable to generate sufficient cash flow from operations to meet our
operating needs and, correspondingly, from time to time during the past several
years, we have raised additional capital from external sources. We expect to
continue to 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. 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 the sale of Andrea. Additionally,
Andrea's funding and capital raising efforts could trigger change in control
payments due to certain executive officers of Andrea under their employment
contracts, or redemptions of Andrea's Series B and Series C Redeemable
Convertible Preferred Stock. Given our current financial condition and market
conditions, it may be difficult to attract additional financings on favorable
terms, or at all, as compared to prior periods. We have revised our business
strategies to reduce our expenses and capital expenditures, but we still do not
generate sufficient cash flow from operations to meet our operating needs and
we cannot assure you that we will be successful in obtaining financings or
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 delisting from the American Stock Exchange.

We face the risk that Andrea could be required to redeem the Series B
Redeemable Convertible Preferred Stock.

           On June 22, 1999, Andrea issued and sold in a private placement
$7,500,000 of Series B Redeemable Convertible Preferred Stock (the "Series B
Preferred Stock"), and a warrant covering 75,000 shares of Andrea's Common
Stock. Each of the 750 shares of Series B Preferred Stock (par value $0.01 per
share) has a stated value of $10,000 plus dividends of 4% per annum, which sum
is convertible into Common Stock (par value $0.50 per share) at a conversion
price equal to the lower of $8.775 (the "Maximum Conversion Price") and the
average of the two lowest closing bid prices of the Common Stock during the 15
consecutive trading days immediately preceding a conversion date (the "Market
Price"), subject to certain adjustments, including anti-dilution. The 4%
dividends may, at the option of Andrea, be paid in cash. The warrant has an
exercise price of $8.775 per share and expires on June 18, 2004.

           Upon the announcement of a major transaction, as defined in Andrea's
Certificate of Incorporation, the investors have the right to require Andrea
to redeem all or a portion of the investor's Preferred Shares at a redemption
price equal to the greater of 120% of the stated value plus any accrued
dividends or the Market Price on the day of announcement. In addition, upon the
occurrence of certain triggering events, as defined, and depending on Andrea's
control over such events, the investors may have the right to require Andrea to
i) redeem all or a portion of the Preferred Shares at a redemption price equal
to the greater of 120% of the stated value plus any accrued dividends or the
Market Price on the day of announcement, or ii) pay a penalty equal to 1% of
the remaining principal amount outstanding for a period not to exceed 20 days
in any 365 day period, and adjust the Maximum Conversion Price, as defined. If
we are forced to redeem the Series B Preferred Stock, we would not have
sufficient cash to satisfy the cost of redemption.

We face the risk that Andrea could be required to redeem the Series C
Redeemable 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"). The Series C Preferred Stock is convertible or redeemable at
maturity by Andrea, based upon certain circumstances at that time, and is
redeemable by the holder upon certain events, including the announcement of a
major transaction, as defined in the Certificate of Amendment, or upon certain
other triggering events. In the first quarter of 2002, a triggering event
occurred and we obtained a waiver from the Series C Preferred Stock holders of
their redemption right. A final agreement regarding the waiver arrangement was
reached on March 28, 2002. The waiver related to the existing triggering event,
as well as certain possible future triggering events, however, the waiver will
be null and void upon the earlier of April 7, 2007, the first date on which

                                      -19-



Andrea fails to comply in any material respect with the terms of the waiver and
related documents, and the first date on which Andrea is insolvent.

           As consideration for the Series C Preferred Stock holder's agreement
to waive its current and, in certain circumstances, any future right to receive
the aggregate Triggering Event Redemption Price for the Series C Preferred
Stock, Andrea agreed to grant a security interest in all of Andrea's assets.
However, the Series C Preferred Stock holder agreed to have its lien on
Andrea's assets subordinated to (1) any lien granted in the future to a
non-affiliated third party in connection with a strategic transaction with a
financing component, provided that such third-party lien relates only to the
amount of the financing component of such transactions, and (2) any lien
granted in the future to a bank or other similar institution pursuant to any
asset based financing transaction. In addition, the Series C Preferred Stock
holder agreed to release its lien in connection with any sale of any assets
subject to its lien, provided they receive a lien on the proceeds of the sale.
The Series C Preferred Stock holder acknowledged that its lien in any portion
of Andrea's intellectual property is effectively subordinate to the interest of
any current or future licensee of such intellectual property, as any interest
the investor may have in such intellectual property cannot be greater than
Andrea's interest therein.

           Given that the waiver granted by the Series C Preferred Stock holder
does not cover all triggering events that could require the redemption of the
Series C Preferred Stock, and that the waiver will be null and void in the
event Andrea fails to comply in any material respect with the terms of the
agreements relating to the waiver, among other things, there is a risk that the
Series C Preferred Stock holder could declare a triggering event that would
trigger the redemption rights. If such redemption rights are triggered and
Andrea has insufficient funds to satisfy the redemption, which would be the
case if a redemption occurred at this time, Andrea will be required to obtain a
new waiver from the holder of the Series C Preferred Stock. If no such waiver
can be obtained, Andrea's ability to continue its current operations will be
materially adversely affected and if Andrea has insufficient funds to redeem
the Series C Preferred Stock, it could result in Andrea's inability to meet its
operating obligations and, consequently, delisting from the American Stock
Exchange.

Shares Eligible For Future Sale May Have An Adverse Effect On Market Price; You
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 70,000,000 shares of common stock presently
authorized, 20,043,864 were outstanding as of November 12, 2002. The number of
shares outstanding does not include 6,632,375 shares of our common stock
reserved for issuance upon exercise of outstanding awards granted under our
1991 Performance Equity Plan and 1998 Stock Plan and shares of our common
stock reserved for further awards under the 1998 Stock Plan; nor does it
include 14,410,947 shares of common stock reserved for issuance upon conversion
of the Series B and Series C convertible preferred stock and exercise of
related warrants.

Conversions of our Series B Preferred Stock and Series C Preferred Stock may
result in substantial dilution to other holders of our common stock.

           As of November 12, 2002, we had 86 shares of Series B Preferred Stock
and 749.19 shares of Series C Preferred Stock outstanding. Both the Series B
Preferred Stock and the Series C Preferred Stock are convertible into shares of
common stock, subject to ownership limitations that prohibit the holders of the
preferred stock from owning more than 4.99% of the outstanding shares of common
stock at the time of conversion or 9.99% over the sixty day period prior to the
conversion. These restrictions do not prevent purchasers from converting and
selling some of their holdings and then later converting the rest of their
holdings.

                                      -20-



As the price of our common stock decreases, the number of shares of common
stock issuable upon conversion of our Series B Preferred Stock and Series C
Preferred Stock increases.

           The variable conversion price of the Series B Preferred Stock and the
Series C Preferred Stock are functions of the market price of our common stock.
If the price of our common stock decreases over time, the number of shares of
common stock issuable upon conversion of each series will increase.

           The following table illustrates the varying amounts of shares of
common stock issuable upon conversion of all 86 shares of Series B Preferred
Stock at the indicated conversion prices (without regard to any limitations on
conversion) and assuming that the 4% dividend is paid in cash:

                        Number of Shares of Common
                          Stock Issuable Upon         Percentage of Outstanding
   Conversion Price          Conversion(/1/)                 Common Stock(/2/)
---------------------  -----------------------------  --------------------------
      $0.25                   3,440,000                           15%
      $0.30                   2,866,667                           13%
      $0.35                   2,457,143                           11%
      $0.40                   2,150,000                           10%
      $0.45                   1,911,111                            9%
      $0.50                   1,720,000                            8%

(1)  The holder of Series B Preferred Stock is prohibited from converting its
     holdings of the Series B Preferred Stock if after giving effect to such
     conversion it would beneficially own in excess of 4.99% or, over the sixty
     day period prior to the conversion, 9.99% of the outstanding shares of our
     Common Stock following such conversion. The numbers in this column do not
     reflect these limitations.

(2)  Based on 20,043,864  shares of common stock outstanding as of November 12,
     2002.

         The following table illustrates, as of any reset date and assuming the
conversion price indicated is lower than the then applicable conversion price on
that date, the varying amounts of shares of common stock that would be issuable
upon conversion of all outstanding 749.19 shares of Series C Preferred Stock at
the indicated conversion prices (without regard to any limitations on
conversion) and assuming that the 5% dividend amount is paid in cash:

                        Number of Shares of Common
                          Stock Issuable Upon         Percentage of Outstanding
   Conversion Price          Conversion(/1/)                 Common Stock(/2/)
---------------------  -----------------------------  --------------------------
      $0.25                   29,967,504                          60%
      $0.26                   28,814,907                          59%
      $0.27                   27,747,689                          58%
      $0.28                   26,756,700                          57%
      $0.29                   25,834,055                          56%
      $0.30                   24,972,920                          55%

(1)  The holder of Series C Preferred Stock is prohibited from converting its
     holdings of the Series C Preferred Stock if after giving effect to such
     conversion it would beneficially own in excess of 4.99% or, over the sixty
     day period prior to the conversion, 9.99% of the outstanding shares of our
     common stock following such conversion. The numbers in this column do not
     reflect these limitations.

(2)  Based on 20,043,864  shares of common stock outstanding as of November 12,
     2002.

         The maximum conversion price of the Series C Preferred Stock is $0.30.

         The following table illustrates the varying amounts of shares of Common
Stock that would be issuable upon conversion of all 86 outstanding shares of
Series B Preferred stock and all 749.19 outstanding shares of Series C Preferred
Stock at the indicated conversion prices (without regard to any limitations on
conversion) and assuming that all additional amounts are paid in cash:

                        Number of Shares of Common
                          Stock Issuable Upon         Percentage of Outstanding
   Conversion Price        Conversion(/1/)(/2/)(/3/)       Common Stock(/4/)
---------------------  -----------------------------  --------------------------
      $0.25                   33,407,504                          63%

                                      -21-



      $0.26                   32,122,600                          62%
      $0.27                   30,932,874                          61%
      $0.28                   29,828,128                          60%
      $0.29                   28,799,572                          59%
      $0.30                   27,839,586                          58%
      $0.35                   27,430,063                          58%
      $0.40                   27,122,920                          58%
      $0.45                   26,884,031                          57%
      $0.50                   26,692,920                          57%

(1)  The calculation assumes that the conversion price of the Series B and
     Series C Preferred Stock are the same at the assumed conversion prices of
     $0.25, $0.26, $0.27, $0.28, $0.29 and $0.30.

(2)  The calculation assumes that for any conversion of the Series B Preferred
     Stock when the prevailing market price is above $ 0.30, the Series C
     Preferred Stock would still be converted at its maximum conversion price of
     $ 0.30.

(3)  The holders of Series B and Series C Preferred Stock is prohibited from
     converting the Series C or Series B Preferred Stock, or from exercising the
     warrants issued in connection with the Series B Preferred Stock, if after
     giving effect to such conversion it would beneficially own in excess of
     4.99% or, over the sixty day period prior to the conversion, 9.99% of the
     outstanding shares of our Common Stock following such conversion.

(4)  Based on 20,043,864  shares of common stock outstanding as of November 12,
     2002.

         The conversion rate at November 12, 2002 of the Series B Preferred
Stock and the Series C Preferred Stock was $0.28. If all of the outstanding
shares of the Series B Preferred Stock and the Series C Preferred Stock were
converted on November 12, 2002, we would have issued a total of 33,043,141
shares of common stock. If the market price of our common stock continues to
decline, the conversion rates would increase, resulting in our issuing a greater
number of shares upon conversion of the Series B Preferred Stock and the Series
C Preferred Stock

Sales of an increased number of shares of common stock issued upon conversion of
the Series B Preferred Stock and the Series C Preferred Stock resulting from a
declining market price for our common stock can cause the market price of our
common stock to decline further.

         Disregarding the manner in which the shares of common stock issued upon
conversion of the Series B Preferred Stock and the Series C Preferred Stock are
sold as well as any other factors such as reactions to our operating results and
general market conditions which may be operative in the market at such time, an
increase in the number of shares of common stock eligible for sale can cause a
decrease in the market price of our common stock. This decrease could reduce the
conversion prices of the Series B Preferred Stock and the Series C Preferred
Stock, leading to a further increase in the number of shares of common stock
issuable upon future conversions and a further decline in our stock price.

Short sales of our common stock may be attracted by or accompany conversions of
Series B Preferred Stock and Series C 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. The
result of conversions of the Series B and Series C Preferred Stock at declining
conversion prices would be increasing and substantial dilution of the interests
of the other holders of common stock.

If we fail to market and commercialize our Andrea DSP Microphone and Audio
Software products, or continue to develop Andrea Anti-Noise Headset and Andrea
Aircraft Communications products, our 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
successful commercialization of our Andrea DSP Microphone and Audio Software
products and technologies. We introduced our first Andrea Digital

                                      -22-



Super Directional Array products in 1998 and we are initially targeting these
and our other Andrea DSP Microphone and Audio Software products at the desktop
computer market, the market for in-vehicle computing and the audio and video
conferencing markets, among others. Since we began sales of our initial Andrea
Anti-Noise Headset products in 1995, we have developed and introduced new
products in this line. However, in the fourth quarter of 2001, we also
restructured this business segment which resulted in a significant reduction in
revenues. In addition, we recently developed and introduced a new aircraft
intercom system aimed at increasing overall manufacturability as well as to
enable future implementations of our Andrea DSP Microphone and Audio Software
technologies. 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 Anti-Noise Headset, Andrea DSP
Microphone and Audio Software and our Aircraft Communication products are highly
competitive. We may not compete successfully with any of our competitors. Most
of our current and potential competitors have significantly greater financial,
technology development, marketing, technical support and other resources than we
do. Consequently, these competitors may be able to respond more quickly to new
or emerging technologies and changes in customer requirements, or devote greater
resources to the development, marketing, and sale of their products than we can.
One or more of these competitors may independently develop technologies that are
substantially equivalent or superior to our technology. The introduction of
products incorporating new technologies could render our products obsolete and
unmarketable and could exert price pressures on existing products.

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

         In the markets for Aircraft Communications Products, we often compete
with major defense electronics corporations as well as smaller manufacturing
firms, which specialize in supplying products and technologies for specific
military initiatives.

         Further, the markets for our products and technologies are
characterized by evolving industry and governmental standards and specifications
that may require us to devote substantial time and expense to adapt our products
and technologies. For example, our Aircraft Communications business segment is
subject to the Federal Aviation Administration (FAA). 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.

                                      -23-



If our marketing collaborators do not effectively market their products with
which our products are included or incorporated, our sales growth could 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
will therefore be dependent to a substantial degree on the efforts of these
collaborators to market their products with which our products are included or
incorporated. 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.

If we fail to maintain sales of Aircraft Communication Products to the U.S.
Government, we would experience a material adverse effect on our business,
results of operations and financial condition.

         We experienced a 71% decline in sales of Aircraft Communication
products in the 2002 Third Quarter when compared to the comparable prior year
period. We are dependent on product sales to the U.S. Government. During the
Third Quarter 2002, the U.S. Government accounted for 6% of our net sales. The
U.S. Government is not obligated to continue to purchase these products and is
free to purchase similar products from our competitors. Our failure to maintain
sales of Aircraft Communication Products to the U.S. Government would have a
material adverse effect on our business, results of operations and financial
condition.

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.

         We conduct assembly operations at our facilities in New York and Israel
and through subcontractors (primarily in the Far East) using purchased
components. Some specialized components for the Andrea Anti-Noise Headset,
Aircraft Communications, and Andrea DSP Microphone products, such as
microphones, digital signal processing boards and specialty switches, are
available from a limited number of suppliers (in some cases foreign) and subject
to long lead times. We may not be able to continue to obtain sufficient supplies
of these more specialized components, particularly if the sales of our products
increase substantially or market demand for these components otherwise
increases.

If our subcontractor fails to meet our production and shipment schedules, our
business, results of operations and financial condition would be materially and
adversely affected.

         We conduct assembly operations at our facilities in New York and Israel
and through subcontracting. During initial production runs of Andrea Anti-Noise
Headset and Andrea DSP Microphone products, we perform assembly operations at
our New York facility from purchased components. As sales of any particular
product increase, assembly operations are primarily transferred to a
subcontractor in Asia.

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, nondisclosure agreements with our employees,
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

                                      -24-



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 sales to regions outside the United States, particularly in
Europe and areas in the Americas and Asia. For the three months and nine months
ended September 30, 2002, sales to customers outside the United States accounted
for approximately 10% and 15%, 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 sales in U.S. dollars, and
have not engaged in any foreign exchange or hedging transactions. We may not
continue to be able to invoice all of our sales in U.S. dollars and to avoid
engaging in foreign exchange or hedging transactions. If we are required to
invoice any material amount of international sales 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.

We face risk from operating in Israel

         Our principal research and development facility is located in the State
of Israel and, as a result, certain of our key research and development
employees are located in Israel. Although substantially all of our sales
currently are being made to customers outside Israel, we are nonetheless
directly influenced by the political, economic and military conditions affecting
Israel. Since the establishment of the State of Israel in 1948, a state of
hostility has existed, varying in degree and intensity, between Israel and Arab
countries. Although Israel has entered into various agreements with certain Arab
countries and the Palestinian Authority, and various declarations have been
signed in connection with efforts to resolve some of the economic and political
problems in the Middle East, we cannot predict whether or in what manner these
problems will be resolved.

                                      -25-




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. As of the date of this filing, Andrea is in
the process of negotiating contracts with each of Douglas J. Andrea, Chairman of
the Board of Directors, Christopher P. Sauvigne, President and Chief Executive
Officer, Joseph Marash, Chief Technology Officer and Richard A. Maue, Chief
Financial Officer. Competition for qualified personnel is intense and we may not
be able to attract, assimilate or retain qualified personnel in the future.


Results Of Operations


         Quarter Ended September 30, 2002 Compared to the Quarter Ended
         September 30, 2001 and Nine Months Ended September 30, 2002 Compared to
         the Nine Months Ended September 30, 2001.


Sales


         Sales for the 2002 Third Quarter were $1,370,029, a decrease of 53%
from sales of $2,937,199 for the 2001 Third Quarter. Sales for the 2002 First
Nine Months were $4,939,679, a decrease of 40% from the 2001 First Nine Months
sales of $8,170,767. The decrease in sales for the 2002 Third Quarter reflects
an approximate 66% decrease in sales of Andrea Anti-Noise Headset Products to
$519,254, or 38% of total sales, an approximate 71% decrease of Aircraft
Communications Product to $347,116, or 25% of total sales, both partially offset
by an approximate 155% increase in sales of our Andrea DSP Microphone and Audio
Software Products, to $503,659 , or 37% of total sales. The decrease in sales
for the 2002 First Nine Months reflects an approximate 56% decrease of Andrea
Anti-Noise Headset Products to $1,772,156, or 36% of total sales, an approximate
39% decrease of Aircraft Communications Product to $2,171,450, or 44% of total
sales, both partially offset by an approximate 66% increase in sales of our
Andrea DSP Microphone and Audio Software Products, to $996,073, or 20% of total
sales.

         The primary reason for the decreases in sales of Andrea Anti-Noise
Headset Product is substantially due to our decision, during the fourth quarter
2001, to exit from an unprofitable, PC OEM/retail headset channel within
Andrea's Anti-Noise Headset product segment. This customer channel included IBM,
and for the Third Quarter 2002, sales to IBM and certain of IBM's affiliates,
such sales representing contractual obligations which we accepted during 2001,
accounted for approximately 2% of our total sales, or $27,361. This reflects an
approximate 98% decrease from $1,164,703 for the Third Quarter 2001.

         The decreases in our Aircraft Communication Product revenues is
primarily a result of a decrease in U.S. Department of Defense funding which
affected programs where Andrea's products are used, primarily during the 2002
Third Quarter. For the 2002 Third Quarter, sales of our Aircraft Communications
Products to the U.S. Government accounted for approximately 6% of our total
sales.

         The increases in sales of Andrea DSP Microphone and Audio Software
Products is primarily due to licensing revenue recognized during the Third
Quarter 2002 associated with our agreements with Analog Devices.


Cost of Sales


         Cost of sales as a percentage of sales for the 2002 Third Quarter
decreased to 49% from 72% in the 2001 Third Quarter. Cost of Sales as a
percentage of sales for the 2002 First Nine Months decreased to 60% from 72% for
the 2001 First Nine Months. These decreases primarily reflect the impact of the
significant changes in the composition of our revenues as described under
"Sales" above, in particular, the significant increase in high-margin license
revenues associated with our agreements with Analog Devices (primarily
attributable to the 2002 Third Quarter), coupled with


                                      -26-



the elimination of sales of low-margin Andrea Anti-Noise Headset Products
associated with our restructuring activity in the fourth quarter of 2001.


Research and Development


         Research and development expenses for the 2002 Third Quarter increased
14% to $884,772 from $774,108 for the 2001 Third Quarter. Research and
development expenses for the First Nine Months were $2,677,128, an increase of
1% from the 2001 First Nine Months research and development expenses of
$2,654,392. The substantial amount of research and development is a reflection
of our continuing efforts to develop and commercialize DSP microphone and audio
technologies, coupled with, to a lesser extent, efforts in Aircraft
Communication product technologies and Andrea Anti-Noise Headset Product
technologies. For the 2002 Third Quarter, the Andrea DSP Microphone and Audio
Software Technology efforts were $727,378, or 82% of total research and
development expenses, Aircraft Communications technology efforts were $104,766
or 12% of total research and development expenses and Andrea Anti-Noise Headset
Product efforts were $52,628, or 6% 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 ("DSDA") and certain other
related technologies obtained through the acquisition of Lamar in May 1998. We
believe that the acquisition of Lamar significantly reinforces our position in
digital signal processing by extending our marketing programs to other
high-growth industries, including automotive telematics, mobile device markets,
the business videoconferencing market and Internet telephony, among others.
Specifically, the core technology acquired produces noise filtering capabilities
that management believes is preferred to other known digital, far-field noise
canceling technologies in the market, and is unattainable in products using
traditional mechanical solutions. In addition, the nature of a DSP-based
solution, together with the people acquired supporting our technology, offers a
solution that is highly scalable and embeddable, and therefore enables the
technology to be integrated into many different applications and form factors.
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 for the 2002 Third Quarter
decreased 34% to $1,391,966 from $2,117,360 for the 2001 Third Quarter. General,
administrative and selling expenses for the 2002 First Nine Months were
$4,314,416 a decrease of 36% from the 2001 First Nine Months general,
administrative and selling expenses of $6,739,458. These decreases are primarily
due to cost reduction efforts, as well as our adoption, on January 1, 2002, of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). Under FAS 142, goodwill and intangible assets
with indefinite lives are no longer amortized but are reviewed for impairment
from time to time. The adoption of this pronouncement resulted in decreases of
$282,047 and $846,141 in amortization expense for the 2002 Third Quarter and
2002 First Nine Months, respectively, when compared to the same periods in the
prior year. Notwithstanding the beneficial impact of this pronouncement to our
2002 Third Quarter and 2002 First Nine Months, goodwill and intangible assets
which are no longer subject to periodic amortization will be reviewed for
impairment as part of a transitional assessment and from time to time (at least
annually) thereafter, and such reviews may result in adjustments that would
negatively impact future operating results.


Other Income (Expense)


         Other expense for the 2002 Third Quarter was $15,947 compared to other
expense of $9,034 for the 2001 Third Quarter. Other income for the 2002 First
Nine Months was $20,834 compared to other income of $137,725 for the 2001 First
Nine Months. These declines are a result of unfavorable market conditions for
our invested cash balances experienced in the 2002 First Nine Months.


Provision for Income Taxes


         We recorded a full valuation allowance against our net deferred tax
assets during the 2002 Third Quarter, recognizing a $1,806,615 non-cash charge
to provision for income taxes.

                                      -27-



In addition, we expect to provide a full valuation allowance on future tax
benefits until we can sustain a level of profitability that demonstrates our
ability to utilize the assets, or other significant positive evidence arises
that suggests our ability to utilize such assets. The future realization of a
portion of our reserved deferred tax assets related to tax benefits associated
with the exercise of stock options, if and when realized, will not result in a
tax benefit in the consolidated statement of operations, but rather will result
in an increase in additional paid in capital. We will continue to re-assess our
reserves on deferred income tax assets in future periods on a quarterly basis.


Net Income (Loss)


         Net loss for the 2002 Third Quarter was $3,400,902 compared to a net
loss of $2,069,151 for the 2001 Third Quarter. Net loss for the 2002 First Nine
Months was $6,822,146 compared to a net loss of $6,983,318 for the 2001 First
Nine Months. The levels of net loss for the 2002 Third Quarter and 2002 First
Nine Months principally reflect the factors described above.


Liquidity And Capital Resources


         Andrea's principal sources of funds have historically been, and are
expected to continue to be, gross cash flows from operations and proceeds from
the sale of convertible notes, preferred stock or other securities to certain
financial institutions and potential industry partners. At September 30, 2002,
we had cash and cash equivalents of $4,711,370 compared with $3,724,130 at
December 31, 2001. The balance of cash and cash equivalents at September 30,
2002 is primarily a result of our recently executed license transactions with
Analog Devices, Inc, together with gross cash flows from operations.

         Working capital at September 30, 2002, was $3,458,981 compared to
$5,630,915 at December 31, 2001. The decrease in working capital reflects an
increase of total current liabilities of $1,702,132, partially offset by a
decrease in total current assets of $469,802. The decrease in total current
assets reflects an increase in cash and cash equivalents of $987,240, a decrease
in accounts receivable of $1,535,288 (such decrease is primarily a result of our
collection of license fees from Analog Devices, Inc.), an increase in inventory
of $227,401, and a decrease in prepaid expenses and other current assets of
$149,155. The increase in total current liabilities reflects a decrease in trade
accounts payable of $187,395, a decrease in current portion of long-term debt of
$127,438, a decrease of $111,131 in accrued restructuring charges, an increase
of $1,408,459 in deferred revenue and an increase of $719,637 in other current
liabilities.

         The increase in cash from December 31, 2001 to the period ending
September 30, 2002 of $987,240 reflects $1,410,184 of net cash provided by
operating activities, $279,568 of cash used in investing activities and $143,376
of cash used in financing activities.

         The cash provided by operating activities, excluding non-cash charges,
is primarily comprised of the $6,822,146 net loss for the 2002 Third Quarter, a
$1,535,288 decrease in accounts receivable, a $227,401 increase in inventory, a
$149,155 decrease in prepaid and other current assets, a $72,151 decrease in
other assets, a $187,395 decrease in accounts payable, a $111,131 decrease in
accrued restructuring charges, a $3,463,314 increase in deferred revenue and a
$567,476 increase in other current and long-term liabilities. The change in
accounts receivable and change in deferred revenue primarily reflects the impact
of our license agreements with Analog Devices, Inc. The changes in inventory,
accounts payable and other current and long-term liabilities primarily reflect
differences in the timing related to both the payments for and the acquisition
of raw materials as well as for other services in connection with ongoing
efforts related to Andrea's various product lines.

         The cash used in investing activities reflects an increase property and
equipment of $132,686 and an increase in patents and trademarks of $146,882. The
increase in property and equipment primarily relates to capital expenditures
related to manufacturing dies for our Andrea Anti Noise Headset business line
and our Andrea DSP

                                      -28-



Microphone and Audio Software business line. The increase in patents and
trademarks reflects capital expenditures associated with intellectual property
related to our Andrea DSP Microphone and Audio Software business line.

         We believe that it will be necessary to raise additional working
capital to support operations. In December 1995, April 1996, August 1996 and
June 1998, Andrea raised working capital through the issuance of convertible
subordinated debentures. In June 1999, Andrea raised $7.5 million through the
issuance and sale of Series B Preferred Stock. In October 2000, Andrea raised
$7.5 million through the issuance and sale of Series C Preferred Stock. Andrea
has incurred significant losses in each of the last three fiscal years. In the
year ended December 31, 2001, Andrea incurred losses from operations, excluding
the impact of restructuring charges, of $9.3 million, and used $4.5 million in
cash from its operating activities. Management currently expects that operating
losses and negative cash flows will continue at least through the first quarter
of Fiscal 2003 as Andrea continues to market its products and technologies.
Notwithstanding, in December 2001 and March 2002, we entered into two agreements
with Analog Devices, Inc. whereby Analog Devices paid us a total of $5 million
in license fees during calendar 2002 (which generated positive operating cash
flow in the 2002 First Nine Months). If we fail to develop revenues from sales
of our products to generate adequate funding from operations, or if we fail to
obtain additional financing through a capital transaction or other type of
funding, we will be required to either significantly reduce our current
operating expenses and/or operations or we may have to relinquish our products,
technologies or markets. We have no commitment for additional financing, and we
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
marketing resources to meet such demand on favorable terms, or at all.



ITEM 3. Quantitative And Qualitative Disclosures About Market Risk



         Our principal source of financing activities is the issuance of
convertible debt 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 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 4.  CONTROLS AND PROCEDURES

         a)  Evaluation of disclosure controls and procedures. Andrea
             maintains controls and procedures designed to ensure that
             information required to be disclosed in the reports that it files
             or submits under the Securities Exchange Act of 1934 is recorded,
             processed, summarized and reported within the time periods
             specified in the rules and forms of the Securities and Exchange
             Commission. Based upon their evaluation of those controls and
             procedures performed within 90 days of the filing date of this
             report, the chief executive officer and the chief financial
             officer of Andrea concluded that Andrea's disclosure controls and
             procedures were adequate.

         b)  Changes in internal controls. Andrea made no significant changes
             in its internal controls or in other factors that could
             significantly affect these controls subsequent to the date of the
             evaluation of those controls by the chief executive officer and
             chief financial officer.

                                      -29-



                         PART II. OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS


         See "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Cautionary Statement Regarding
Forward-Looking Statements--An unfavorable ruling in any current litigation
proceeding or future proceeding may adversely affect our business, results of
operations and financial condition" and Note 11 to the unaudited condensed
consolidated financial statements in this quarterly report for a discussion of
the legal proceedings of Andrea.

ITEM 2.    CHANGES IN SECURITIES AND USE OF PROCEEDS

         None.


ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

         None.

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


         On October 11, 2002, at the Annual Meeting of Shareholders of the
Company, the shareholders elected as directors of the Company for terms of one
year, the following individuals Douglas J. Andrea (14,812,643 shares for,
1,888,362 shares withheld); Christopher P. Sauvigne (16,272,476 shares for,
428,529 shares withheld); John R. Croteau (16,305,292 shares for, 395,713 shares
withheld); James M. Griffin (16,184,274 shares for, 516,731 shares withheld);
Gary A. Jones (16,205,492 shares for, 495,513 shares withheld); Scott Koondel
(15,993,945 shares for, 707,060 shares withheld); Jack Lahav (16,302,892 shares
for, 398,113 shares withheld); Louis Libin (16,073,067 shares for, 627,938
shares withheld). The shareholders authorized an amendment to the 1998 Stock
Plan of the Company to increase the number of shares of common stock issuable
thereunder to 5,275,000 shares from 4,375,000 shares (14,388,351 shares for,
2,259,688 shares against, 52,966 shares abstained). In addition, the
shareholders ratified the selection of Marcum & Kliegman LLP as the Company's
independent accountants for the year ending December 31, 2002 (16,471,409 shares
for, 142,015 shares against, and 87,521 shares abstained).


ITEM 5.    OTHER INFORMATION


         None.

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K


   a)  Reports on Form 8-K


              On August 12, 2002, Andrea filed a Current Report on Form 8-K
              reporting that Arthur Andersen LLP was no longer its independent
              accountant and that PricewaterhouseCoopers LLP had been engaged as
              Andrea's independent accountants.

              On August 15, 2002, Andrea filed a Current Report on Form 8-K
              reporting that it had dismissed PricewaterhouseCoopers LLP as it's
              independent accountant.

              On August 15, 2002, Andrea filed a Current Report on Form 8-K
              reporting that Marcum & Kliegman LLP had been engaged as Andrea's
              independent accountants.


                                      -30-



                                    SIGNATURES


Pursuant to the requirements 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



                                                                             
     /s/ Christopher P. Sauvigne         Chief Executive Officer and President     November 13, 2002

     --------------------------------
     Christopher P. Sauvigne


     /s/ Richard A. Maue                  Executive Vice President, Chief          November 13, 2002

     --------------------------------        Financial Officer, and Secretary
     Richard A. Maue




                                CERTIFICATION

I, Christopher P. Sauvigne, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Andrea Electronics
       Corporation;

2.     Based on my knowledge, this quarterly report does not contain any untrue
       statement of a material fact or omit to state a material fact necessary
       to make the statements made, in light of the circumstances under which
       such statements were made, not misleading with respect to the period
       covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other financial
       information included in this quarterly report, fairly present in all
       material respects the financial condition, results of operations and
       cash flows of the registrant as of, and for, the periods presented in
       this quarterly report;

4.     The registrant's other certifying officers and I are responsible for
       establishing and maintaining disclosure controls and procedures (as
       defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
       we have:

       a)   designed such disclosure controls and procedures to ensure that
            material information relating to the registrant, including its
            consolidated subsidiaries, is made known to us by others within
            those entities, particularly during the period in which this
            quarterly report is being prepared;

       b)   evaluated the effectiveness of the registrant's disclosure controls
            and procedures as of a date within 90 days prior to the filing date
            of this quarterly report (the "Evaluation Date"); and

       c)   presented in this quarterly report our conclusions about the
            effectiveness of the disclosure controls and procedures based on
            our evaluation as of the Evaluation Date;

5.     The registrant's other certifying officers and I have disclosed, based
       on our most recent evaluation, to the registrant's auditors and the
       audit committee of registrant's board of directors (or persons
       performing the equivalent function):

       a)   all significant deficiencies in the design or operation of the
            internal controls which could adversely affect the registrant's
            ability to record, process, summarize and report financial data and
            have identified for the registrant's auditors any material
            weaknesses in internal controls; and

       b)   any fraud, whether or not material, that involves management or
            other employees who have a significant role in the registrant's
            internal controls; and

6.     The registrant's other certifying officers and I have indicated in this
       quarterly report whether or not there were significant changes in
       internal controls or in other factors that could significantly affect
       the internal controls subsequent to the date of our most recent
       evaluation, including any corrective actions with regard to significant
       deficiencies and material weaknesses.

 Date:  November 13, 2002             /s/ Christopher P. Sauvigne
                                     ---------------------------
                                         Christopher P. Sauvigne


                                      -31-





                                      Chief Executive Officer and President
                                     (principal executive officer)

                                       CERTIFICATION

I, Richard A. Maue, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Andrea Electronics
       Corporation;

2.     Based on my knowledge, this quarterly report does not contain any untrue
       statement of a material fact or omit to state a material fact necessary
       to make the statements made, in light of the circumstances under which
       such statements were made, not misleading with respect to the period
       covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other financial
       information included in this quarterly report, fairly present in all
       material respects the financial condition, results of operations and
       cash flows of the registrant as of, and for, the periods presented in
       this quarterly report;

4.     The registrant's other certifying officers and I are responsible for
       establishing and maintaining disclosure controls and procedures (as
       defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
       we have:

       a)   designed such disclosure controls and procedures to ensure that
            material information relating to the registrant, including its
            consolidated subsidiaries, is made known to us by others within
            those entities, particularly during the period in which this
            quarterly report is being prepared;

       b)   evaluated the effectiveness of the registrant's disclosure controls
            and procedures as of a date within 90 days prior to the filing date
            of this quarterly report (the "Evaluation Date"); and

       c)   presented in this quarterly report our conclusions about the
            effectiveness of the disclosure controls and procedures based on our
            evaluation as of the Evaluation Date;

5.     The registrant's other certifying officers and I have disclosed, based
       on our most recent evaluation, to the registrant's auditors and the audit
       committee of registrant's board of directors (or persons performing the
       equivalent function):

       a)   all significant deficiencies in the design or operation of the
            internal controls which could adversely affect the registrant's
            ability to record, process, summarize and report financial data and
            have identified for the registrant's auditors any material
            weaknesses in internal controls; and

       b)   any fraud, whether or not material, that involves management or
            other employees who have a significant role in the registrant's
            internal controls; and

6.     The registrant's other certifying officers and I have indicated in this
       quarterly report whether or not there were significant changes in
       internal controls or in other factors that could significantly affect
       the internal controls subsequent to the date of our most recent
       evaluation, including any corrective actions with regard to significant
       deficiencies and material weaknesses.

Date:  November 13, 2002             /s/ Richard A. Maue
                                     -----------------------------------------
                                     Richard A. Maue
                                     Executive Vice President, Chief
                                     Financial Officer and Secretary
                                     (principal financial officer)


                                      -32-



                         ANDREA ELECTRONICS CORPORATION

                         Special Meeting of Shareholders
                                January 31, 2003
                             9:30 a.m., Eastern time

               This proxy is solicited by the board of directors.

     The undersigned shareholder(s) of Andrea Electronics Corporation, a New
York corporation ("Company"), hereby appoints Douglas J. Andrea and Christopher
P. Sauvigne, or either of them, with full power of substitution and to act
without the other, as the agents, attorneys and proxies of the undersigned, to
vote the shares standing in the name of the undersigned at the special meeting
of shareholders of the Company to be held on January 31, 2003 and at all
adjournments thereof with all the powers the undersigned would possess if
personally present at such meeting. This proxy will be voted in accordance with
the instructions given below. If no instructions are given, this proxy, properly
signed and dated, will be voted "FOR" all of the following proposals.

1.   To approve the amendment to the Restated Certificate of Incorporation of
     the Company to increase the authorized shares of common stock from
     70,000,000 shares to 200,000,000 shares.

           FOR ( )                AGAINST ( )             ABSTAIN ( )

2.   To approve the amendment to the Restated Certificate of Incorporation of
     the Company to reduce the par value of the Company's common stock from
     $0.50 per share to $0.01 per share.

           FOR ( )                AGAINST ( )             ABSTAIN ( )

     The board of directors recommends a vote "FOR" approval of Proposal 1 and
Proposal 2.



     This proxy, properly signed and dated, will be voted as directed, but if no
instructions are specified, this proxy will be voted "FOR" both proposals. If
any other business is presented at the special meeting, including whether or not
to adjourn the meeting, this proxy will be voted by the proxies in their best
judgment. At the present time, the board of directors knows of no other business
to be presented at the special meeting.

(  ) The undersigned plan on attending the special meeting.


                                              Dated:____________________________



                                              __________________________________
                                              SIGNATURE OF STOCKHOLDER


                                              __________________________________
                                              SIGNATURE OF CO-HOLDER (IF ANY)


     The above signed acknowledges receipt from the Company prior to the
execution of this proxy of a notice of special meeting of stockholders and of a
proxy statement for the special meeting of stockholders.

     Please sign exactly as your name appears on this card. When signing as
attorney, executor, administrator, trustee or guardian, please give your full
title. If shares are held jointly, each holder may sign but only one signature
is required.

                          -----------------------------

            PLEASE COMPLETE, DATE, SIGN AND PROMPTLY MAIL THIS PROXY
                     IN THE ENCLOSED POSTAGE-PAID ENVELOPE.