2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

American Technology Corporation
BALANCE SHEETS
Unaudited(Unaudited)

See accompanying notes to interim financial statements.

3

American Technology Corporation
STATEMENTS OF OPERATIONS
(Unaudited)

See accompanying notes to interim financial statements.

4

American Technology Corporation
STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to interim financial statements.

5

1. OPERATIONS

American Technology Corporation (the Company) is engaged in design, development and commercialization of sound, acoustic and other technologies. The Company produces products based on its HyperSonic® Sound (HSS®), Long Range Acoustic Device (LRAD™), Medium Range Acoustic Device (MRAD^TM), NeoPlanar® and other sound technologies.

The Company’s operations are organized into two segments by the end-user markets they serve. The Commercial Products Group, (Commercial Group), formerly known as the Business Products and Licensing Group, markets and licenses HSS and NeoPlanar products to companies that employ audio in consumer, commercial and professional applications. The Government and Force Protection Systems Group (Government Group) markets LRAD, MRAD, NeoPlanar, SoundCluster™ and HSS products to government and military customers and to the expanding force protection and commercial security markets.

The Company’s principal markets for its proprietary sound reproduction technologies and products are in North America, Europe and Asia.

The Company continues to be subject to certain risks, including history of net losses and expectation to continue to incur net losses; need for additional capital; potential dilutive impact on its stockholders of the Committed Equity Financing Facility (CEFF) described in Note 11 below; dependence on a limited number of customers; reliance on third partythird-party suppliers and manufacturers; competition; the uncertainty of the market for new sound products; limited manufacturing, marketing and sales experience; uncertainty regarding future warranty costs; and the substantial uncertainty of ability to achieve profitability and positive cash flow.

2.  STATEMENT OF PRESENTATION AND MANAGEMENT’S PLAN

The accompanying unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. In the opinion of management, the interim financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the results for interim periods. Operating results for the three and sixnine months are not necessarily indicative of the results that may be expected for the year. The interim financial statements and notes thereto should be read in conjunction with the Company’s audited financial statements and notes thereto for the year ended September 30, 2004 included in the Company’s annual report on Form 10-K. Certain amounts reported in prior periods have been reclassified to be consistent with the current period presentation.

Other than cash of $6,162,409$2,369,591 at March 31,June 30, 2005, accounts receivable collections and possiblethe net proceeds fromof the CEFF describedequity financing completed in July 2005 (see Note 11 below,15 below) (the 2005 Equity Financing), the Company has no other material unused sources of liquidity at this time. The Company has financed its operations primarily through cash generated from product sales and from financing activities. Management expects to incur additional operating losses during the balance of fiscal 2005 as a result of expenditures for research and development and marketing costs for proprietary sound products.costs. The timing and amounts of these expenditures and the extent of the Company’s operating losses will depend on future product sales levels and other factors, some of which are beyond management’s control. Based on the Company’s cash position at June 30, 2005 and possiblethe proceeds fromof the CEFF,2005 Equity Financing, and assuming currently planned expenditures and level of operations, management believes the Company will have sufficient capital resources for at least the next twelve months. Management believes increased product sales will provide additional operating funds. If required, management has significant flexibility to adjust the level of research and development and selling and administrative expenses based on the availability of resources.

3.  NET LOSS PER SHARE

Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common stockholders, after deduction for cumulative imputed and accreted dividends, by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution of securities that could share in the earnings of an entity. The Company’s losses for the periods presented cause the inclusion of potential common stock instruments outstanding to be antidilutive. Stock options and warrants exercisable into 4,437,5454,442,044 shares of common stock were outstanding at March 31,June 30, 2005 and stock options, warrants and convertible preferred stock exercisable or convertible into 4,900,8705,071,647 shares of common stock were outstanding at March 31,June 30, 2004. These securities wereare not included in the computation of diluted earnings (loss) per share because of the losses but could potentially dilute earnings (loss) per share in future periods.

6

The Company has allocated the proceeds from prior preferred stock issuances between the preferred stock and warrants and also calculated the beneficial conversion discount for each series of preferred stock. The value of the beneficial conversion discount and the value of the warrants were recorded as a deemed dividend and were accreted over the conversion period of the preferred stock. Net loss available to common stockholders was increased in each period presented in computing net loss per share by the accretion of the value of these imputed deemed dividends. Such imputed deemed dividends were not included in the Company’s stockholders’ equity as the Company has an accumulated deficit. Amounts were included in net loss available to common stockholders. The imputed deemed dividends were not contractual obligations of the Company to pay such imputed dividends. All of the Company’s outstanding shares of Series D and E Preferred Stock were converted to common stock during the quarter ending March 31, 2005.

The provisions of each of the Company’s series of preferred stock also provided for a 6% per annum accretion in the conversion value (similar to a dividend). These amounts also increased the net loss available to common stockholders. Net loss available to common stockholders is computed as follows:

On January 18, 2005, the Company gave notice to all holders of Series D and Series E Preferred Stock that it had elected to convert all of the outstanding shares of Series D and Series E Preferred Stock to common stock. The designations, rights and preferences of the Series D and Series E Preferred Stock permitted the Company to exercise this conversion option if the market price of its common stock exceeded $9.50 for ten consecutive trading days and certain other conditions were satisfied. The price condition was satisfied on January 6, 2005. The conversion of the Series D Preferred Stock was effective on January 18, 2005 and resulted in all 50,000 issued and outstanding shares of Series D Preferred Stock converting into an aggregate of 129,259 shares of common stock. The conversion of the Series E Preferred Stock was effective on February 1, 2005, and resulted in all 233,250 issued and outstanding shares of Series E Preferred Stock converting into an aggregate of 801,306 shares of common stock.

As all the Series D and Series E Preferred Stock waswere called for conversion as described above, $1,504,711 wasof deemed dividends were accelerated and accreted in the quarter ending March 31, 2005, in addition to the accretion of $13,940 at the stated rate of 6%, increasing the net loss available to common stockholders for that period.

7

4.  STOCK-BASED COMPENSATION

The Company accounts for employee stock-based compensation using the intrinsic value method. In most cases, the Company does not recognize compensation expense for its employee stock option grants, as they have been granted at the fair market value of the underlying Common Stockcommon stock at the grant date. Had compensation expense for the Company’s employee stock option grants been determined based on the fair value at the grant date for awards through March 31,June 30, 2005 consistent with the provisions of Statement of Financial Accounting Standards No. 123, its after-tax net income and after-tax net income per share would have been reduced to the pro forma amounts indicated below:

The Company estimates the fair value of each stock award at the grant date by using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2005 and 2004, respectively: dividend yield of zero percent for each period; expected volatility of 53 to 5658 percent in 2005 and 60 to 75 percent in 2004; risk-free interest rates of 3.82 to 1.84 percent; and expected lives of 2.5 years for each period. The estimated fair value of the options so determined is then amortized to expense over the options’ vesting periods.

5.  RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (FAS) 123(R),123R, “Share Based Payment.”Payment” (“Statement 123R”) Although Statement 123(R)123R states that it is effective for public companies at the beginning of the first interim or annual period after June 15, 2005, the Securities and Exchange Commission has adopted a rule delaying the required compliance date to the first interim or annual reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. Therefore, the Company will first be required to comply with Statement 123(R)123R in the quarter ending December 31, 2005. This statement eliminates the ability to account for share-based compensation using the intrinsic value-based method under APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement 123(R)123R would require the Company to calculate equity-based compensation expense for stock options and employee stock purchase plan rights granted to employees based on the fair value of the equity instrument at the time of grant. Currently, the Company discloses the pro forma net income (loss) and the related pro forma income (loss) per share information in accordance with FAS 123 and FAS 148, “Accounting for Stock-Based Compensation Costs-Transition and Disclosure.” The Company has not evaluated the impact that Statement 123(R)123R will have on its financial position and results of operations.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs an amendment of ARB 43, Chapter 4.” SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. The Company is currently evaluating the financial statement impact of the implementation of SFAS No. 151.

8

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets, an Amendment of APB Opinion No. 29”, which is effective for non-monetary exchanges occurring in fiscal periods beginning after June 15, 2005. SFAS No. 153 amends APB Opinion No. 29, “Accounting for Non-monetary Transactions” to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Company does not expect SFAS No. 153 to affect the Company’s financial condition or results of operations.

In September 2004, the Emerging Issues Task Force (EITF) reached consensus on EITF Issue 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share”, which provides guidance on when the dilutive effect of contingently convertible debt securities with a market price trigger should be included in diluted earnings per share. The guidance is effective for all periods ending after December 15, 2004. The Company’s adoption of EITF 04-8 did not have an impact on the Company’s loss per share calculation for the periods presented herein and is not expected to have an impact in the future.

In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations.” FIN 47 clarifies that an entity must record a liability for a “conditional” asset retirement obligation if the fair value of the obligation can be reasonably estimated. The provision is effective no later than the end of fiscal years ending after December 15, 2005. The Company does not expect FIN 47 to affect the Company’s financial condition or results of operations.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, applying to all voluntary accounting principle changes as well as the accounting for and reporting of such changes. SFAS No. 154 replaces APB Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect SFAS No. 154 to affect the Company’s financial condition or results of operations.

In March 2005, the Securities and Exchange Commission (“SEC”) issued staff accounting bulletin 107 (“SAB 107”) which expresses views of the SEC staff regarding the interaction between Statement 123R and certain SEC rules and regulations and provide the staff’s views regarding the valuation of share-based payment arrangements for public companies. SAB 107 provides guidance related to share-based payment transactions with non-employees, the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of Statement 123R in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of Statement 123R, the modification of employee share options prior to adoption of Statement 123R and disclosures in Management’s Discussion and Analysis subsequent to adoption of Statement 123R. The Company has not evaluated the impact that SAB 107 will have on its financial position and results of operations.

9

6.  INVENTORIES AND CONTRACT MANUFACTURERMANUFACTURING

Inventory is stated at the lower of cost, which approximates actual costs on a first-in first-out (FIFO)standard cost basis, or market. At March 31,June 30, 2005 $597,560$104,535 of inventory value was located at the Company’s contract manufacturer in San Jose, California.manufacturer.

Inventories consisted of the following:

During the sixnine months ended March 31,June 30, 2005, the Company shipped materials to it'sits contract manufacturer, booked an amount due from the contract manufacturer and reduced inventory by $387,889.$439,312. The Company did not recognize any revenue on these transactions. At March 31,June 30, 2005, the remaining balance due from the contract manufacturer, for shipments made to it, was $160,050.$67,619. The contract manufacturer usedis using these materials to build products for the Company. The aboveamount due from the contract manufacturer of $160,050$67,619 has been netted against the payable due to the contract manufacturer.

7.  CUSTOMER CONCENTRATION

For the sixthree months ended March 31,June 30, 2005, sales to one customer in the Government Group accounted for 82%62% of total revenues. At June 30, 2005, this customer accounted for 21% of accounts receivable, net, and three other customers accounted for 30%, 21% and 14% of accounts receivable, net, respectively. No other customer accounted for more than 10% of accounts receivable, net, at June 30, 2005. For the three months ended June 30, 2004, sales to three customers in the Government Group accounted for 62%, 22% and 13% of total revenues. At June 30, 2004 the accounts receivable from these three customers accounted for 40%, 28% and 6% of accounts receivable, net, respectively and no other customer accounted for more than 10% of accounts receivable, net. For the nine months ended June 30, 2005, sales to one customer in the Government Group accounted for 79% of total revenues and sales to a second customer in the Government Group, including affiliates of the customer, accounted for 10% of total revenues. For the threenine months ended March 31, 2005, sales to one customer in the Government Group accounted for 93% of total revenues. At March 31, 2005,this customer accounted for 56% of accounts receivable, and two other customers accounted for 21% and 14% of accounts receivable. No other customer accounted for more than 10% of accounts receivable at March 31, 2005. For the six months ended March 31, 2004, sales to three customers in the Government Group accounted for 41%, 32% and 11% of total revenues respectively. For the three months ended March 31,June 30, 2004, sales to two customers in the Government Group accounted for 62%51% and 17%28% of total revenues. At March 31, 2004, the accounts receivable from these two customers accounted for 66% and 12% of accounts receivable respectively and no other customer accounted for more than 10% of accounts receivable.revenues, respectively. Management believes that the loss of any one of these significant customers would have a material adverse effect on the Company’s results of operations and financial condition.

8.  INTANGIBLES

Patents are carried at cost and, when granted, are amortized over their estimated useful lives. The carrying value of patents is periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than its carrying value. Patents consisted of the following:

10

9.  PRODUCT WARRANTY COST

The Company establishes a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. Factors affecting warranty reserve levels include the number of units sold and anticipated cost of warranty repairs and anticipated rates of warranty claims. The Company evaluates the adequacy of the provision for warranty costs each reporting period.

Changes in the warranty reserve during the three and sixnine months ended March 31,June 30, 2005 and 2004 were as follows:

10.  UNSECURED SUBORDINATED PROMISSORY NOTES AND RELATED PARTY TRANSACTION

In December 2004, the Company sold an aggregate of $2,000,000 of 8% unsecured subordinated promissory notes due December 31, 2006. Interest on these notes accrues at the rate of 8% per year and is due and payable quarterly in arrears. For the three and sixnine months ended March 31,June 30, 2005, wethe Company recorded interest on these notes of $39,452$39,890 and $42,959,$82,849, respectively. The Company iswas required to use 40% of the net proceeds of any future equity financing to prepay these notes, including any amountsand the Company raises pursuant to the CEFF described in Note 11 below. The Company may prepaybalance due on the notes at its discretion at any time without penalty after June 30, 2005.

and accrued interest were paid in full in July 2005 following the completion of the 2005 Equity Financing (see Note 15). In connection with the issuance of thesethe notes, the purchasers were granted warrants to purchase an aggregate of 150,000 shares of its common stock. The exercise price of the warrants was $9.28 per share for purchasers who were directors, officers, employees or consultants of the Company, or affiliates of such persons, and $8.60 per share for other purchasers. Warrants exercisable for 75,000 shares were issued at each such exercise price. The fair value of such warrants, which amounted to $723,000, and closing costs of $20,977 have beenwere recorded as debt discount to beand amortized over the term of the notes. The following variables were used to determine the fair value of the warrants under the Black-Scholes option pricing model: volatility of 56%, term of five years, risk free interest of 2.97% and underlying stock price equal to fair market value at the time of grant. For the three and sixnine months ended March 31,June 30, 2005, $90,734$91,737 and $98,793,$190,530, respectively, of debt discount was amortized.

A trust affiliated with an officer, director and significant stockholder of the Company purchased one of the aforementioned promissory notes in the principal amount of $500,000 and received a warrant exercisable for 37,500 shares with an exercise price of $9.28 per share.

1011

11.  STOCKHOLDERS’ EQUITY

Summary

The following table summarizes changes in equity components from transactions during the sixnine months ended March 31,June 30, 2005:

As ofDuring the quarter ended March 31, 2005, all previously outstanding shares of Series D and Series E Preferred Stock were converted into an aggregate of 930,565 shares of common stock.stock and no preferred stock was outstanding at June 30, 2005.

Committed Equity Financing Facility

In December 2004, the Company entered into a $25 millioncommon stock purchase agreement, registration rights agreement and warrant as part of a Committed Equity Financing Facility (CEFF) with Kingsbridge Capital Limited, a firm specializing in financing smallLtd., pursuant to medium sized technology-based companies. The CEFF allows the Companywhich Kingsbridge committed to sellpurchase up to Kingsbridge, subject to certain significant limiting conditions, a maximum of 3,684,782 shares of its common stock at a price between 88% and 92%$25 million of the volume weighted average price during 15 day purchase periods.

Company’s common stock. As part of the arrangement, the Company issued a warrant to Kingsbridge to purchase 275,000 shares of its common stock at a price of $8.60 per share. The warrant iswas exercisable beginning six months after the date of issuancegrant and for a period of five years thereafter. The Company also agreedSubject to filecertain conditions, including the effectiveness of a registration statement forregistering the resaleshares issuable to Kingsbridge, the Company had the right to require Kingsbridge to purchase a maximum of 3,684,782 newly-issued shares acquired under the CEFF, or upon exerciseof its common stock at a price between 88% and 92% of the warrant, within 45 days after entering into the agreement for the CEFF. In January 2005 the Company filed the required resale registration statement. The registration statement has not yet been declared effective.volume weighted average price during a 15 day purchase period. The 3,684,782 share maximum also includesincluded any shares that the Company may issuehave issued in lieu of paying Kingsbridge liquidated damages in the event that a registration statement iswas unavailable for the resale of the securities purchased by Kingsbridge under the CEFF once the registration statement hashad been declared effective. The Company hashad no obligation to draw down all or any portion of the commitment during its 24-month term.

The Company is obligated to use 40%As part of the proceeds it may receive fromarrangement, the CEFF or other equity financingsCompany also agreed to prepay any outstanding interest and principal on the notes described in Note 10 above. The Company may also be required to pay liquidated damages of up to $2,500,000 in the event thatfile a registration statement, is not availablewithin 45 days after entering into the agreement for the CEFF, for the resale of securities purchased byshares to be acquired under the CEFF, or upon exercise of the warrant. In January 2005, the Company filed the required resale registration statement. In June 2005, the Company decided to terminate the CEFF; and on July 1, 2005, the Company requested withdrawal of the registration statement.

12

In July 2005, the Company entered into a termination, settlement and release agreement with Kingsbridge. Under the terms of this agreement, the Company and Kingsbridge agreed that the common stock purchase agreement entered into with Kingsbridge in December 2004, and the related registration rights agreement and warrant issued to Kingsbridge of the same date would be terminated, and Kingsbridge would return the warrant, which was not exercised, to the Company for cancellation. No shares were sold to Kingsbridge under the CEFF.CEFF prior to the termination. The Company has also agreed to pay toincurred no early termination penalties in connection with this termination. The termination agreement contains a consultant, who is not an affiliatemutual release of the Company or Kingsbridge, a finder fee equal to 4% of the first $5 million raised under the CEFF, 3% for the second $5 million raised under the CEFF, 2% for the third $5 million raised under the CEFF, and 1.5% for any additional amounts raised.claims.

The fair value of the warrant at the date of issuance, which amounted to $843,105, and legal, audit and associated fees of $193,079$293,826, were recorded as prepaid transaction costs. These costs will be reclassified to equity once the registration statement is declared effective or upon exercise of the warrant. The following variables were used to determine the fair value of the warrant under the Black-Scholes option pricing model: volatility of 56%, term of 5.5 years, risk free interest of 2.97% and underlying stock price equal to fair market value at the time of issuance. The warrant has been accounted for as a derivative instrument in accordance with Emerging Issues Task Force (EITF) 00-19 “Accounting for Derivative Financial Instruments, Indexed to, and Potentially Settled in a Company’s Own Stock.” As a derivative, the fair value of the warrant is recorded as a liability at its estimated fair value at each balance sheet date until the effective date of the related registration statement, or upon warrant exercise, when the warrant liability, as may be further revalued, will bewould have been reclassified to equity. Changes in the fair value of the warrant are recorded as other income or expense in the accompanying income statement. For the three and nine months ended March 31,June 30, 2005, $682,210$451,190 and $183,259, respectively, was recorded as unrealized gain for the change in valuation of the fair value of the warrant. For the period measured from the issuance date of December 14, 2004 until March 31, 2005, $267,931 was recorded as an unrealized expenseon derivative revaluation for the change in valuation of the fair value of the warrant.

Due to the decision to terminate this financing, the Company determined that the value of the prepaid transaction cost asset was impaired at June 30, 2005. Accordingly, the Company recognized an impairment charge in the total amount of $477,085, of which $293,826 is legal, audit and associated fees and is recorded as selling, general and administrative expense for the three and nine months ended June 30, 2005, and $183,259,is the excess of the fair value of the warrant over the associated derivative instrument liability and is recorded as warrant impairment expense for the three and nine months ended June 30, 2005. The remaining asset of $659,846 in prepaid transaction costs will be offset against the derivative instrument liability of the same amount during the quarter ending September 30, 2005, with no net effect on other income or expense.

Stock Options

During the sixnine months ended March 31,June 30, 2005, the Company recorded non-cash compensation expense of $266,963 for the extension of time to exercise stock options for former employees relating to an aggregate of 92,675 shares of common stock.stock and $57,619 for option expense relating to options for 68,125 shares held by an officer of the Company who transitioned from employee to consultant. For the three and sixnine months ended March 31,June 30, 2005, the Company also recognized $1,540 and $3,080$4,620 of non-cash compensation expense, respectively, for the value of options granted to non-employees. These options were valued in the same manner as described in Note 4 for employee options. There were no non-cash compensation expenses for the quarter ended March 31,June 30, 2004 or for the sixnine months ended March 31,June 30, 2004.

The following table summarizes information about stock option activity during the sixnine months ended March 31,June 30, 2005:

Options outstanding are exercisable at prices ranging from $2.50 to $10.06 and expire over the period from 2005 to 2010 with an average life of 3.1 years.

13

Stock Purchase Warrants

The following table summarizes information about warrant activity during the sixnine months ended March 31,June 30, 2005:

At March 31,June 30, 2005, the following stock purchase warrants were outstanding arising from offerings and other transactions, eachtransactions:

As a result of the termination of the Kingsbridge Agreement (see Committed Equity Financing Facility section above), the warrant for 275,000 shares which was exercisable into one common share:until June 14, 2010 at $8.60 per share was cancelled on July 11, 2005.

12

Number		Exercise Price			Expiration Date
655,000		$	2.00		September 30, 2006
451,880		$	3.01		March 31, 2007
272,729		$	6.75		July 10, 2007
100,000		$	4.25		September 30, 2007
353,625		$	3.25		December 31, 2007
50,000		$	3.63		April 8, 2008
75,000		$	8.60		December 31, 2009
75,000		$	9.28		December 31, 2009
275,000		$	8.60		June 14, 2010
2,308,234

The warrants exercisable for 272,729 shares which expire on July 10, 2007 contain anti-dilution provisions, and as a result of the 2005 Equity Financing (see Note 15 below) the exercise price of those warrants will adjust from $6.75 to $6.55 at the option of the holders.

12.  BUSINESS SEGMENT DATA

The Company is engaged in design, development and commercialization of sound, acoustic and other technologies. The Company’s operations are organized into two segments by the end-user markets they serve. The Company’s reportable segments are strategic business units that sell the Company’s products to distinct distribution channels. The Commercial Products Group (Commercial Group) markets and licenses HSS, NeoPlanar and NeoPlanarother sound products incorporating the Company’s technologies to companies that employ audio in consumer, commercial and professional applications. The Government and Force Protection Systems Group (Government Group) markets LRAD, MRAD, NeoPlanar, Sound Cluster and HSS sound products to government and military customers and to the expanding force protection and commercial security markets. The segments are managed separately because each segment requires different selling and marketing strategies as the class of customers within each segment is different.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company does not allocate operating expenses or assets between its two reportable segments. Accordingly the measure of profit for each reportable segment is gross profit.

13.  LEGAL PROCEEDINGS

In September 2003, the Company filed a complaint against eSoundIdeas, Inc., in the Superior Court of California, County of San Diego, alleging breach of contract and seeking a declaratory judgment to the effect that a License, Purchase and Marketing Agreement dated September 28, 2000 (the “ESI License Agreement”) with eSoundIdeas, a California partnership, was properly terminated in May 2003. The principals of eSoundIdeas are Greg O. Endsley and Douglas J. Paschall. The principals also founded a corporation, eSoundIdeas, Inc., which purported to assume the contractual obligations of eSoundIdeas. The Company amended the complaint in November 2003 to include eSoundIdeas (the general partnership), Mr. Endsley and Mr. Paschall as defendants. For convenience, the following discussion refers to eSoundIdeas and eSoundIdeas, Inc. collectively as “ESI.” In November 2003, the Company filed complaints in the Superior Court of California, County of San Diego, against Mr. Endsley and Paschall seeking declaratory judgments that options granted to each of Mr. Endsley and Mr. Paschall in April 2001 were terminated in October 2002.

The three cases were consolidated upon motion by the defendants and order of the court. The defendants filed a cross-action in the consolidated action alleging fraud, breach of contract in connection with the ESI License Agreement and the options, breach of the implied covenant of good faith and fair dealing, intentional interference with contract, negligent interference with contract, intentional interference with prospective economic advantage, negligent interference with prospective economic advantage, defamation, and violation of California Business and Professions Code §17200. The Company filed its answer to the second amended cross-complaint in August 2004.

In April 2005, the Company, ESI and its two principals entered into a Settlement Agreement and Mutual Release. As part of the settlement, the Company agreed to pay $150,000, which was previously accrued and recorded as a general and administrative expense, and to issue 17,500 shares of common stock to ESI, for which theESI. The fair market value of these as of April 27, 2005 wasof $140,175 which was recorded in the quarter ended March 31, 2005 as a general and administrative expense. In addition, Mr. Endsley and Mr. Paschall will be entitled to receive an aggregate commission equal to 1% of net sales from April 1, 2005 to September 28, 2007, of the Company’s HSS products specifically targeted for use in North America in the point of sale/purchase, kiosk, display, event, trade show and exhibit markets, subject to a maximum aggregate commission of $500,000. The Company also granted the recipients of the shares “piggyback” rights to have their shares included on future registration statements that the Company might file.

The Company may at times be involved in litigation in the ordinary course of business. The Company will also, from time to time, when appropriate in management’s estimation, record adequate reserves in the Company’s financial statements for pending litigation. Except as set forth above, there are no pending material legal proceedings to which the Company is a party or to which any of its property is subject.

14.  INCOME TAXES

At March 31,June 30, 2005, a valuation allowance has been provided to offset the net deferred tax asset as management has determined that it is more likely than not that the deferred tax asset will not be realized. At September 30, 2004 the Company had for federal income tax purposes net operating loss carryforwards of approximately $37,400,000, which expire through 2025 of which certain amounts are subject to significant limitations under the Internal Revenue Code of 1986, as amended.

15.SUBSEQUENT EVENTS

On July 18, 2005, the Company sold 2,868,851 shares of common stock at a purchase price of $4.88 per share (the 2005 Equity Financing). The Company also issued warrants in two series to the investors to purchase 1,581,919 shares of common stock. The “A” Warrants are exercisable for an aggregate of 717,213 shares of common stock at an exercise price of $6.36 per share until July 18, 2009. The “B” Warrants are exercisable for an aggregate of 864,706 shares of common stock at an exercise price of $7.23 per share and are exercisable from the date the registration statement referred to below becomes effective until the date six months after that effective date.

The gross proceeds from this financing were approximately $14 million. The Company incurred financing and closing costs of approximately $740,000. The Company used approximately $2.0 million of the gross proceeds to discharge the principal balance of and accrued interest on the 8% unsecured subordinated promissory notes due December 31, 2006 (see Note 10). The Company entered into a registration rights agreement with the investors, and agreed to prepare and file, within 30 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold and the common stock issuable upon the exercise of the warrants. Failure to have an effective registration statement within 90 days obligates the Company to pay liquidated damages to the purchasers in the amount of 0.5% of the gross proceeds per month until 180 days after the closing and 1% of the gross proceeds per month thereafter.

The Company has also agreed to submit the financing to a vote of its stockholders for approval prior to June 2006. The Company further agreed that, subject to certain exceptions, if during the next year it sells shares of its common stock, or options or warrants to purchase shares of its common stock, in a private placement or in a public offering using a Form S-3, the purchasers will have certain rights of first refusal to participate in the financing. The Company has also agreed to indemnify the purchasers for certain losses.

The “A” Warrants and “B” Warrants contain provisions that would adjust the exercise price, and in inverse proportion adjust the number of shares subject to the warrant, in the event the Company pays or effects stock dividends or splits, or in the event the Company sells shares of its common stock at a purchase price, or options or warrants to purchase shares of its common stock having an exercise price, less than the exercise price of the applicable warrant. The “A” Warrants also feature a net exercise provision, which enables the holder to choose to exercise the warrant without paying cash by surrendering shares subject to the warrant with a market value equal to the exercise price. This right is available only if a registration statement covering the shares subject to the “A” Warrants is not available after it is initially declared effective. The Company has the right to redeem the “B” Warrants if the closing price of the shares of its common stock is $10.00 or greater for 15 consecutive trading days and the holder does not exercise within 20 days after the Company gives notice of redemption.

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

The following discussion should be read in conjunction with the accompanying unaudited interim financial statements and the related notes included under Item 1 of this Quarterly Report on Form 10-Q, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2004.

The following discussion provides an overview of our results of operations for the three and sixnine months ended March 31,June 30, 2005 and 2004. Significant period-to-period variances in the statements of operations are discussed under the caption “Results of Operations.” Our financial condition and cash flows are discussed under the caption “Liquidity and Capital Resources.”

Forward Looking Statements

This report contains certain statements of a forward-looking nature relating to future events or future performance. Words such as  “expects,”“anticipates,”“intends,”“plans,”“believes,”“seeks,”“estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the only means of identifying forward-looking statements. Prospective investors are cautioned that such statements are only predictions and that actual events or results may differ materially. In evaluating such statements, prospective investors should specifically consider various factors identified in this report, including the matters set forth below under the caption“Business Risks”, which could cause actual results to differ materially from those indicated by such forward-looking statements.

16

Overview

We are an innovator of proprietary sound reproduction technologies and products. We believe our innovative proprietary sound technologies provide us a significant competitive advantage in our principal markets. We believe we are the leader in developing and commercializing parametric loudspeakers, branded as HyperSonic® soundSound or HSS®. We believe we are also the leader in developing and commercializing high intensity directed acoustical devices, branded as our Long Range Acoustic Device or LRAD™ and Medium Range Acoustic Device or MRAD™. We have filedmore than 55 patents issued world-wide covering our various sound technologies, of which over 7045 are patents issued in the United States. We also have over 265 pending patent applications world-wide, of which over 110 are pending patent applications in the United States, and over 90 patent applications internationally covering our various sound technologies and products.States.

We make significant investments in research and development to expand our technology and product portfolio. We are expandinghave recently expanded our LRADacoustic device product family by (a) introducing a new force protection product, the MRAD, a smaller and more portable product that complements our existing LRAD device; (b) introducing and signing the first license agreement for our new SoundVector scaleable, directional sound product; and (c) introducing a new NeoPlanar product line for emergency notification and general announcementannouncing markets whichthat require high intelligibility, andintelligibility. In our fiscal quarter ending September 30, 2005, we expect to begin deliveries of the H450, our latest generation HSS product model employing a new plastic emitter. The H450 provides improved performance over our previous models at approximately half the cost. We are utilizing our technologies and products to provide solutions for difficult acoustic challenges. We offer our products for sale worldwide, but expect our largest markets to be the United States, Europe and Asia.

OurThe four major products from our technology portfolio are listed below.

1517

We believe we are uniquely equipped to provide our technologies and products in rapidly growing markets for new sound applications not currently served by conventional sound devices and as an alternative to conventional loudspeakers. We believe market factors such as the rapid growth of plasma and flat panel screens offer significant growth opportunities for our HSS focused sound solutions. We also believe that the growth in defense and homeland security and related protection spending by commercial customers provides a growing market for our sound products to be used for intelligible communication over long distances.

Our primary products sold to date have been LRAD and HSS products. TheseDuring the nine months ended June 30, 2005, these products are currentlywere manufactured for us by Pemstar, Inc., an established contract manufacturer with multiple locations worldwide. However, during the quarter ended June 30, 2005, we terminated the relationship with Pemstar, and starting in our fiscal fourth quarter expect to start manufacturing our products at a new contract manufacturer.

Our sales have been highly dependent on large orders from a fewsmall number of customers. We target our products for sale worldwide, but expect the largest markets to be the U.S., Europe and Asia. To date, our sales have been made in U.S. Dollarsdollars and we do not expect currency fluctuations to have a material impact on our operations.

Overall Performance

Our secondFor our third fiscal quarter ended March 31,June 30, 2005, showed a substantial increase in revenues overwere 34% lower than the same period in the prior fiscal year. However, dueyear primarily as a result of reduced LRAD deliveries to significant increases in operatinggovernment customers. Operating expenses for the third fiscal quarter were 66% higher than the comparable prior year period, and as a result, our net loss for the fiscal quarter ended March 31,June 30, 2005, was 158% higher than for the same period in thecomparable prior fiscal year.year period. Our revenues for the three months ended March 31,June 30, 2005 were $2,817,393,$1,393,797, compared to $1,493,250$2,107,281 for the three months ended March 31, 2004, an increase of 89%.June 30, 2004. Our gross profit for the three months ended March 31,June 30, 2005 was 48%29% of revenues, compared to 37%52% of revenues for the comparable period in the prior fiscal year. We recorded a gross profit of $1,363,427$402,007 for the three months ended March 31,June 30, 2005, which was higher$698,955 lower than the gross profit of $548,026$1,100,962 for the three months ended March 31,June 30, 2004. Operating expenses increased from $1,723,720$2,504,650 for the three months ended March 31,June 30, 2004 to $3,546,429$4,147,489 for the three months ended March 31,June 30, 2005. In addition, for the three months ended March 31,June 30, 2005, there was a non-cash gain on derivative revaluation$115,217 of $682,210net interest expense associated with the decreasesubordinated notes sold in value of the warrant we issued to Kingsbridge Capital, and for the six months ended March 31, 2005 there was a non-cash expense of $267,931 associated with the increase in value of the same warrant. There were no corresponding entries for the same periods in the prior fiscal year.December 2004. Our net loss increased from $1,165,196$1,390,411 for the three months ended March 31,June 30, 2004 to $1,613,016$3,592,768 for the three months ended March 31,June 30, 2005.

We are continuingAs a result of our performance for the quarter and the substantial completion of major development projects such as MRAD, HSS 450 and SoundVector, we initiated an effort to reduce expenses while we continue to focus our efforts on near-term revenue and gross margin improvement from our existing, marketable products. We have filled key managementAs a result we decreased our headcount from 71 employees at March 31, 2005, to 46 employees as of June 30, 2005. The majority of the reductions were in research and operations positionsdevelopment. At June 30, 2005, 9 employees were in research and increased personneldevelopment, 13 were in ourproduction, quality assurance and materials control, 11 were in general and administrative and 13 were in marketing, sales and marketing and engineering departments. While new hires have necessarily resulted in increased expenses, we believe these new hires are important to near-term revenue and gross margin improvements. We are currently focusing our resources primarily on sales, marketing, engineering and production of existing products.licensing. We are closely monitoring expenses for all of our Advanced Development department, charged with development of new products.departments. Our policy is to establish a compelling business case for each Advanced Development initiative.all initiatives.

Our various technologies are high risk in nature. Our future is largely dependent upon the success of our sound technologies. We invest significant funds in research and development, marketing and sales and on patent applications related to our proprietary technologies. Unanticipated technical or manufacturing obstacles can arise at any time and disrupt sales or licensing activities and result in lengthy and costly delays. See “Business Risks” below.

18

Recent Developments

In April 2005, we entered into a Settlement Agreement and Mutual Release with eSoundIdeas, Inc., its two principals and a related partnership, which we refer to collectively as the ESI Parties. Pursuant to the Settlement Agreement, we and the ESI Parties settled litigation arising out of a dispute regarding a license and marketing agreement that we terminated in May 2003, and regarding stock options issued to each of the principals in April 2001 which expired unexercised following termination of consulting services provided to us by these principals. As part of the settlement, the Company agreed to pay $150,000, which was previously recorded as a general and administrative expense, and to issue 17,500 shares of common stock to the ESI Parties, for which the fair market value as of April 27, 2005 was $140,175, which was recorded in the quarter ended March 31, 2005 as a general and administrative expense. We granted the recipients of these shares “piggyback” rights to have their shares included on future registration statements that we might file. In addition, the ESI Parties will be entitled to receive an aggregate commission equal to 1% of net sales from April 1, 2005 to September 28, 2007, of our HSS products specifically targeted for use in North America in the point of sale/purchase, kiosk, display, event, trade show and exhibit markets, subject to a maximum aggregate commission of $500,000. We and the ESI Parties have executed a mutual release of claims, and have agreed to dismiss with prejudice the pending litigation among us.

In May 2005, Carl Gruenler, Vice President, Government and Force Protection Systems Group, left our company. Kalani Jones, President and Chief Operating Officer, will assumeassumed Mr. Gruenler's dutiesGruenler’s duties. In July 2005, A.J. Ballard was appointed as Senior Director of the Government and Force Protection Systems Group, reporting to Kalani Jones.

In June 2005 we entered into a design and manufacturing licensing agreement with ECCO Group (ECCO), the world’s largest manufacturer of backup alarms for commercial vehicles. The agreement covers the initial licensing and product development of our SoundVector technology to ECCO and its affiliates for backup vehicle alarms and similar uses. The agreement includes technology transfer, product development assistance and upfront licensing fees, with royalties payable, based on unit volume production. The agreement is renewable on an annual basis after an initial three-year term, with further fees due upon each renewal.

In July 2005 we entered into an agreement to terminate the Committed Equity Financing Facility with Kingsbridge Capital Limited entered into in December 2004. The termination agreement resulted from our determination that the interim untilcommon stock purchase agreement was no longer consistent with our financing plans.

In July 2005 we locate a replacementcompleted an institutional financing providing gross proceeds of $14 million. After paying financing and closing costs and retiring approximately $2 million of unsecured subordinated promissory notes, we expect to use the net proceeds for Mr. Gruenler.marketing, sales and deliveries of our proprietary directed sound products and for general working capital.

Critical Accounting Policies

We have identified the policies below as critical to our business operations and the understandings of our results of operations. Our accounting policies are more fully described in our financial statements located in Item 1 of Part I, “Financial Statements.”

The methods, estimates and judgments we use in applying our accounting policies, in conformity with generally accepted accounting principles in the United States, have a significant impact on the results we report in our financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The estimates affect the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Revenue Recognition.  We currently derive our revenue primarily from two sources: (i) component and product sale revenues and associated engineering and installation, which we refer to collectively as Product Sales and (ii) contract and license fee revenue. Product Sales revenues are recognized in the periods that products are shipped to customers, FOB shipping point or destination, when a signed contract exists, the fee is fixed and determinable, collection of resulting receivables is probable and there are no remaining obligations. Revenues from engineering contracts are recognized based on milestones or completion of the contracted services. Revenues from ongoing per unit license fees are earned based on units shipped incorporating our patented proprietary technologies and are recognized in the period when the ultimate customer accepts the product and collectibility is reasonably assured. Revenues from up-front license and other fees and annual license fees are generally recognized ratably over the specified term of the particular license or agreement.

Valuation of Intangible Assets.  Intangible assets include purchased technology and patents, which are amortized over their estimated useful lives. We must make judgments and estimates regarding the future utility and carrying value of intangible assets. The carrying values of such assets are periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than its carrying value. In fiscal 2004, we reviewed the carrying value of our intangible assets and reduced the carrying value of these assets by $37,798. Our judgments and estimates regarding carrying value and impairment of intangible assets have an impact on our financial statements.

19

Warranty Reserve.  We establish a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. These warranties require us to make estimates regarding the amount and costs of warranty repairs we expect to make over a period of time. Factors affecting warranty reserve levels include the number of units sold and anticipated cost of warranty repairs and anticipated rates of warranty claims. We evaluate the adequacy of the provision for warranty costs each reporting period. See Note 9 to our financial statements for additional information regarding warranties. The estimates we use have an impact on our financial statements. In the three and sixnine months ended March 31,June 30, 2005, we recorded a net warranty reduction of $158,886$10,350 and $76,723,$103,430, respectively, as a result of the following: 1)(a) we reduced the warranty reserve that we had previously established in fiscal 2003 for HSS Generation 1 products, primarily as a result of the expiration of time to return failedthe warranty period for HSS Generation 1 product to the company for replacement,products sold, and 2)(b) we recorded a warranty provision for current sales of all products.sales.

Derivative Instruments.We account for the warrant issued in December 2004 in conjunction with the Committed Equity Financing Facility with Kingsbridge Capital Limited as a derivative financial instrument. As a derivative, the fair value of the warrant is recorded as a liability in the balance sheet and changes in the fair value of the warrant are recognized as other income or expense during each period. The fair value of the warrant is expected to change primarily in response to changes in our stock price.

Significant increases in the fair value of our stock could give rise to significant expense in the period of the change. Likewise, a reduction in our stock price could give rise to significant income in the period of the change. The warrant liability will be reclassified to equity as of the effective date of the related registration statement, or upon the exercise of the warrant.

Guarantees and Indemnifications. Under our bylaws, we have agreed to indemnify our officers and directors for certain events. We also enter into certain indemnification agreements in the normal course of our business. We have no liabilities recorded for such indemnities.

Deferred Tax Asset.We have provided a full valuation reserve related to our substantial deferred tax asset as management has not determined that it is more likely than not that the deferred tax asset will not be realized. In the future, if sufficient evidence of our ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, we may be required to reduce our valuation allowances, resulting in income tax benefits in our consolidated statement of operations. We evaluate the realizability of the deferred tax assets and assess the need for valuation allowance quarterly. The utilization of the net operating loss carryforwards could be substantially limited due to restrictions imposed under federal and state laws upon a change in ownership. Congress passed the American Jobs Creation Act of 2004 in October 2004. The new law contains numerous changes to existing tax laws, including both domestic and foreign tax incentives. We have not yet determined what impact, if any, this new law may have on our deferred tax asset, or our future results of operations and financial condition.

Legal Proceedings. We are currently involved in certain legal proceedings. We estimate the range of liability relating to pending litigation, where the amount and range of loss can be estimated. We record our best estimate of a loss when the loss is considered probable. Where a liability is probable and there is a range of estimated loss with no best estimate in the range, we record the minimum estimated liability related to the claim. As additional information becomes available, we assess the potential liability related to our pending litigation and revise our estimates.

Valuation of Inventory.Our inventory is comprised of raw materials, assemblies and finished products that we intend to sell to our customers.We must periodically make judgments and estimates regarding the future utility and carrying value of our inventory. The carrying value of our inventory is periodically reviewed and impairments, if any, are recognized when the expected future benefit from our inventory is less than its carrying value. In the quarter ended March 31,June 30, 2005, we reviewed the carrying value of our inventory and increaseddecreased the reserve for obsolescence to $293,535 from the level of $349,986 at March 31, 2005. The reserve is primarily for raw materials and finished goods that were used on our older HSS and PMT products for which there is anticipated to be reduced demand.

Results of Operations

Revenues

Revenues for the sixthree months ended March 31,June 30, 2005 were $7,226,306, which was$1,393,797, representing a 219% increase over the $2,268,02834% decrease from $2,107,281 in revenues for the sixthree months ended March 31,June 30, 2004. Revenues for the sixthree months ended March 31,June 30, 2005 and March 31, 2004 included $7,161,206 and $2,111,834$1,378,648 of product sales and $65,100$15,149 of contract and $156,194license revenues. Revenues for the three months ended June 30, 2004 consisted of $2,089,359 of product sales and $17,922 of contract and license revenues. The decrease in revenues was due to reduced sales of LRAD products by our Government Group and reduced sales of HSS products by our Commercial Products Group. The prior year period also included revenues from the sale of a 5MC public address system which we did not market during the current period. Our revenues are highly dependent on the timing of large orders from a small number of customers. We expect continued uneven quarterly revenues in future periods due to the lack of established markets for our proprietary products.

At June 30, 2005, we had $450,000 in deferred revenue consisting of deposits for existing contracts, agreements and licenses.

20

Revenues for the nine months ended June 30, 2005 were $8,620,104, representing a 97% increase from $4,375,309 in revenues for the nine months ended June 30, 2004. Revenues for the nine months ended June 30, 2005 and June 30, 2004 included $8,539,855 and $4,201,193 of product sales, and $80,249 and $174,116 of contract and license revenues, respectively. The increase in product sales was due primarily due to increased sales of LRAD products by our Government Group.

Revenues for the three months ended March 31, 2005 were $2,817,393, which was an 89% increase over the $1,493,250 in revenues for the three months ended March 31, 2004. Revenues for the three months ended March 31, 2005 included $2,814,293 of product sales and $3,100 of contract and license revenues. Revenues for the three months ended March 31, 2004 consisted entirely of product sales. The increase in revenues was primarily due to increased sales of LRAD products by our Government Group.

At March 31, 2005, we had $300,000 in deferred revenue or deposits for existing contracts, agreements and licenses.

We have only a limited record of recurring sales, so we do not consider order backlog to be an important index of future performance at this time. Our backlog is affected by the timing of large orders and order deliveries, especially to government customers. Our order backlog was approximately $128,017$660,000 at March 31,June 30, 2005 and approximately $600,000$46,800 at March 31,June 30, 2004. Backlog orders are subject to modification, cancellation or rescheduling by our customers. Future shipments may also be delayed due to production delays, component shortages and other production and delivery related issues.

Our Commercial Products Group, or Commercial Group, markets and licenses HSS, NeoPlanar and NeoPlanarSoundVector products to companies, which employ audio in consumer, commercial and professional applications. Our Government and Force Protection Systems Group, or Government Group, markets LRAD, NeoPlanar, SoundCluster and HSS products to government and military customers and to the expanding force protection and commercial security markets.

Presented below is a summary of revenues by business segment:

Commercial Group revenues for all reported periods consisted primarily of HSS and Neoplanar product sales. The decrease in Commercial Group revenues for the three and six monthsnine month periods ended March 31,June 30, 2004 consisted of multiple small volume sales. Commercial Group revenues for the three and nine month periods ended June 30, 2005 compared to the comparable prior fiscal periods was due toreflect a shift in our marketing focus from multiple small volume sales to pursuit of high volume contracts. These contracts which require much longer sales cycles.cycles, and we had not at June 30, 2005 recognized significant revenues from such contracts.

Government Group revenues for all reported periods consisted primarily of sales of LRAD, NeoPlanar, and NeoPlanar5MC products and engineering services such as installation design and support. These revenues are derived primarily from a limited number of large orders, and the timing of follow-on orders, if any, is difficult to predict. Government Group revenues for the three and six months ended March 31, 2005 were $2,707,870 and $6,929,434 respectively, and consisted primarily of LRAD product sales and engineering services. Government Group sales for the three and sixnine month periods ended March 31, 2004 were $1,038,094 and $1,730,933, respectively, andJune 30, 2005 consisted primarily of LRAD and NeoPlanar product sales and, to a much lesser extent, engineering services.

For the sixthree months ended March 31,June 30, 2005, sales to one customer in the Government Group accounted for 82%62% of total revenues and sales to a second customer in the Government Group, including affiliates of the customer, accounted for 12% of total revenues. For the nine months ended June 30, 2005, sales to one customer in the Government Group accounted for 79% of total revenues and sales to a second customer in the Government Group, including affiliates of the customer, accounted for 10% of total revenues. For the three months ended March 31, 2005,June 30, 2004, sales to one customer in the Government Groupthree customers accounted for 93%62%, 22% and 13% of total revenues.revenues, respectively. For the sixnine months ended March 31,June 30, 2004, sales to two customers in the Government Group accounted for 41%51% and 32%28% of total revenues, respectively, and sales to one customer in the Commercial Group accounted for 11% of total revenues. For the three months ended March 31, 2004, sales to one customer in the Government Group accounted for 62% of total revenues, and sales to one customer in the Commercial Group accounted for 17% of total revenues.respectively. The loss of any one of these significant customers would have a material adverse effect on our results of operations and financial condition.

21

Gross Profit

Presented below is the gross profit or loss by business segment:

The overall gross profit for the sixthree months ended March 31,June 30, 2005 was $4,244,637,$402,007, or 59%29% of revenues, compared to gross profit of $914,326$1,100,962, or 40%52% of revenues, for the comparable period of the prior fiscal year. Gross profit as a percentage of revenues declined over the comparable period of the prior fiscal year as a result of reduced gross profit in our Government Group, offset in part by decreased gross losses in our Commercial Group.

The overall gross profit for the nine months ended June 30, 2005 was $4,646,643, or 54% of revenues, compared to gross profit of $2,015,288, or 46% of revenues, for the comparable period of the prior fiscal year. The significant improvement in gross profit as a percentage of revenues reflected improved gross profit in our Government Group, offset in part by increased gross losses in our Commercial Group.

The overall gross profitGroup and increased expenses for the three months ended March 31, 2005 was $1,363,427 or 48% of revenues, compared to gross profit of $548,026 or 37% of revenues for the comparable period of the prior fiscal year. Gross profit as a percentage of revenues improved over the comparable period of the prior fiscal year as a result of improved gross profit in our Government Group, offset in part by increased gross losses in our Commercial Group.inventory reserves.

We experienced gross losses in our Commercial Group for the three and sixnine months ended March 31,June 30, 2005 of $408,137$91,184 and $612,433$703,617, respectively, as limited sales were not sufficient to absorb fixed manufacturing overhead costs and substantial reserves were taken for obsolete and slow moving inventory, particularly for our older HSS products. For the three and sixnine months ended March 31,June 30, 2004, we had gross losses in our Commercial Group of $73,180$167,833 and $76,292$244,625 respectively, primarily as a result of limited sales compared to fixed overhead and warranty costs. During fiscal year 2003 and fiscal 2004 we changed our HSS Generation 1 emitter design to eliminate the requirement for a vacuum in the emitter, and we improved film quality. During fiscal 2004, we made further raw material improvements in the electronics and the manner in which the film and emitters are produced. In May 2005 we introduced a new, lower-cost model of our HSS product. We believe that future generationsthe latest generation of our products will be more reliable. We expect that warranty costs will decrease in fiscal 2005, and that as the volume of HSS product sales grow, we will achieve positive gross margins in future periods.

Gross profit for our Government Group for the three and sixnine months ended March 31,June 30, 2005, was $1,771,564$493,191 and $4,857,070$5,350,260, respectively, compared to $621,206$1,268,795 and $991,118$2,259,913 for the three and sixnine months ended March 31,June 30, 2004. Cost of revenues for the three and nine months ended June 30, 2005 included $127,214 of costs associated with the partial shipment of an order.  The revenue associated with the order will be recognized upon shipment of complete products which is expected to occur in our fiscal fourth quarter. Gross profit percentage continues to be highly dependent on sales prices, sales volumes, purchasing costs and overhead allocations. Our various sound products have different margins, so product sales mix will materially affect gross profits. In addition, we continue to make model updates and changes including raw material and component changes, which change product costs.costs and may result in expense for raw material and products that are deemed obsolete. We therefore do not believe that historical gross profit margins should be relied upon as an indicator of future gross profit margins.

Selling, General and Administrative Expenses

Selling, general and administrative expenses as a percentagewere 207% of revenues were 57% for the sixthree months ended March 31,June 30, 2005 compared to 95%77% of revenues for the sixthree months ended March 31,June 30, 2004. These costs for the sixthree months ended March 31,June 30, 2005 totaled $4,089,951,$2,879,021, which represents an increase of $1,264,670 from selling, general and administrative expenses of $2,151,786$1,614,351 for the sixthree months ended March 31,June 30, 2004.

22

The overall increase for the sixthree months ended March 31,June 30, 2005 included the following:

Selling, general and administrative expenses were 81% of revenues for the nine months ended June 30, 2005 compared to 86% for nine months ended June 30, 2004. These costs for the nine months ended June 30, 2005 totaled $6,968,972, which represents an increase of $3,202,835 from selling general and administrative expenses of $3,766,137 for the nine months ended June 30, 2004. The overall increase for the nine months ended June 30, 2005 included the following:

We expect selling, general and administrative expenses to increase in future periods as we increase our marketing efforts for our proprietary sound technologies. We will also incur substantial additional expense over the remainder of fiscal 2005 to improve and document our internal control over financial reporting in anticipation of management’s required assessment of the effectiveness of our internal control over financial reporting and the attestation of such assessment by our independent registered public accounting firm, required by Section 404 of the Sarbanes-Oxley Act of 2002 in connection with our report on Form 10-K for the fiscal year ending September 30, 2005.

23

Research and Development Expenses

Research and development expenses increased by $1,819,789$378,169 from $1,093,219$890,299 to $1,268,468 for the sixthree months ended March 31, 2004 to $2,913,008 for the six months ended March 31,June 30, 2005. Research and development expenses as a percentage of sales were 40%91% for the sixthree months ended March 31,June 30, 2005 compared to 48%42% for the sixthree months ended March 31,June 30, 2004.

The overall increase for the sixthree months ended March 31,June 30, 2005 included the following:

Research and development expenses increased by $808,145$2,197,958 from $644,248$1,983,518 for the threenine months ended March 31,June 30, 2004 to $1,452,393$4,181,476 for the threenine months ended March 31,June 30, 2005. Research and development expenses as a percentage of sales were 52%49% for the threenine months ended March 31,June 30, 2005 compared to 43%45% for the threenine months ended March 31,June 30, 2004.

The overall increase for the threenine months ended March 31,June 30, 2005 included the following: