UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 27, 2008

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

For the transition period from                      to                     

HearUSA, Inc.

Delaware		22-2748248
(State of Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)
1250 Northpoint Parkway, West Palm Beach, Florida		33407
(Address of Principal Executive Offices)		(Zip Code)

Indicate by check 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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” and “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting Company o

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

On November 6, 2008, 37,918,254 shares of the Registrant’s Common Stock and 506,661 exchangeable shares of HEARx Canada, Inc. were outstanding.

 

 

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets September 27, 2008 and December 29, 2007			3
Consolidated Statements of Operations Nine months ended September 27, 2008 and September 29, 2007			4
Consolidated Statements of Operations Three months ended September 27, 2008 and September 29, 2007			5
Consolidated Statements of Cash Flows Nine months ended September 27, 2008 and September 29, 2007			6
Notes to Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			35
Item 4. Controls and Procedures			36
PART II. OTHER INFORMATION
Item 1A. Risk Factors			37
Item 6. Exhibits			38
Signatures			40
Exhibit 10.1
Exhibit 10.2
Exhibit 31.1
Exhibit 31.2
Exhibit 32

Part I – Financial Information

Item 1. Financial Statements

HearUSA, Inc.

		September 27,				December 29,
		2008				2007
		(Dollars in thousands)
ASSETS (Note 4)
Current assets
Cash and cash equivalents		$	3,546			$	3,369
Accounts and notes receivable, less allowance for doubtful accounts of $503,000 and $498,000			8,848				8,825
Inventories			2,814				2,441
Prepaid expenses and other			1,238				1,283
Deferred tax asset			62				62
Total current assets			16,508				15,980
Property and equipment, net (Note 2)			4,896				4,356
Goodwill (Note 2)			68,405				63,134
Intangible assets, net (Note 2 and 3)			35,378				16,165
Deposits and other			819				691
Restricted cash and cash equivalents			216				216
Total Assets		$	126,222			$	100,542
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	15,051			$	12,467
Accrued expenses			3,060				2,523
Accrued salaries and other compensation			3,572				3,521
Current maturities of long-term debt			19,350				10,746
Current maturities of subordinated notes, net of debt discount of $60,000 in 2007			—				1,480
Dividends payable			34				34
Minority interest in net income of consolidated joint venture, currently payable			1,636				1,221
Total current liabilities			42,703				31,992
Long-term debt (Notes 4 and 7)			50,177				36,499
Deferred income taxes			7,299				6,462
Total long-term liabilities			57,476				42,961
Commitments and contingencies
Stockholders’ equity (Note 8)
Preferred stock (aggregate liquidation preference $2,330,000, $1 par, 7,500,000 shares authorized)
Series H Junior Participating (none outstanding)			—				—
Series J (233 shares outstanding)			—				—
Total preferred stock			—				—
Common stock: $0.10 par; 75,000,000 shares authorized 38,424,915 and 38,325,414 shares issued			3,842				3,833
Stock subscription			—				(412	)
Additional paid-in capital			133,624				133,261
Accumulated deficit			(113,589	)			(113,076	)
Accumulated other comprehensive income			4,651				4,468
Treasury stock, at cost: 523,662 common shares			(2,485	)			(2,485	)
Total Stockholders’ Equity			26,043				25,589
Total Liabilities and Stockholders’ Equity		$	126,222			$	100,542

See accompanying notes to consolidated financial statements.

HearUSA, Inc

		September 27,				September 29,
		2008				2007
		(Dollars in thousands, except per
		share amounts)
Net revenues
Hearing aids and other products		$	81,640			$	70,107
Services			5,890				5,178
Total net revenues			87,530				75,285
Operating costs and expenses
Hearing aids and other products (Note 4)			23,541				18,576
Services			1,793				1,531
Total cost of products sold and services			25,334				20,107
Center operating expenses			42,999				37,316
General and administrative expenses (Notes 1 and 8)			11,664				11,306
Depreciation and amortization			1,922				1,597
Total operating costs and expenses			81,919				70,326
Income from operations			5,611				4,959
Non-operating income (expense):
Interest income			29				106
Interest expense (Notes 2, 3, 4, 5 and 6)			(4,060	)			(6,707	)
Income (loss) from continuing operations before income tax expense and minority interest in income of consolidated joint venture			1,580				(1,642	)
Income tax expense			(815	)			(634	)
Minority interest in income of consolidated joint venture			(1,174	)			(1,077	)
Net loss			(409	)			(3,353	)
Dividends on preferred stock			(104	)			(103	)
Net loss applicable to common stockholders		$	(513	)		$	(3,456	)
Net loss applicable to common stockholders per common share – basic and diluted		$	(0.01	)		$	(0.10	)
Weighted average number of shares of common stock outstanding – basic and diluted			38,501				35,860

See accompanying notes to consolidated financial statements.

HearUSA, Inc.

		September 27,				September 29,
		2008				2007
		(Dollars in thousands, except per
		share amounts)
Net revenues
Hearing aids and other products		$	26,740			$	25,050
Services			1,977				1,812
Total net revenues			28,717				26,862
Operating costs and expenses
Hearing aids and other products (Note 4)			7,448				6,807
Services			638				499
Total cost of products sold and services			8,086				7,306
Center operating expenses			14,424				12,585
General and administrative expenses (Notes 1 and 8)			3,275				3,890
Depreciation and amortization			635				572
Total operating costs and expenses			26,420				24,353
Income from operations			2,297				2,509
Non-operating income (expense):
Interest income			7				21
Interest expense (Notes 2, 3, 4, 5 and 6)			(1,566	)			(1,330	)
Income from continuing operations before income tax expense and minority interest in income of consolidated joint venture			738				1,200
Income tax expense			(296	)			(284	)
Minority interest in income of consolidated joint venture			(482	)			(394	)
Net income (loss)			(40	)			522
Dividends on preferred stock			(35	)			(34	)
Net income (loss) applicable to common stockholders		$	(75	)		$	488
Net income (loss) applicable to common stockholders per common share – basic		$	(0.00	)		$	0.01
Net income (loss) applicable to common stockholders per common share – diluted		$	(0.00	)		$	0.01
Weighted average number of shares of common stock outstanding – basic			38,408				37,950
Weighted average number of shares of common stock outstanding –diluted			38,408				46,415

See accompanying notes to consolidated financial statements.

HearUSA, Inc.

		September 27,				September 29,
		2008				2007
		(Dollars in thousands)
Cash flows from operating activities
Net loss		$	(409	)		$	(3,353	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Debt discount amortization			192				1,958
Interest on reduction of warrant exercise price			—				1,371
Depreciation and amortization			1,922				1,597
Employee and director stock-based compensation			607				386
Provision for doubtful accounts			396				372
Minority interest in income of Joint Venture			1,174				1,077
Deferred income tax expense			815				625
Interest on discounted notes payable			355				—
Interest on discounted long-term contractual commitment to AARP			260				—
Consulting stock-based compensation			33				128
Loss on disposition of property and equipment			70				—
Principal payments on long-term debt made through rebate credits			(2,996	)			(3,521	)
Other			(200	)			(2	)
(Increase) decrease in:
Accounts and notes receivable			(453	)			(1,273	)
Inventories			(342	)			202
Prepaid expenses and other			(44	)			501
Increase in:
Accounts payable and accrued expenses			5,886				485
Accrued salaries and other compensation			41				212
Net cash provided by operating activities			7,307				765
Cash flows from investing activities
Purchase of property and equipment			(1,192	)			(551	)
Business acquisitions			(3,551	)			(3,844	)
Net cash used in investing activities			(4,743	)			(4,395	)
Cash flows from financing activities
Proceeds from issuance of long-term debt			3,408				8,891
Principal payments on long-term debt			(3,620	)			(2,728	)
Principal payments on convertible subordinated notes			—				(784	)
Principal payments on subordinated notes			(1,540	)			(1,320	)
Proceeds from the exercise of warrants			—				1,734
Proceeds from the exercise of employee options			146				17
Dividends paid on preferred stock			(104	)			(103	)
Distributions paid to minority interest			(759	)			(890	)
Net cash provided by (used in) financing activities			(2,469	)			4,817
Effects of exchange rate changes on cash			82				13
Net increase in cash and cash equivalents			177				1,200
Cash and cash equivalents at the beginning of period			3,369				2,326
Cash and cash equivalents at the end of period		$	3,546			$	3,526
Supplemental disclosure of cash flows information:
Cash paid for interest		$	647			$	1,169
Supplemental schedule of non-cash investing and financing activities:
Principal payments on long-term debt made through rebate credits		$	(2,996	)		$	(3,521	)
Issuance of notes payable in exchange for business acquisitions		$	2,976			$	3,540
Long-term contractual commitment to AARP in exchange for intellectual property		$	19,533			$	—
Issuance of capital lease in exchange for property and equipment		$	223			$	416
Purchase of equipment with volume discount credit		$	200			$	—
Conversion of accounts payable to notes payable		$	2,843			$	—

See accompanying notes to consolidated financial statements.

HearUSA, Inc.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three month and the nine month periods ended September 27, 2008 are not necessarily indicative of the results that may be expected for the year ending December 27, 2008. For further information, refer to the audited consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 29, 2007.

1.

Description of the Company and Summary of Significant Accounting Policies

The Company

HearUSA Inc. (“HearUSA” or “the Company”), a Delaware corporation, was organized in 1986. As of September 27, 2008 the Company has a network of 198 company-owned hearing care centers in ten states and the Province of Ontario, Canada. The Company also sponsors a network of approximately 1,900 credentialed audiology providers that participate in selected hearing benefit programs contracted by the Company with employer groups, health insurers and benefit sponsors in 49 states. The centers and the network providers provide audiological products and services for the hearing impaired.

Basis of Consolidation

The Company’s 50% owned joint venture, HEARx West, generated net income of approximately $2.3 million and $2.2 million during the first nine months of 2008 and 2007, respectively. The Company records 50% of the venture’s net income as minority interest in the income of a Joint Venture in the Company’s consolidated statements of operations. The minority interest for the first nine months of 2008 and 2007 was approximately $1.2 million and $1.1 million, respectively.

Net income (loss) applicable to common stockholders per common share

The Company calculates net income per share in accordance with SFAS No. 128, “Earnings Per Share.” Basic earnings per share (“EPS”) is computed by dividing net income or loss attributable to common stockholders by the weighted average of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (convertible preferred stock, warrants to purchase common stock and common stock options using the treasury stock method) were exercised or converted into common stock. Potential common shares in the diluted EPS computation are excluded where their effect would be antidilutive.

Common stock equivalents for convertible debt, outstanding options and warrants to purchase common stock of approximately 8.9 million and 9.3 million, respectively, were excluded from the computation of net loss applicable to common stockholders per common share – diluted for the nine and three month periods ended September 27, 2008 and approximately 8.5 million were excluded from the computation of net loss applicable to common stockholders per common share – diluted for the nine month period ended September 29, 2007. For purposes of computing net loss applicable to common stockholders per common share – basic and diluted, for the nine and three months ended September 27, 2008 and September 29, 2007, respectively, the weighted average number of shares of common stock outstanding includes the effect of the 506,661 and 603,461, respectively, exchangeable shares of HEARx Canada, Inc., as if they were outstanding common stock of the Company.

HearUSA, Inc.
Notes to Consolidated Financial Statements

Comprehensive income (loss)

Components of comprehensive income (loss) are as follows:

		Nine Months Ended								Three Months Ended
		September 27,				September 29,				September 27,				September 29,
Dollars in thousands		2008				2007				2008				2007
Net income (loss) for the period, applicable to common stockholders		$	(513	)		$	(3,456	)		$	(75	)		$	488
Foreign currency translation adjustments			(183	)			2,012				(319	)			915
Comprehensive income (loss) for the period		$	(696	)		$	(1,444	)		$	(394	)		$	1,403

2.

Business Acquisitions

The Company is continuing its strategic acquisition program in 2008. The program consists of acquiring hearing care centers located in the Company’s core and target markets.

During the first nine months of 2008, the Company acquired the assets of eighteen hearing care centers in Michigan, Florida, California, New York, North Carolina, Pennsylvania and the Province of Ontario in ten separate transactions. Consideration included cash of approximately $3.3 million and notes payable of approximately $3.0 million. The acquisitions resulted in additions to goodwill of approximately $5.3 million, fixed assets of approximately $114,000 and customer lists and non-compete agreements of approximately $1.0 million. The notes payable bear interest varying from 5% to 7% and are payable in quarterly installments varying from $3,000 to $83,000, plus accrued interest, through September 2012. In accordance with SFAS 141 “Business Combinations” these notes have been recorded at their fair value on the date of issuance using an imputed interest rate of 10%. The Company withdrew approximately $3.4 million from its acquisition line of credit with Siemens (see Note 4 – Long-term Debt) to fund these acquisitions.

The following unaudited pro forma information represents the results of operations for HearUSA, Inc. for the nine and three months ended September 27, 2008, as if the acquisitions had been consummated as of December 29, 2007. This pro forma information does not purport to be indicative of what may occur in future years.

		Nine Months Ended				Three Months Ended
Dollars in thousands, except per share amounts		September 27, 2008				September 27, 2008
Total revenue		$	89,266			$	29,331
Net income (loss) applicable to common stockholders		$	(369	)		$	(35	)
Net income (loss) applicable to common stockholders per share – basic		$	(0.01	)		$	(0.00	)
Net income (loss ) applicable to common stockholders per share –diluted		$	(0.01	)		$	(0.00	)

3.

Intangible- AARP License Agreement (Note 4)

On August 8, 2008, HearUSA, Inc. (the “Company”) entered into a Hearing Care Program Services Agreement with AARP, Inc. and AARP Services, Inc. (the “Services Agreement”), and an AARP License Agreement with AARP, Inc. (the “License Agreement”), pursuant to which the Company will provide an AARP-branded discount hearing care program to AARP members.

HearUSA, Inc.
Notes to Consolidated Financial Statements

Under the Services Agreement, the Company has agreed to provide to AARP members discounts on hearing aids and related services, through the Company’s company-owned centers and independent network of hearing care providers. Hearing aids sold under the AARP program will come with a three- year limited warranty and a three-year supply of batteries included in the price of the hearing aid. The Company will allocate $4.4 million annually to promote the AARP program to AARP members and the general public, and will contribute 9.25% of that amount to AARP’s marketing cooperative. The Company will also contribute $500,000 annually to fund an AARP sponsored education campaign to educate and promote hearing loss awareness and prevention to AARP members and the general public. The Company has also committed, in cooperation with AARP, to donate a number of hearing aids annually (1,000 hearing aids in calendar year 2009) to be distributed free of charge to economically disadvantaged individuals who have experienced hearing loss. The Company expects to begin the program during the fourth quarter of 2008. The Company has agreed to make the program available through a combination of company-owned centers and independent network providers in all 50 States, the District of Columbia and five U.S. Territories (American Samoa, Guam, Marianas Islands, Puerto Rico and the U.S. Virgin Islands) by 2010. The Services Agreement has an initial term of three years ending on December 1, 2011. At the end of the initial three year term, the Company has an option to extend the term of the Services Agreement for an additional two year period.

Pursuant to the License Agreement, AARP granted the Company a limited license to use the AARP name and related trade and service marks in connection with the operation and administration of the AARP program, including the advertising and promotion of the program. The term of the License Agreement will run concurrently with the term of the Services Agreement. The Company will pay AARP a fixed annual royalty of $7.6 million for each year of the initial three year term of the AARP program. The royalty payment is payable to AARP in equal quarterly installments beginning on January 10, 2009. If the Company exercises its option to extend the AARP program for the additional two-year period, the royalty payment to AARP will increase to $11 million in the first option year and $12 million in the second option year.

The License Agreement has been recorded at its fair value of approximately $19.3 million in accordance with SFAS 142 “Goodwill and Other Intangibles”, with a corresponding increase in long-term debt.

4.

Long-term Debt (Notes 5 and 6)

Long-term debt consists of the following:

		September 27,				December 29,
Dollars in thousands		2008				2007
Notes payable to Siemens Tranche B		$	5,268			$	5,403
Tranche C			23,685				23,670
Tranche D			8,361				7,895
Tranche E			2,907				—
Total notes payable to Siemens			40,221				36,968
Long-term contractual commitment to AARP			19,533				—
Notes payable from business acquisitions and other			9,773				10,277
			69,527				47,245
Less current maturities			19,350				10,746
		$	50,177			$	36,499

The approximate aggregate maturities on long-term debt obligations are as follows (dollars in thousands):

For the twelve months ended September:

		Total				Siemens				AARP				Other
2009		$	19,350			$	9,490			$	5,857			$	4,003
2010			12,118				2,382				6,499				3,237
2011			11,310				2,382				7,177				1,751
2012			3,122				2,361				—				761
2013			23,627				23,606				—				21

HearUSA, Inc.
Notes to Consolidated Financial Statements

Notes payable to Siemens

The Company entered into a Second Amended and Restated Credit Agreement, Amended and Restated Supply Agreement, Amendment No. 1 to Amended and Restated Security Agreement and an Investor Rights Agreement with Siemens Hearing Instruments, Inc. on December 30, 2006. Pursuant to these agreements, the parties increased and restructured the credit facility, extended the term of the credit facility and the supply arrangements, increased the rebates to which the Company may be entitled upon the purchase of Siemens hearing aids and granted Siemens certain conversion rights with respect to the debt.

These agreements were amended again in September 2007 to defer payment of approximately $4.2 million from September 2007 to December 19, 2008. The interest rate on the Tranche D was increased to 9.5% but Siemens agreed to provide the Company with marketing expense reimbursements, equivalent to the increase in interest rate, to develop and promote our business and advertise Siemens products. Siemens also agreed to provide an additional $3 million to fund operating expenses on an as-needed basis through the end of 2008.

The credit facility is a $50 million revolving credit facility expiring in February 2013. All outstanding amounts bear annual interest of 9.5%, are subject to varying repayment terms, and are secured by substantially all of the Company’s assets.

Tranches B and C of the credit facility are a line of credit for acquisitions totaling $30 million. Approximately $29 million was outstanding at September 27, 2008. Borrowing for acquisitions under Tranche B is generally based upon a formula equal to 1/3 of 70% of the acquisition’s trailing 12 months revenues and any amount greater than that may be borrowed from Tranche C with Siemens’ approval. Amounts borrowed under Tranche B are repaid quarterly at a rate of $65 per Siemens units sold by the acquisition plus interest and amounts borrowed under Tranche C are repaid quarterly at $500,000 plus interest. There required payments are subject to the rebate credits described below.

The credit facility also includes Tranche D which may be used for acquisitions once Tranches B and C are completely utilized and Tranche E, a $3 million line of credit available for working capital purposes. The amount available for acquisitions under Tranche D is equal to $20 million less any outstanding amount borrowed under Tranche E. There was $8.4 million outstanding under Tranche D and $2.9 million outstanding under Tranche E on September 27, 2008. Interest on amounts outstanding on Tranche D and E is payable monthly.

The balance on Tranche E and $ 4.2 million of Tranche D are due on December 19, 2008. The remaining balance on Tranche D is due February 2013. Additional amounts under Tranche E will not be available after December 19, 2008.

The credit facility also provides that the Company will reduce the principal balance by making annual payments in an amount equal to 20% of Excess Cash Flow (as defined in the Amended Credit Agreement), and by paying Siemens 25% of proceeds from any equity offerings the Company may complete. The Company did not have any Excess Cash Flow (as defined) in the first nine months of 2008 or fiscal 2007.

Rebate credits on product sales

The required quarterly principal and interest payments on Tranches B and C are forgiven by Siemens through rebate credits of similar amounts as long as 90% of hearing aid units sold by the Company are Siemens products. All amounts rebated reduce the Siemens outstanding debt and accrued interest and are accounted for as a reduction of cost of products sold. If HearUSA does not maintain the 90% sales requirement, those amounts are not rebated and must be paid quarterly. The 90% requirement is based on a cumulative twelve month calculation. Approximately $30.7 million has been rebated since HearUSA entered into this arrangement in December 2001. Approximately $5.1 million and $7.2 million, respectively was rebated in the first nine months of 2008 and for the year ended December 29, 2007.

HearUSA, Inc.
Notes to Consolidated Financial Statements

Additional quarterly volume rebates of $156,250, $312,500 or $468,750 can be earned by meeting certain quarterly volume tests during 2008. Such rebates will reduce the cost of sales of products and the principal and interest on Tranches B and C. Volume rebates of $938,000 were recorded in the first nine months of 2008.

At such time as there are no amounts due under Tranche B and C, Siemens will continue to provide a $500,000 quarterly rebate, provided that HearUSA continues to comply with the minimum 90% sales requirement, and to provide the additional volume rebates if the Siemens unit sales targets are met. These rebates will then reduce the outstanding balance of Tranche D and Tranche E and cost of products sold. If there is no outstanding balance the rebates will be paid in cash.

The following table shows the rebate credits received from Siemens pursuant to the supply agreement and the application of such rebate credits against principal and interest payments on Tranches B and C:

		Nine Months Ended								Three Months Ended
		September 27,				September 29,				September 27,				September 29,
Dollars in thousands		2008				2007				2008				2007
Portion applied against quarterly principal payments		$	2,996			$	3,521			$	1,017			$	1,183
Portion applied against quarterly interest payments			2,104				2,006				716				688
		$	5,100			$	5,527			$	1,733			$	1,871

Conversion rights

After December 30, 2009, Siemens has the right to convert the outstanding debt, but in no event more than approximately $21.2 million, into HearUSA common shares at a price of $3.30 per share, representing approximately 6.4 million shares of the Company’s outstanding common stock. These conversion rights are accelerated in the event of a change of control or an event of default (as defined in the agreement) by HearUSA. These conversion rights may entitle Siemens to a lower conversion price, but in all events Siemens will be limited to approximately 6.4 million shares of common stock. The parties have entered into an Investor Rights Agreement pursuant to which the Company granted Siemens resale registration rights for the common stock underlying the credit facility. On June 30, 2007, the Company filed the required Form S-3 registration statement to register the shares for resale and the registration statement was declared effective September 27, 2007.

The Company has granted to Siemens certain rights of first refusal in the event the Company chooses to engage in a capital raising transaction or if there is a change of control transaction involving an entity in the hearing aid industry.

Covenants

The Siemens credit facility imposes certain financial and other covenants on the Company which are customary for loans of this size and nature, including restrictions on the conduct of the Company’s business, the incurrence of indebtedness, merger or sale of assets, the modification of material agreements, changes in capital structure and making certain payments. If the Company cannot maintain compliance with these covenants, Siemens may terminate future funding under the credit facility and declare all then outstanding amounts under the facility immediately due and payable. In addition, a material breach of the supply agreement or a willful breach of certain of the Company’s obligations under the Investor Rights Agreement may be declared to be a breach of the credit agreement and Siemens would have the right to declare all amounts outstanding under the credit facility immediately due and payable. Any non-compliance with the credit or supply agreement could have a material adverse effect on the Company’s financial condition and continued operations. Management believes the Company is in compliance with these covenants at September 27, 2008.

HearUSA, Inc.
Notes to Consolidated Financial Statements

Long-term contractual commitment to AARP

Long-term contractual commitment pursuant to the AARP License Agreement totaled approximately $19.5 million including accrued interest at September 27, 2008 and is payable in equal quarterly installments of $1.9 million beginning on January 10, 2009. The liability has been discounted using a market rate of 10%.

Notes payable from business acquisitions and other

Notes payable from business acquisitions and other are primarily notes payable related to acquisitions of hearing care centers totaling approximately $9.8 million at September 27, 2008 and approximately $10.3 million at December 29, 2007 are payable in monthly or quarterly installments of principal and interest varying from $3,000 to $83,000 over periods varying from 2 to 5 years and bear interest varying from 5% to 7%. The notes have been discounted to a market rate of 10%.

5.

Convertible Subordinated Notes

On April 9, 2007, the Company entered into a transaction with the holders of 14 of 15 outstanding notes originally issued in December 2003 through a private placement of $7.5 million of subordinated notes and related warrants. These holders converted the balance of their notes into approximately 3.1 million common shares, after a prepayment of approximately $409,000 by the Company, and exercised approximately 2.5 million warrants for a consideration of approximately $1.7 million, or $0.70 per share. The Company also paid down $375,000 of the approximately $417,000 outstanding balance to the non-participating note holder on the closing date. This transaction resulted in a non-cash charge of approximately $2.6 million that was recorded in the second quarter of 2007. The charge was due to the acceleration of the remaining balance of the debt discount amortization (approximately $1.2 million) and the reduction in the price of the warrants (approximately $1.4 million). The remaining principal balance of approximately $42,000 owed to the non-participating note holder was converted to common stock in June 2007.

During the nine months of 2007, approximately $3.2 million of interest expense was recorded related to this financing, including non-cash prepaid finder fees, a debt discount amortization charge and deemed dividend related to the reduction in the price of the warrants of approximately $3.0 million (including the $2.6 million charge indicated above related to the conversion and exercise of warrants).

6.

Subordinated Notes and Warrant Liability

On August 22, 2005, the Company completed a private placement of $5.5 million three-year subordinated notes (“Subordinated Notes”) with warrants (“Note Warrants”) to purchase approximately 1.5 million shares of the Company’s common stock at $2.00 per share expiring on August 2010. The Note Warrants are all currently exercisable. The quoted closing market price of the Company’s common stock on the commitment date for this transaction was $1.63 per share. The notes bear interest at 7% per annum. Proceeds from this financing were used to redeem all of the Company’s 1998-E Series Convertible Preferred Stock. The notes were subordinate to the Siemens notes payable.

The Company recorded a debt discount of approximately $1.9 million based on the portion of the proceeds allocated to the fair value of the Note Warrants, using a Black-Scholes option pricing model. The debt discount was amortized as interest expense over the three-year term of the notes using the effective interest method. In addition to the Note Warrants, the Company also issued 55,000 common stock purchase warrants with the same terms as the Note Warrants and paid cash of approximately $330,000 to third parties as finder fees and financing costs. These warrants were valued at approximately $66,000 using a Black-Scholes option pricing model. The total of costs of approximately $396,000 was amortized as interest expense using the effective interest method over the three-year term of the notes.

HearUSA, Inc.
Notes to Consolidated Financial Statements

During the first nine months of 2008 and 2007, respectively, approximately $189,000 and $668,000, in interest expense was recorded related to this financing, including non-cash prepaid finder fees and debt discount amortization charges of approximately $109,000 and $405,000, respectively.

On December 22, 2005, the Company began making quarterly payments of principal corresponding to 8% of the original principal amount plus interest and a premium of 2% of the principal payment made. The balance of these notes was repaid in August 2008.

7.

Fair Value

Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” defines and establishes a framework for measuring fair value and expands related disclosures. This Statement does not require any new fair value measurements. SFAS No. 157 was effective for the Company’s financial assets and financial liabilities beginning in 2008. In February 2008, FASB Staff Position 157-2, “Effective Date of Statement 157,” deferred the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008.

On January 1, 2008, we adopted the provisions of SFAS 157, except as it applies to those nonfinancial assets and nonfinancial liabilities for which the effective date has been delayed by one year. The full adoption of SFAS 157 will not have a material effect on our financial position or results of operations. The book values of cash and cash equivalents, accounts receivable and accounts payable approximate their respective fair values due to the short-term nature of these instruments, these are Level 1 in the fair value hierarchy.

SFAS No. 157 prioritizes the inputs used in measuring fair value into the following hierarchy:

	Level 1-		Quoted prices (unadjusted) in active markets for identical assets or liabilities;

	Level 2-		Inputs other than quoted prices included in Level 1 that are either directly or indirectly observable;

	Level 3-		Unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing.

As of September 27, 2008, the fair value of the Company’s long-term debt is estimated at approximately $69.5 million based on discounted cash flows and the application of the fair value interest rates applied to the expected cash flows, which is consistent with its carrying value. The Company has determined that the long-term debt is defined as Level 2 in the fair value hierarchy. Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument.

On January 1, 2008, we adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial Assets or Financial Liabilities – including an amendment of FASB Statement No. 115” (“SFAS 159”), which provides companies with an option to report selected financial assets and liabilities at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. The fair value options: (i) may be applied instrument by instrument, with a few exceptions, such as investments accounted for by the equity method; (ii) is irrevocable (unless a new election date occurs); and (iii) is applied only to entire instruments and not to portions of instruments. We did not elect to report any additional assets or liabilities at fair value and accordingly, the adoption of SFAS 159 did not have a material effect on our financial position or results of operations.

HearUSA, Inc.
Notes to Consolidated Financial Statements

8.

Stockholders’ Equity

A.

Common Stock

During the nine months ended September 27, 2008, employee stock options for 210,000 shares of common stock were exercised, at a weighted average exercise price of $0.69. During the nine months ended September 29, 2007, approximately 2.5 million warrants were exercised at an exercise price of $0.70, approximately 3.2 million shares of common stock were issued in connection with the conversion of the 2003 Convertible Subordinated Notes and employee stock options for 25,000 shares of common stock were exercised.

B.

Stock Subscription

On April 1, 2001, the Company sold 200,000 shares of the Company’s common stock to an investment banker for $2.0625 per share, and received a secured, nonrecourse promissory note receivable for the principal amount of $412,500. The note receivable was collateralized by the common stock purchased which was held in escrow. The principal amount of the note and accrued interest was payable on April 1, 2006. The note bore interest at the prime rate published by the Wall Street Journal adjusted annually. The interest rate at December 29, 2007 of the note was 7.5%. A cancellation agreement was signed and the stock was returned to the Company and cancelled in June 2008. The note receivable under the caption Stock Subscription was part of stockholders’ equity in the accompanying consolidated balance sheet at December 29, 2007.

9.

Stock-based Compensation

Under the terms of the company’s stock option plans, officers, certain other employees and non-employee directors may be granted options to purchase the company’s common stock at a price equal to the closing price of the Company’s common stock on the date the option is granted. For financial reporting purposes, stock-based compensation expense is included in general and administrative expenses. Stock-based compensation expense totaled approximately $607,000 and $386,000 in the first nine months of 2008 and 2007, respectively. As of September 27, 2008, there was approximately $2.1 million of unrecognized compensation cost related to share-based compensation under our stock award plans. That cost is expected to be recognized over a straight-line period of four years from the date of grant.

During the first quarter of 2008, the Company extended the exercise period relating to 400,000 fully vested options held by Dr. Paul Brown as part of his retirement agreement. As a result of this modification, the Company recognized additional stock-based compensation of approximately $91,000, which is included in general and administrative expense.

HearUSA, Inc.
Notes to Consolidated Financial Statements

Stock-based payment award activity

The following table provides additional information regarding options outstanding and options that were exercisable as of September 27, 2008 (options and in-the-money values in thousands):

										Weighted
										Average
										Remaining
						Weighted				Contractual
						Average				Term				Aggregate
		Shares				Exercise Price				(in years)				Intrinsic Value
Outstanding at December 29, 2007			5,158			$	1.28								—
Granted			970			$	1.67
Exercised			(210	)		$	0.69							$	143
Forfeited/expired/cancelled			(490	)			2.07								—
Outstanding at September 27, 2008			5,428			$	1.30				6.41			$	1,003
Exercisable at September 27, 2008			3,773			$	1.18				5.14			$	1,002

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for the options that were in-the-money at September 27, 2008. As of September 27, 2008, the aggregate intrinsic value of the non-employee director options outstanding and exercisable was approximately $270,000.

A summary of the status and changes in our non-vested shares related to our equity incentive plans as of and during the nine months ended September 27, 2008 is presented below:

						Weighted
						Average
						Grant-Date
		Shares				Fair Value
Non-vested at December 29, 2007			1,460			$	1.44
Granted			970			$	1.67
Vested			(775	)		$	1.42
Forfeited unvested			—				—
Non-vested at September 27, 2008			1,655			$	1.58

Restricted stock units

In 2008 the Company began granting restricted stock units pursuant to its stockholder approved plans as part of its regular annual employee equity compensation review program. Restricted stock units are share awards that, upon vesting, will deliver to the holder shares of the Company’s common stock. Restricted stock units granted during 2008 have graded vesting of one-third each year for three years. Some restricted stock units are performance based and therefore subject to forfeiture if certain performance criteria are not met.

HearUSA, Inc.
Notes to Consolidated Financial Statements

A summary of the Company’s restricted stock unit activity and related information for the nine months ended September 27, 2008 is as follows:

		Restricted Stock Units (1)
Outstanding at December 29, 2007			—
Awarded			482,000
Vested			—
Cancelled			—
Outstanding at September 27, 2008			482,000

The weighted average grant-date fair value per share for the restricted stock units was $1.40 for the nine months ended September 27, 2008.

Based on the closing price of the Company’s common stock of $1.25 on September 27, 2008, the total pretax value of all outstanding restricted stock units on that date was approximately $603,000.

10.

Segments

The following operating segments represent identifiable components of the Company for which separate financial information is available. The following table represents key financial information for each of the Company’s business segments, which include the operation and management of centers; the establishment, maintenance and support of an affiliated network; and the operation of an e-commerce business. The centers offer people afflicted with hearing loss a complete range of services and products, including diagnostic audiological testing, the latest technology in hearing aids and listening devices to improve their quality of life. The network, unlike the Company-owned centers, is comprised of hearing care practices owned by independent audiologists. The network revenues are mainly derived from administrative fees paid by employer groups, health insurers and benefit sponsors to administer their benefit programs as well as maintaining an affiliated provider network. E-commerce offers on-line product sales of hearing aid related products, such as batteries, hearing aid accessories and assistive listening devices. The Company’s business units are located in the United States and Canada.

HearUSA, Inc.
Notes to Consolidated Financial Statements

The following is the Company’s segment information:

Dollars in thousands		Centers				E-commerce				Network				Corporate				Total
Hearing aids and other product revenues
9 months ended September 27, 2008		$	81,560			$	80				—				—			$	81,640
9 months ended September 29, 2007		$	70,019			$	88				—				—			$	70,107
Service revenues
9 months ended September 27, 2008		$	4,396			$	—			$	1,494				—			$	5,890
9 months ended September 29, 2007		$	3,996			$	—			$	1,182				—			$	5,178
Income (loss) from operations
9 months ended September 27, 2008		$	16,871			$	(115	)		$	850			$	(11,995	)		$	5,611
9 months ended September 29, 2007		$	15,741			$	(30	)		$	826			$	(11,578	)		$	4,959
9 months ended September 27, 2008
Depreciation and amortization		$	1,591				—			$	—			$	331			$	1,922
Total assets		$	67,963				—			$	20,193			$	38,066			$	126,222
Capital expenditures		$	1,080				—				—			$	112			$	1,192
9 months ended September 29, 2007
Depreciation and amortization		$	1,325				—			$	39			$	233			$	1.597
Total assets		$	75,520				—			$	923			$	17,528			$	93,971
Capital expenditures		$	460				—				—			$	91			$	551

Hearing aids and other product revenues consisted of the following:

		Nine months ended
		September 27,				September 29,
		2008				2007
Hearing aid revenues			95.5	%			95.4	%
Other product revenues			4.5	%			4.6	%

Services revenues consisted of the following:

		Nine months ended
		September 27,				September 29,
		2008				2007
Hearing aid repairs			47.6	%			49.5	%
Testing and other income			52.4	%			50.5	%

HearUSA, Inc.
Notes to Consolidated Financial Statements

Income (loss) from operations at the segment level is computed before the following, the sum of which is included in the column “Corporate” as loss from operations:

		Nine months ended
		September 27,				September 29,
Dollars in thousands		2008				2007
General and administrative expense		$	11,664			$	11,306
Corporate depreciation and amortization			331				272
Corporate loss from operations		$	11,995			$	11,578

Information concerning geographic areas:

As of and for the six months ended September 27, 2008 and September 29, 2007:

		United States				Canada				United States				Canada
Dollars in thousands		2008				2008				2007				2007
Hearing aid and other products revenues		$	69,241			$	12,399			$	61,097			$	9,010
Service revenues			5,389				501				4,768				410
Long-lived assets			61,059				13,278				50,867				11,688
Total assets			105,796				20,426				75,323				18,648

11.

Liquidity

The working capital deficit increased $10.2 million to $26.2 million at September 27, 2008 from $16.0 million at December 29, 2007. The increase in the deficit is mainly attributable to an increase in cash used for investment and financing activities in excess of cash generated from operations.

Approximately $2.4 million of the current maturities of long-term debt to Siemens may be repaid through rebate credits. In the first nine months of 2008, the Company generated income from operations of approximately $5.6 million (net of approximately $2.2 million of severance expense, non-cash employee stock-based compensation and amortization of intangible assets) compared to $5.0 million (including approximately $1.3 million of severance expense, non-cash employee stock-based compensation and amortization of intangible assets) in the first nine months of 2007. Cash and cash equivalents as of September 27, 2008 were approximately $3.5 million.

The Company believes that current cash and cash equivalents, cash generated at current net revenue levels and acquisition financing provided by its strategic partner, Siemens, will be sufficient to support the Company’s operating and investing activities through the next twelve months.  The Company’s credit agreement with Siemens contemplates a $7.2 million payment to Siemens under Tranche D and E in December 2008.  The Company and its strategic partner are currently evaluating different alternatives to address this repayment.   Management believes the Company will address this through amendments to its agreements with Siemens or through other means.  The Company intends to fund part of its contractual commitments to AARP by charging fees to the suppliers and providers who participate in the program.  The Company also intends to collect royalties for units sold under the program.  The Company is actively negotiating with suppliers and providers who have expressed interest in the program and expects to reach agreement with them in the near future. However, there can be no assurance that the Company can maintain compliance with the Siemens loan covenants,  that the Company and Siemens will reach agreement on amending their agreements, that the Company will reach agreement with a sufficient number of suppliers and participants and receive royalties under the AARP program, that net revenue levels will remain at or higher than current levels or that unexpected cash needs will not arise for which the cash, cash equivalents and cash flow from operations will not be sufficient.  In the event of a shortfall in cash, the Company might consider short-term debt, or additional equity or debt offerings.  There can be no assurance however, that such financing will be available to the Company on favorable terms or at all.  The Company also is continuing its aggressive cost controls.

HearUSA, Inc.
Notes to Consolidated Financial Statements

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, the FASB issued SFAS No 160 (“SFAS 160”), “Non-controlling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51,” which requires all entities to report minority interests in subsidiaries as equity in the consolidated financial statements, and requires that transactions between entities and non-controlling interests be treated as equity transactions. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008, and will be applied prospectively. We are currently evaluating the effect of SFAS 160, and the impact it will have on our financial position and results of operations.

In December 2007, the FASB issued SFAS No. 141(R) (“SFAS 141R”), “Business Combinations,” which will significantly change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. Some of the changes, such as the accounting for contingent consideration, will introduce more volatility into earnings, and may impact a company’s acquisition strategy. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008, and will be applied prospectively. We are currently evaluating the effect of SFAS 141R, and the impact it will have on our financial position and results of operations.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (SFAS No. 161).  SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 with the intent to provide users of financial statements with an enhanced understanding of: (I) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows.  This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.  

In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (FSP FAS 142-3). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). The intent of FSP FAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other applicable accounting literature. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company does not anticipate that the adoption of FSP FAS 142-3 will have a significant impact on its financial position and results of operations.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”, (SFAS 162). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting “Principles. The Company does not expect this standard will have a material impact on its results of operations, financial position and results of operations.

In May 2008, the FASB issued Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”, or FSP APB 14-1. FSP APB 14-1 specifies that issuers of convertible debt instruments that may be settled in cash upon conversion should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. We are required to adopt FSPAPB 14-1 at the beginning of 2009 and apply FSP APB 14-1 retrospectively to all periods presented. We are currently evaluating the impact of adopting FSP APB14-1 on our financial position and results of operations.

Forward Looking Statements

This Form 10-Q and, in particular, this management’s discussion and analysis contain or incorporate a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. These statements include those relating to the Company’s belief that its current cash and cash equivalents and cash flow from operations at current net revenue levels will be sufficient to support the Company’s operational needs through the next twelve months; expectation that in the remainder of 2008 the total cost of products sold before the Siemens rebate credits as a percentage of total net revenues will be consistent with the first nine months of 2008; expectation that sales will continue to suffer for the short term in light of general economic conditions and hope that changes in product mix planned by the Company will stimulate appointments and result in sales; expectation that quarterly center operating expenses will continue to increase in total dollars in 2008; and expectation that funds will continue to be used for acquisitions in 2008 from the Siemens line of credit. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and management’s beliefs and assumptions. Any statements that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our consolidated financial statements and notes to the consolidated financial statements included in this report. The statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict, the Company’s ability to maintain sales levels of acquired centers; successful implementation of the acquisition program and integration of acquired centers; the Company’s ability to decrease expenses, maintain until sales of Siemens’ products and meet all debt and trade payables as they become due; market demand for the Company’s products and services; changes in the product pricing environment; and general economic conditions in these regions where the Company’s centers are located; and those risks described in the Company’s annual report on Form 10-K for fiscal 2007 filed with the Securities and Exchange Commission.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

In the first nine months of 2008, the Company continued its acquisition program, closing on ten transactions involving eighteen centers with trailing 12 months revenues of approximately $6.7 million. Two additional transactions were completed in October 2008 involving two centers with trailing 12 months revenues of approximately $700,000. The Company currently has fifteen non-binding letters of intent representing trailing 12 months revenues of approximately $7.6 million.

RESULTS OF OPERATIONS

For the three months ended September 27, 2008 and September 29, 2007

Revenues

Dollars in thousands		2008				2007				Change				% Change
Hearing aids and other products		$	26,740			$	25,050			$	1,690				6.7	%
Services			1,977				1,812				165				9.1	%
Total net revenues		$	28,717			$	26,862			$	1,855				6.9	%

		2008				2007				Change				% Change (3)
Revenues from centers acquired in 2007 (1)		$	1,194			$	—			$	1,194				4.4	%
Revenues from centers acquired in 2008			1,261				—				1,261				4.7	%
Revenues from acquired centers			2,455				—				2,455				9.1	%
Revenues from comparable centers (2)			26,262				26,862				(600	)			(2.2	)%
Total net revenues		$	28,717			$	26,862			$	1,855				6.9	%

The $1.9 million or 6.9% increase in net revenues over the third quarter of 2007 is principally a result of revenues from acquired centers of approximately $2.5 million. Organic revenue declined in the later part of the third quarter as a result of worsening economic conditions. Management expects that sales will continue to suffer for the short term in light of the general economic conditions. It is hoped that changes in product mixed planned by the Company will stimulate appointments and result in sales.

The number of hearing aids sold in the third quarter of 2008 increased 5.6% over the third quarter of 2007 primarily as a result of acquired centers. Service revenues increased approximately $165,000, or 9.1%, over the third quarter of 2007.

Cost of Products Sold and Services

Dollars in thousands		2008				2007				Change				%
Hearing aids and other products		$	7,448			$	6,807			$	641				9.4	%
Services			638				499				139				27.9	%
Total cost of products sold and services		$	8,086			$	7,306			$	780				10.7	%
Percent of total net revenues			28.2	%			27.2	%			1.0	%			3.7	%

The cost of products sold includes the effect of rebate credits pursuant to our agreements with Siemens. The following table reflects the components of the rebate credits which are included in the cost of products sold (see Note 4 – Long-term Debt, Notes to Consolidated Financial Statements included herein):

		2008				2007				Change				%
Base required payments on Tranche C forgiven		$	813			$	1,043			$	(230	)			(22.1	)%
Required payments of $65 per Siemens unit from acquired centers on Tranche B forgiven			204				140				64				45.7	%
Interest expense on Tranches B and C forgiven			716				688				28				4.1	%
Total rebate credits		$	1,733			$	1,871			$	(138	)			(7.4	)%
Percent of total net revenues			6.0	%			7.0	%			(1.0	)%			(14.3	)%

The increase of total cost of products sold and services as a percentage of total net revenues is primarily due to the required base payment on Siemens Tranche C being reduced from $730,000 to $500,000 per quarter following the September 2007 amendments (see Note 4 – Long-term Debt, Notes to the Consolidated Financial Statements included herein). Cost of products sold as a percentage of revenues excluding the Siemens’ rebate credits were 34.2% in the third quarter of both 2008 and 2007.

Expenses

Dollars in thousands		2008				2007				Change				%
Center operating expenses		$	14,424			$	12,585			$	1,839				14.6	%
Percent of total net revenues			50.2	%			46.9	%			3.3	%			7.0	%
General and administrative expenses		$	3,275			$	3,890			$	(615	)			(15.8	)%
Percent of total net revenues			11.4	%			14.5	%			(3.1	)%			(21.4	)%
Depreciation and amortization		$	635			$	572			$	63				11.0	%
Percent of total net revenues			2.2	%			2.1	%			0.1	%			4.8	%

The increase in center operating expenses in the third quarter of 2008 is mainly attributable to additional expenses of approximately $1.4 million related to acquired centers owned less than twelve months. The remaining increase of approximately $400,000 is attributable to expenses of $167,000 in the implementation of the AARP program, $98,000 related to incentive compensation on additional revenues, $147,000 related to increased regional management expenses and increases in gross marketing costs of approximately $172,000. These were partially offset by increases in advertising reimbursements from Siemens of approximately $95,000. Center operating expenses as a percent of total net revenues increased from 46.9% in the third quarter of 2007 to 50.2% in the third quarter of 2008 principally as a result of the decrease in organic sales, lower than expected revenue from acquired centers and the AARP program implementation costs. The operating expenses of the acquired centers were 56.8% of the related net revenues during the third quarter of 2008.

General and administrative expenses decreased by approximately $615,000 in the third quarter of 2008 as compared to the same period of 2007. The decrease is attributable to decreases in wages due to employee severance cost of approximately $282,000 included in the third quarter of 2007, professional fees of approximately $256,000 and the benefit of vendor rebates of $168,000 recorded in reduction of communication expense.

Depreciation was $386,000 in the third quarter of 2008 and $347,000 in the third quarter of 2007. Amortization expense was $249,000 in the third quarter of 2008 and $225,000 in the third quarter of 2007. Most of the amortization expense is related to the amortization of intangible assets of acquisitions made by the Company.

Interest Expense

Dollars in thousands		2008				2007				Change				%
Notes payable from business acquisitions and others (1)		$	262			$	137			$	125				91.2	%
Long-term contractual commitment to AARP (2)			260				—				260				100.0	%
Siemens Tranches B and C – interest forgiven (3)			716				688				28				4.1	%
Siemens Tranches D and E			289				335				(46	)			(13.7	)%
2005 Subordinated Notes (4)			39				170				(131	)			(77.1	)%
Total interest expense		$	1,566			$	1,330			$	236				17.7	%

		2008				2007				Change				%
Total cash interest expense (5)		$	494			$	529			$	(35	)			(6.6	)%
Total non-cash interest expense (6)			1,072				801				271				33.8	%
Total interest expense		$	1,566			$	1,330			$	236				17.7	%

Income Taxes

The Company has net operating loss carryforwards of approximately $57.4 million for U.S. income tax purposes. In addition, the Company has temporary differences between the financial statement and tax reporting arising primarily from differences in the amortization of intangible assets and goodwill and depreciation of fixed assets. The deferred tax assets for US tax purposes have been offset by a valuation allowance because it was determined that these assets were not likely to be realized. The deferred tax assets for Canadian tax purposes are recorded as a reduction of the deferred income tax liability.

During the third quarter of 2008, the Company recorded a deferred tax expense of approximately $296,000 compared to approximately $284,000 in the third quarter of 2007 related to estimated taxable income generated by the Canadian operations during the quarter and to the estimated deduction of tax deductible goodwill from its US operations. The deferred income tax expense was recorded because it cannot be offset by other temporary differences as it relates to infinite-lived assets and the timing of reversing the liability is unknown.

Minority Interest

During the third quarter of 2008 and 2007, the Company’s 50% owned joint venture, HEARx West, generated net income of approximately $964,000 and $774,000, respectively. The Company records 50% of the venture’s net income as minority interest in the income of a joint venture in the Company’s consolidated statements of operations. The minority interest for the third quarter of 2008 and 2007 was approximately $482,000 and $394,000, respectively.

For the nine months ended September 27, 2008 and September 29, 2007

Revenues

Dollars in thousands		2008				2007				Change				% Change
Hearing aids and other products		$	81,640			$	70,107			$	11,533				16.5	%
Services			5,890				5,178				712				13.8	%
Total net revenues		$	87,530			$	75,285			$	12,245				16.3	%

		2008				2007				Change				% Change (3)
Revenues from centers acquired in 2007 (1)		$	6,027			$	—			$	6,027				8.0	%
Revenues from centers acquired in 2008			2,004				—				2,004				2.7	%
Revenues from acquired centers			8,031				—				8,031				10.7	%
Revenues from comparable centers (2)			79,499				75,285				4,214				5.6	%
Total net revenues		$	87,530			$	75,285			$	12,245				16.3	%

The $12.2 million or 16.3% increase in net revenues over the first nine months of 2007 is a result of revenues from acquired centers which generated approximately $8.0 million and an increase in revenues from comparable centers of approximately $4.2 million. The comparable centers total net revenues also include a favorable impact of $1.0 million (22.9% of the comparable centers total net revenues increase) related to fluctuations in the Canadian exchange rate.

The number of hearing aids sold in the first nine months of 2008 increased 7.4% over the first nine months of 2007 primarily as a result of the acquired centers. The average unit selling price increased by 8.9% as a result of changes in mix resulting from patients choosing higher technology hearing aids. Service revenues increased approximately $712,000, or 13.8%, over the first nine months of 2007.

Cost of Products Sold and Services

Dollars in thousands		2008				2007				Change				%
Hearing aids and other products		$	23,541			$	18,576			$	4,965				26.7	%
Services			1,793				1,531				262				17.1	%
Total cost of products sold and services		$	25,334			$	20,107			$	5,227				26.0	%
Percent of total net revenues			28.9	%			26.7	%			2.2	%			8.2	%

The cost of products sold includes the effect of rebate credits pursuant to our agreements with Siemens. The following table reflects the components of the rebate credits which are included in the cost of products sold (see Note 4 – Long-term Debt, Notes to Consolidated Financial Statements included herein):

		2008				2007				Change				%
Base required payments on Tranche C forgiven		$	2,443			$	3,127			$	(684	)			(21.9	)%
Required payments of $65 per Siemens unit from acquired centers on Tranche B forgiven			553				394				159				40.4	%
Interest expense on Tranches B and C forgiven			2,104				2,006				98				4.9	%
Total rebate credits		$	5,100			$	5,527			$	(427	)			(7.7	)%
Percent of total net revenues			5.8	%			7.3	%			(1.5	)%			(20.5	)%

The increase of total cost of products sold and services as a percentage of total net revenues is primarily due to the required base payment on Siemens Tranche C being reduced from $730,000 to $500,000 per quarter following the September 2007 amendments (see Note 4 – Long-term Debt, Notes to the Consolidated Financial Statements included herein). Cost of products sold as a percentage of revenues excluding the Siemens’ rebate credits increased from 34.0% in the first nine months of 2007 to 34.8% in the first nine months of 2008 due to the change in mix to higher technology hearing aids which result in net higher gross profit per unit sold but bear a higher cost as a percent of total net revenues.

Management expects, excluding Siemens rebate credits, that the total cost of products sold and services for the remainder of the year should remain consistent as with the first nine months of 2008 as a percentage of total net revenues.

Expenses

Dollars in thousands		2008				2007				Change				%
Center operating expenses		$	42,999			$	37,316			$	5,683				15.2	%
Percent of total net revenues			49.1	%			49.6	%			(0.5	)%			(1.0	)%
General and administrative expenses		$	11,664			$	11,306			$	358				3.2	%
Percent of total net revenues			13.3	%			15.0	%			(1.7	)%			(11.3	)%
Depreciation and amortization		$	1,922			$	1,597				325				20.4	%
Percent of total net revenues			2.2	%			2.1	%			0.1	%			4.8	%