UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended June 30,December 31, 2009

or

For the transition period fromto                    .

Commission File Number: 000-24248

AMERICAN TECHNOLOGY CORPORATION

(Exact name of registrant as specified in its charter)

(858) 676-1112

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    ¨  No

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

The number of shares of Common Stock, $0.00001 par value, outstanding on July 28, 2009January 29, 2010 was 30,538,332.30,552,498.

AMERICAN TECHNOLOGY CORPORATION

INDEX

PART I. FINANCIAL INFORMATION

American Technology Corporation

CONSOLIDATED BALANCE SHEETS

See accompanying notes to interim consolidated financial statements

American Technology Corporation

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes to interim consolidated financial statements

American Technology Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to interim consolidated financial statements

American Technology Corporation

Notes to Interim Consolidated Financial Statements (unaudited)

1. OPERATIONS

American Technology Corporation, a Delaware corporation (the “Company”), is engaged in the design, development and commercialization of directed sound technologies and products. The principal markets for the Company’s proprietary sound reproduction technologies and products are in North America, Europe and Asia. The Company operates its business in one operating segment.

The Company has a currently inactive wholly owned subsidiary, American Technology Holdings, Inc., through which the Company intends to conduct international marketing, sales and distribution activities. The consolidated financial statements include the accounts of this subsidiary after elimination of intercompany transactions and accounts.

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

General

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 8 of Regulation S-X. In the opinion of management, the interim financial statements reflect all adjustments necessary in order to make the financial statements not misleading. The consolidated balance sheet as of September 30, 20082009 was derived from the Company’s most recent audited financial statements. Operating results for the three and nine month period 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, 20082009 included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (“SEC”) on December 4, 2008.1, 2009.

Revenue Recognition

The Company derives its revenue primarily from two sources: (i) product sales, and (ii) contract and license fees.

Product sales to customers, including resellers and system integrators, are recognized in the periods that products are shipped to customers (FOB shipping point) or received by customers (FOB destination), when the fee is fixed or determinable, when collection of resulting receivables is probable and there are no remaining obligations on the part of the Company. Most sales to resellers and system integrators are based on firm commitments from the end user; as a result resellers and system integrators carry little or no inventory. Revenues from associated engineering and installation contracts are recognized based on milestones or completion of the contracted services. The Company’s customers do not have the right to return product unless the product is found to be defective.

In limited circumstances, product sales may be recognized prior to shipment when, based on the Company’s evaluation, the criteria specified in ASC 605-10-S99-1 for recognizing revenue under bill and hold arrangements have been met.

The Company provides research and development services and licenses its technology to third parties. Revenues from up-front license and other fees and annual license fees are evaluated for multiple elements but are generally recognized ratably over the specified term of the particular license or agreement. Revenues from ongoing per unit license fees are earned based on units shipped and are recognized in the period when the ultimate customer accepts the product and collection is reasonably assured.

Accounting for Warrant Liability

Based on the Company’s adoption of authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) in June 2008, as codified in Accounting Standards Codification (ASC) 815-40, “Derivatives and Hedging; Contracts in Entity’s Own Equity” (formerly Emerging Issues Task Force Issue No. 07-5), effective October 1, 2009, certain outstanding warrants were determined to be derivative instruments, and accordingly, the estimated fair value of these warrants was reclassified from equity and recorded as a warrant liability. The cumulative effect of the change in accounting for these warrants was recognized as an adjustment to the opening accumulated deficit balance at October 1, 2009 based on the difference between the fair value of the warrants at issuance and at the reclassification date. The warrant liability is adjusted to fair value at each reporting period and the corresponding change in fair value is recorded as an unrealized gain or loss in current earnings. (See Notes 3 and 10).

3. RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”). This standard defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America, and expands disclosure about fair value measurements. According to the original pronouncement, SFAS No. 157 was effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued FASB Staff Position (“FSP”) SFAS 157-2, “Effective Date of FASB Statement No. 157”, which defers the effective date of SFAS No. 157 for all non-financial assets and liabilities, except those items recognized or disclosed at fair value on an annual or more frequent recurring basis, until years beginning after November 15, 2008. The Company’s adoption of SFAS No. 157 for its financial assets and liabilities on October 1, 2008 did not have a material impact on the Company’s consolidated financial statements. The Company does not expect that the adoption of SFAS No. 157 for its non-financial assets and liabilities will have a material impact on its consolidated financial statements.

In October 2008, the FASB issued FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS 157-3”). FSP SFAS 157-3 clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP SFAS 157-3 is effective upon issuance, including for prior periods for which financial statements have not been issued. Revisions resulting from a change in the valuation technique or its application should be accounted for as a change in accounting estimate following the guidance in SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”). However, the disclosure provisions in SFAS No. 154 for a change in accounting estimate are not required for revisions resulting from a change in valuation technique or its application. The adoption of this pronouncement by the Company did not have a material effect on its consolidated financial statements.

In April 2009, the FASB issued FSP SFAS No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP SFAS No. 157-4”). FSP SFAS No. 157-4 provides additional guidance for estimating fair value in accordance with FASB Statement No. 157 Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. FSP SFAS No. 157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. This FSP emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This statement is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this pronouncement by the Company did not have a material effect on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”), which will permit the option of choosing to measure certain eligible items at fair value at specified election dates and report unrealized gains and losses in earnings. SFAS No. 159 became effective for the Company on October 1, 2008. The Company has not elected to adopt the option available under SFAS No. 159 to measure any of its eligible financial instruments or other items at fair value. Accordingly, the Company continues to measure all of its assets and liabilities on the historical cost basis of accounting except as required under generally accepted accounting principles and disclosed herein. The adoption of SFAS No. 159 did not have a material impact on the Company’s consolidated financial statements.

In April 2008, the FASB issued authoritative guidance, as codified in ASC 350-30, “Goodwill and other; General Intangibles Other Than Goodwill” (formerly FSP SFAS 142-3, “Determination of Useful Life of Intangible Assets” (“FSP SFAS 142-3”)142-3). FSP SFAS 142-3 amends theThis guidance provides factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, “Goodwill and Other Intangible Assets.” FSP SFAS 142-3asset. This guidance also requires expanded disclosure related to the determination of intangible asset useful lives. FSP SFAS 142-3It is effective for fiscal years beginning after December 15, 2008. Earlier adoption iswas not permitted. The Company doesadoption of this guidance on October 1, 2009 did not expect FSP SFAS 142-3 to have a materialany impact on itsthe Company’s consolidated financial statements.

In June 2008, the FASB ratifiedissued authoritative guidance, as codified in ASC 815-40, “Derivatives and Hedging; Contracts in Entity’s Own Equity” (formerly Emerging Issues Task Force (“EITF”) Issue No. 07-5, “Determining whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock”(“EITF 07-5”)07-5). EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early application is not permitted. EITF 07-5This guidance provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the scope exception codified in ASC 815-10 (formerly SFAS No. 133 paragraph 11(a) scope exception. Some of the warrants issued by the). The Company contain a strike price adjustment feature, which upon adoption of EITF 07-5, will result in the instruments no longer being considered indexed to the Company’s own stock. Accordingly, our adoption of EITF 07-5adopted this guidance effective October 1, 2009 will cause theseand determined that warrants to be classified as liabilitiesgranted in 2006 were not equity-linked financial instruments, and to be remeasured at each reporting period with changes inaccordingly, were derivative instruments. The Company has recorded the fair value recognizedof these instruments and the resulting cumulative effect of this change in operating results. Theaccounting method, as of October 1, 2009 (See Note 10).

Effective October 1, 2009, the Company adopted new standards regarding business combinations issued by the FASB in December 2007, as codified under ASC 805, “Business Combinations” (formerly FAS 141R) that require the acquisition method to be applied to all transactions and other events in which an entity obtains control over one or more other businesses, requires the acquirer to recognize the fair value of all assets and liabilities acquired, even if less than one hundred percent ownership is acquired, and establishes the acquisition date fair value as measurement date for all assets and liabilities assumed. For the Company, this accounting update was effective on a prospective basis for all business combinations for which the acquisition date is on or after October 1, 2009. Since the Company is currently evaluating thenot contemplating any business combinations it does not presently expect any impact theof adoption of EITF 07-5 will have on its consolidated financial statements.

In April 2009,December 2007, the FASB issued FSP FAS No. 107-1authoritative guidance, as codified in ASC 810-10, “Consolidation” (formerly SFAS 160) that establishes accounting and APB 28-1, “Interim Disclosures about Fair Valuereporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of Financial Instruments” (“FSP FAS No. 107-1”). FSP FAS No. 107-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well asa subsidiary. This guidance clarifies that a non-controlling interest in annuala subsidiary is an ownership interest in the consolidated financial statements. FSP FAS No. 107-1 also amends APB Opinion No. 28, “Interim Financial Reporting”, to require those disclosures in summarized financial information at interim reporting periods. This statement becameguidance is effective for interim and annual reporting periods ending after June 15, 2009. The application of FSP FAS-107-1 expands the Company’s disclosures regardingfiscal years beginning after December 15, 2008. The provisions of are applied prospectively upon adoption except for the usepresentation and disclosure requirements that are applied retrospectively. The Company has no non-controlling interests and accordingly the adoption of fair value in interim periods butthis guidance effective October 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

In MaySeptember 2009, the FASB issued SFASAccounting Standards Update (ASU) No. 165, “Subsequent Events” (“SFAS2009-13, “Revenue Recognition (Topic 605)—Multiple Deliverable Arrangements” (formerly EITF Issue 08-1). This guidance updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 165”). SFAS No. 165 establishes general standards00-21, “Revenue Arrangements with Multiple Deliverables.” The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available torevenue recognition. ASU 2009-13 will be issued. SFAS No. 165 was effective for fiscal years and interim periods endingthe first annual reporting period beginning on or after June 15, 2009.2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The implementationCompany is currently assessing the future impact of this new accounting update to its consolidated financial statements.

In October 2009, the FASB issued ASU 2009-14, “Software (Topic 985)-Certain Revenue Arrangements that Include Software Elements” (formerly EITF Issue 09-3) and changes the accounting model for revenue arrangements that include both tangible products and software elements. Under this guidance, tangible products containing software components and nonsoftware components that function together to deliver the tangible product’s essential functionality are excluded from the software revenue guidance in Subtopic 985-605, “Software-Revenue Recognition”. In addition, hardware components of a tangible product containing software components are always excluded from the software revenue guidance. The guidance in this ASU is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. The adoption of this standard didis not expected to have a materialan impact on the Company’s consolidated financial statements. (See Note 15).position and results of operations since this accounting standard update provides only implementation and disclosure amendments.

In June

4. FAIR VALUE MEASUREMENTS

At December 31, 2009 throughthere was no difference between the issuancecarrying values of SFAS No. 168, “The FASB Accounting Standards Codificationthe Company’s cash equivalents and fair market value. For certain financial instruments, including accounts receivable, accounts payable, accrued expenses the Hierarchy of Generally Accepted Accounting Principles,carrying amounts approximate fair value due to their relatively short maturities.

On October 1, 2008, the FASB confirmed that the FASB Accounting Standards Codification (the “Codification”) will become the single official source of authoritative US generally accepted accounting principles (“US GAAP”) (other thanCompany adopted guidance issued by the SEC), superseding existing FASB American Instituteas codified in ASC 820-10,“Fair Value Measurements and Disclosures” (formerly SFAS No. 157). This guidance defines fair value, and establishes a three-level valuation hierarchy for disclosures of Certified Public Accountants, Emerging Issues Task Force (“EITF”), and related literature. Afterfair value measurement that enhances disclosure requirements for fair value measures. Financial instruments measured at fair value on a recurring basis as of December 31, 2009 are classified based on the effective datevaluation technique level in the table below:

As described in Note 10, the Company has warrants issued in 2006 subject to an anti-dilution reset provision. In accordance with ASC 815-40,the Company reclassified the fair value of the Codification, only one levelwarrant from equity to a liability as of authoritative US GAAP will exist. All other literature will be considered non-authoritative. The Codification does not change US GAAP; instead, it introduces a new structure that is organized in an easily accessible, user-friendly online research system. The Codification becomes effective for interim and annual periods ending on or after September 15,October 1, 2009. The warrant liability is being marked to market each quarter-end until they are completely settled. The Company will applyused Level 2 inputs for its valuation methodology as their fair value was determined by using the Codification beginning in the fourth quarter of fiscal 2009. The adoption of the Codification will not have an effectBlack-Scholes option pricing model based on various assumptions (see Note 10) consistent with the Company’s consolidated financial statements, but will impact the Company’s financial statement disclosures since all future references to authoritative accounting literature will be referenced in accordance with the Codification.

4.5. INVENTORIES

Inventories are stated at the lower of cost, which approximates actual costs on a first in, first out cost basis, or market. Inventories consisted of the following:

5.6. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

Included in office furniture and equipment at June 30,December 31, 2009 and September 30, 20082009 was $420,438$416,034 and $411,963,$414,921, respectively, for purchased software, which is being amortized over three years. The unamortized portion of software at June 30,December 31, 2009 and September 30, 20082009 was $14,046$9,397 and $13,755,$9,885, respectively.

Depreciation expense, excluding amortization of software, was $143,308$44,763 and $167,394$39,252 for the ninethree months ended June 30,December 31, 2009 and 2008, respectively. Amortization of purchased software was $8,183$1,601 and $20,288$3,026 for the ninethree months ended June 30,December 31, 2009 and 2008, respectively.

6.7. PATENTS

Patents consisted of the following:

Amortization expense for the Company’s patents was $81,242$26,516 and $93,283$27,553 for the ninethree months ended June 30,December 31, 2009 and 2008, respectively.

Each quarter, the Company reviews the ongoing value of its capitalized patent costs. In the first nine monthsquarter of fiscal 2009,2010, some of these assets were identified as being associated with patents that are no longer consistent with its business strategy. As a result of this review, the Company reduced the value of previously capitalized patents by $88,895$40,996 and $36,453 during the ninethree months ended June 30,December 31, 2009 compared to a reduction of $310,347 from the impairment of patents in the nine months ended June 30, 2008.and 2008, respectively.

7.8. INCOME TAXES

An incomeAt December 31, 2009, the Company had federal net operating losses (“NOLs”), related state NOLs and certain Federal and California research and development (“R&D”) tax expense hascredits but in accordance with ASC 740,Accounting for Income Taxesrecorded a full valuation allowance as it is more likely than not been recordedthat some or all of the deferred tax assets will not be realized in the three and nine monthsfuture.

The Company provided a tax provision of $85,498 during the quarter ended June 30,December 31, 2009 based upon the year to date pretaxestimated annual tax rate. The tax provision includes (a) federal taxes, resulting from the Alternative Minimum Tax (“AMT”) where only 90% of taxable income may be applied against NOLs, and (b) California state taxes resulting from the suspension of net income as the Company’s projected effective tax rateoperating losses for the 2009 tax year ending September 30, 2009 will remain zero. and a state tax R&D credit limitation of 50% of the tax liability.

The effective tax rate is projected to remain zerolower than the statutory rate as any income recognized for the tax year will permit a decrease in the valuation allowance for net operating losses offset by the AMT and the temporary suspension of California loss carryforwardscarryforwards.

ASC Topic 740,Accounting for Income Taxes,requires the Company to recognize in its financial statements uncertainties in tax positions taken that existed atmay not be sustained upon examination by the beginning oftaxing authorities. If interest or penalties are assessed, the year.Company would recognize these charges as income tax expense. The Company has not recorded aany income tax provisionexpense or benefit for uncertain tax positions. The Company expects during the next twelve months to update unrecognized R&D tax benefits not currently recognized in either the three or nine months ended June 30, 2009.deferred tax assets.

8.9. SHARE-BASED COMPENSATION

Stock Option Plans

At June 30,December 31, 2009, the Company had two equity incentive plans. The 2005 Equity Incentive Plan (“2005 Equity Plan”), as amended, authorizes for issuance as stock options, stock appreciation rights, or stock awards an aggregate of 3,250,000 new shares of common stock to employees, directors or consultants. The total plan reserve, including the new shares and shares currently reserved under prior plans, allows for the issuance of up to 4,999,564 shares. At December 31, 2009, there were options outstanding covering 3,910,742 shares of common stock under the 2005 Equity Plan. The 2002 Stock Option Plan (“2002 Plan”) reserved for issuance 2,350,000 shares of common stock. The 2002 Plan was terminated with respect to new grants in April 2005 but remains in effect for grants issued prior to the termination. The 2005 Equity Incentive Plan (“2005 Plan”), as amended, authorizes for issuance as stock options, stock appreciation rights, or stock awards an aggregate of

3,250,000 new shares of common stock to employees, directors or consultants, plus the 1,749,564 shares remaining eligible for issuance under the 2002 Plan for a total plan reserve of 4,999,564. The current plan reserve at June 30, 2009, net of exercises, allows for the issuance of up to 4,641,538 shares.that time. At June 30,December 31, 2009, there were options outstanding covering 85,000 and 3,973,57570,000 shares of common stock under the 2002 Plan and 2005 Plan, respectively.Plan.

At June 30,December 31, 2009, there were also options outstanding covering 32,000 shares of common stock from grants outside the stock option plans. See Note 8 for summary

Stock Option Activity

The following table summarizes information about stock option activity during the ninethree months ended June 30, 2009.December 31, 2009:

Options outstanding are exercisable at prices ranging from $0.46 to $9.48 and expire over the period from 2010 to 2014 with an average life of 2.54 years. The aggregate intrinsic value of options outstanding and exercisable at December 31, 2009 was $916,162 and $610,652, respectively.

Share-Based PaymentsCompensation

The Company accounts for share-based payments under the provisions of SFAS No. 123(R) “Share-based payments” (“SFAS 123(R)”). Options or stock awards issued to non-employees who are not directors of the Company are recorded at their estimated fair value at the measurement date in accordance with SFAS No. 123(R)$150,823 and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services,” and are periodically revalued as the options vest and are recognized as expense over the related service period. The Company recorded $1,388,857 and $1,669,035$568,256 of share-based compensation expense for the ninethree months ended June 30,December 31, 2009 and 2008, respectively. The amounts of share-based compensation expense are classified in the consolidated statements of operations as follows:

The weighted-average estimated fair value of employee stock options granted during the ninethree months ended June 30,December 31, 2009 and 2008 was $0.28$1.00 and $1.00,$0.24, per share, respectively, using the Black-Scholes option pricing model with the following weighted-average assumptions (annualized percentages):

The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with the expected life of the options. The risk-free interest rate is based on rates published by the Federal Reserve Board. The expected life is based on observed and expected time to post-vesting exercise. The expected forfeiture rate is based on past experience and employee retention data. Forfeitures are estimated at the time of the grant and revised in subsequent periods if actual forfeitures differ from those estimates or if the Company updates its estimated forfeiture rate. Such amounts will be recorded as a cumulative adjustment in the period in which the estimate is changed.

Since the Company has a net operating loss carryforward as of June 30,December 31, 2009, no excess tax benefit for the tax deductions related to share-based awards was recognized for the ninethree months ended June 30,December 31, 2009 and 2008. Additionally, as there were no options exercised in the three months ended December 31, 2009 or 2008, there was no incremental tax benefits were recognized from stock options exercised in the quarters ended June 30, 2009 or 2008.recognized. Such recognition would have resulted in a reclassification to reduce net cash provided by operating activities with an offsetting increase in net cash provided by financing activities.

As of June 30,December 31, 2009, there was approximately $600,000$300,000 of total unrecognized compensation cost related to non-vested share-based employee compensation arrangements. The cost is expected to be recognized over a weighted-average period of 1.41.1 years.

9.10. STOCKHOLDERS’ EQUITY

Summary

The following table summarizes changes in stockholders’ equity components during the ninethree months ended June 30,December 31, 2009:

Common Stock Activity

DuringThe Company adopted ASC 815-40 effective October 1, 2009 and determined that 1,948,204 warrants granted in 2006 contain a strike price adjustment feature resulting in the nineinstruments no longer being considered indexed to the Company’s own stock. Accordingly, on October 1, 2009, these warrants were reclassified from equity and the Company recorded a warrant liability of $747,917 with a cumulative effect adjustment to accumulated deficit of $1,499,063 based on the change in fair value of the warrants from their issuance date to the reclassification date. The warrant fair value is adjusted each reporting period based on current assumptions, with the change in value recognized in current earnings. At December 31, 2009, the estimated fair value of the warrant liability was reduced to $150,901 and other income of $597,016 was recognized during the three months ended June 30,December 31, 2009 based on the Company issued 3,125 shareschange in fair value. The warrant fair value at December 31, 2009 (and October 1, 2009) was determined using the Black-Scholes valuation model using the closing price stock price at each date, a volatility rate of common stock in connection with71% (October 1, 2009 of 96%), a risk free interest rate of 0.17% (October 1, 2009 of 0.27%), and a contractual life equal to the exerciseremaining term of stock options.

Stock Option Activity

The following table summarizes information about stock option activity during the nine months ended June 30, 2009:

Options outstanding are exercisable at prices ranging from $0.46 to $9.48 and expire over the period from 2009 to 2014 with an average life of 3.11 years. The aggregate intrinsic value of options outstanding and exercisable at June 30, 2009 was $1,354,118 and $664,420, respectively.warrants expiring August 7, 2010.

Stock Purchase Warrants

There was no warrant activity duringDuring the ninethree months ended June 30, 2009.December 31, 2009, 150,000 stock purchase warrants expired at a weighted average purchase price of $8.94. The number of shares purchasable under outstanding warrants at June 30,December 31, 2009 was 2,936,6931,948,204 at a weighted average purchase price of $3.78.

At June 30, 2009,$2.67 that expire on August 7, 2010. These warrants contain antidilution rights if the following stock purchaseCompany sells securities for less than the exercise price. As noted above, the remaining outstanding warrants were outstanding arisinghave been reclassified from offerings and other transactions:equity to a warrant liability in connection with the Company’s adoption of ASC 815-40.

10.11. ACCRUED LIABILITIES

Accrued liabilities consisted of the following:

Warranty Reserve

Changes in the warranty reserve during the three and nine months ended June 30,December 31, 2009 and 2008 were as follows:

11.12. INCOME (LOSS) PER SHARE

Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares of common stock outstanding during the period increased to include the number of dilutive potential common shares outstanding during the period. The dilutive effect of outstanding stock options and warrants is reflected in diluted earnings per share by application of the treasury stock method, which assumes that the proceeds from the exercise of the outstanding options and warrants are used to repurchase common stock at market value. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities. The Company’s losses for certain periods presentedthe three months ended December 31, 2008 cause the inclusion of potential common stock instruments outstanding to be antidilutive. In addition, under the treasury stock method, the inclusion of stock options and warrants with an exercise price greater than the per share market value, would be antidilutive. Potential common shares that would be antidilutive are excluded from the calculation of diluted income (loss) per share.

The following table sets forth the computation of basic and diluted earnings (loss) per share:

12. FAIR VALUE MEASUREMENTS

The Company’s financial instruments consist of cash and cash equivalents, accounts receivables, accounts payable and accrued liabilities. The carry values of these instruments approximate fair values due to their short-term maturities.

13. MAJOR CUSTOMERS

For the three months ended June 30,December 31, 2009, revenues from two customers each accounted for 22%60% and 11% of revenues, respectively, and for the nine months ended June 30, 2009, revenues from one customer accounted for 29%12% of revenues, with no other single customer accounting for more than 10% of revenues. At June 30,December 31, 2009, accounts receivable from two customersone customer accounted for 29% and 20%75% of total accounts receivable respectively, with no other single customer accounting for more than 10% of the accounts receivable balance.

For the three months ended June 30,December 31, 2008, revenues from twothree customers each accounted for 12%14%, 14% and 11% of revenues, and for the nine months ended June 30, 2008, revenues from one customer accounted for 12% of revenues,respectively; with no other single customer accounting for more than 10% of revenues. At June 30,December 31, 2008, accounts receivable from fourfive customers accounted for 18%17%, 13%16%, 12%11%, 10% and 12%10% of total accounts receivable, respectively, with no other single customer accounting for more than 10% of the accounts receivable balance.

14. COMMITMENTS AND CONTINGENCIES

Facility Lease

The Company’s executive offices, research and development, assembly and operational facilities in San Diego, California, are occupied under a sublease agreement that commenced in January 2006 and expires May 31, 2011. The Company currently occupies approximately 23,698 square feet of office, laboratory, production and warehouse space with aggregate monthly payments of approximately $29,623, plus certain costs and charges specified in the sublease, including the Company’s proportionate share of the building operating expenses and real estate taxes.

Bank and Other Cash Equivalent Deposits in Excess of FDIC Insurance Limits

The Company currently maintains its cash and cash equivalent accounts with a major Federal Deposit Insurance Corporation (FDIC) guaranteed financial institution. Effective October 14, 2008, Federal Deposit Insurance CorporationFDIC deposit insurance was changed to provide full deposit insurance coverage for non-interest bearing deposit transaction accounts through December 31, 2009. Also in October 2008,This full coverage for non-interest bearing accounts was subsequently extended through June 30, 2010. During the financial institution enrolled in the U.S. Treasury Department’s Temporary Guarantee Program for money market funds. Under this program, the U.S. Treasury guarantees the $1.00 per share value of fund shares outstanding as of September 19, 2008, subject to certain terms and limitations. As a result, since all ofquarter ended December 31, 2009, the Company’s cash equivalentswas maintained in a non-interest bearing deposit transaction account and as a result was fully guaranteed under current FDIC coverage at June 30, 2009 consistDecember 31, 2009. Future changes in the FDIC insurance provisions or changes in the nature of money market funds with this financial institution, these funds are guaranteed at 100% up to the balance held as of September 19, 2008. Based on these changes, as of June 30, 2009,accounts maintained by the Company did not have any cash and cash equivalents that are eithercould result in excess of current FDIC limits orthe Company maintaining account balances that are not guaranteedfully insured by the U.S. Treasury Department.FDIC.

Litigation

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

Bonus Plan

The Company has an incentive bonus plan for fiscal year 2010 designed to motivate our employees to achieve our financial objectives. All of our employees are entitled to participate in the incentive plan. Target bonus amounts vary based on a percentage of the employee’s base salary which range from 10% to 50% of base salary and a bonus payment will be made at three levels, including at 50% of target, at 100% of target and at 200% of target, depending upon the achievement by our company of specified earnings per share goals, including in such calculation the cost of the incentive plan and excluding from such calculation expenses related to the revaluation of warrants in accordance with Accounting Standards Codification 815-40. For purposes of the earnings per share calculation, the number of shares outstanding will also be held constant as of October 1, 2009. During the three months ended December 31, 2009 we recorded accrued bonus expense of $113,562 in connection with the 2010 plan.

15. SUBSEQUENT EVENTS

Subsequent events have been evaluated through August 3, 2009,February 2, 2010, which was the date the Company’s financial statementsFinancial Statements were issued.

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 our Annual Report on Form 10-K for the year ended September 30, 2008.2009.

The following discussion provides an overview of our results of operations for the three and nine months ended June 30,December 31, 2009 and 2008. Significant period-to-period variances in the consolidated 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. ReadersProspective investors are cautioned that such statements are only predictions and that actual events or results may differ materially. In evaluating such statements, readersprospective investors should specifically consider various factors identified in this report and any matters set forth under Part I, Item 1A (Risk Factors) of our Annual Report on Form 10-K, which could cause actual results to differ materially from those indicated by such forward-looking statements.

Overview

We are a pioneer of highly intelligible, high clarity, directed sound technologies and products.products that beam, focus and control sound over short and long distances. We aggressively seek to create markets for our products, and we are increasing our focus on and investment in worldwide sales and marketing activities while we continue to innovate.

During 2008, we completed the development of aWe have expanded our market penetration by developing new generation ofproducts to meet customer operational needs. Our LRAD^® products called the LRAD-X^®. Our new LRAD-X-X products use directionality and focused acoustic output to clearly transmit critical information, instructions and warnings 500 meters and beyond. The LRAD-X product line can be manually operated or integrated into a remotely controlled security network’s command and control center. Through the use of powerful voice commands and deterrent tones, large safety zones can be created while determining the intent and influencing the behavior of an intruder. Our LRAD-X products are the industry’s loudest, most intelligible line of directed acoustic hailing and warning devices (AHDs), and feature rugged, weatherproof construction and enhanced voice, tone and frequency response. We continue to improve and expand our LRADOur product line that includes the following major products:following:

These products have been well received by our military customers and interest has been strong foras well as other commercial applications such as oil rig protection, maritime and homeland security, port security, bird and wildlife deterrents and by law enforcement. We believe these products provide an increased opportunity for us in both the government and commercial markets that we are developing, and will allow us to continue as the leader in this market. We believe that our products are offered at price and performance points to attract serious market interest. Accelerating our product sales and revenue growth will require organizational discipline, improved customer focus, and a new, sustained marketing push of our Company and products. We are focused on these areas of our business while also containing costs.

As has been widely reported, financial markets in the United States, Europe and Asia have been experiencing extreme disruption in recent months,over the past year, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. Governments have taken unprecedented actions intended to address extreme market conditions that include severely restricted credit and declines in real estate values. While currently these conditions have not impaired our ability to operate our business, there can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies, which can then lead to challenges in the operation of our business. These economic developments affect businesses such as ours in a number of ways. The current tightening of credit in financial markets adversely affects the ability of commercial customers to finance purchases and operations and could result in a decrease in orders and spending for our products as well as create supplier disruptions. Economic developments could also reduce future government spending on our products. We are unable to predict the likely duration and severity of the current disruption in financial markets and adverse economic conditions and the effects they will have on our business and financial condition.

Overall Performance for the ThirdFirst Quarter of Fiscal 20092010

For our thirdfirst fiscal quarter ended June 30,December 31, 2009:

We believe we have a solid technology and product foundation for business growth over the next several years. We have additional new technologies and products in various stages of development. We believe we have strong market opportunities, particularly given the continuing global threats to both governments and commerce, where our LRAD products have proven to be effective at determining intent and hailing and notification for force protection.

Critical Accounting Policies

We have identified a number of accounting policies as critical to our business operations and the understanding of our results of operations. These are described in our consolidated financial statements located in Item 1 of Part I, “Financial Statements,” and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report of Form 10-K for the year ended September 30, 2008.2009. The impact and any associated risks related to these policies on our business operations is discussed below and throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations when such policies affect our reported and expected financial results.

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.

The following is additional information on our critical accounting policies and estimates involving significant management valuation judgments affecting fiscal 2010 results.

Accounting for Warrants Classified as Derivatives – We adopted ASC 815-40 effective October 1, 2009 and determined that 1,948,204 warrants granted in 2006 contain a strike price adjustment feature resulting in the instruments no longer being considered indexed to our common stock. Accordingly, on October 1, 2009, these warrants were reclassified from equity and the Company recorded a warrant liability of $747,917 with a cumulative effect adjustment to accumulated deficit of $1,499,063 based on the change in fair value of the warrants from their issuance date to the reclassification date. We adjust the fair value each reporting period based on current assumptions, with the change in value recognized in current earnings. At December 31, 2009, the estimated fair value of the warrant liability was reduced to $150,901 and other income of $597,016 was recognized during the three months ended December 31, 2009 based on the change in fair value. In future periods, increases in stock price and stock volatility and decreases in interest rates will increase the warrant liability and negatively affect our consolidated statement of operations.

Comparison of Results of Operations for the Three Months Ended June 30,December 31, 2009 and 2008

Revenues

The following table sets forth for the periods indicated certain items of our consolidated statement of operations expressed in dollars and a percentage of net sales. The financial information and the discussion below should be read in conjunction with the consolidated financial statements and notes contained in this report.

		For the three months ended											Change
		December 31,
		2009					2008
		Dollars		% of Revenue			Dollars			% of Revenue			Dollars			%
Revenues:
Product sales		5,271,282		98.6	%		2,430,843			97.5	%		2,840,439			117	%
Contract, license and other		74,587		1.4	%		62,400			2.5	%		12,187			20	%
		5,345,869		100.0	%		2,493,243			100.0	%		2,852,626			114	%
Cost of revenues		2,287,301		42.8	%		1,350,972			54.2	%		(936,329	)		(69	%)
Gross profit		3,058,568		57.2	%		1,142,271			45.8	%		1,916,297			168	%
Operating Expenses:
Selling, general and administrative		1,198,201		22.4	%		1,586,960			63.7	%		(388,759	)		(24	%)
Research and development		551,921		10.3	%		452,458			18.1	%		99,463			22	%
		1,750,122		32.7	%		2,039,418			81.8	%		(289,296	)		(14	%)
Income (loss) from operations		1,308,446		24.5	%		(897,147	)		(36.0	%)		2,205,593			246	%
Other Income		596,280		11.2	%		16,118			0.6	%		580,162			3599	%
Net income (loss) before provision for income taxes		1,904,726		35.6	%		(881,029	)		(35.3	%)		2,785,755			316	%

Revenues for the three months ended June 30,December 31, 2009 were $4,404,040,$5,345,869, representing a 60%114.4% increase from $2,748,234$2,493,243 in revenues for the three months ended June 30,December 31, 2008. Revenues for the three months ended June 30,December 31, 2009 included $4,289,200$5,271,282 of product sales and $114,840$74,587 of contract, license and other revenues. Revenues for the three months ended June 30,December 31, 2008 included $2,505,601$2,430,843 of product sales and $242,633$62,400 of contract, license and other revenues. The revenue growth wasLRAD revenues increased significantly in the first fiscal quarter over prior year, primarily due to some larger orders for the U.S. Army Reserves. Our HSS revenues also increased and our LRADSoundSaber product line partially offset by reductions in our HSS and SoundSaber product sales. In addition to strong sales to the U.S. Navy and Army, we have continued to diversify our revenues to foreign military groups, shipping companies, fisheries, police, bird and wildlife protection and other commercial applications.decreased. 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.

For the three months ended June 30, 2008, we recognized $54,167 in contract revenue representing ratable earned revenue under a three year license agreement. We did not record any similar contract revenue in the three months ended June 30, 2009 as the contract expired in September 2008. At June 30, 2009, there was no revenue unearned under this agreement. At June 30,December 31, 2009, we had aggregate deferred license revenue of $275,509$273,954 representing amounts collected from another license agreement in advance of recognized earnings. This revenue component is subject to significant variability based on the timing, amount and recognition of new arrangements, if any.

Gross Profit

Gross profit for the three months ended June 30,December 31, 2009 was $1,987,803,$3,058,568, or 45%57.2% of revenues, compared to $1,044,322,$1,142,271, or 38%45.8% of revenues, for the three months ended June 30,December 31, 2008. The increase in gross profit was driven by higher revenues, increased product marginsis due to reducedincreased revenue in the quarter, increased absorption of fixed cost over the higher revenue, and decreased product cost and favorable mix, and broader absorption of our fixed overhead expenses as a result of theresulting from improved pricing on higher revenues. We incurred increased warranty costs during the most recent quarter compared to the prior year’s third quarter primarily to replace some units that were damaged due to unique application of our product by one of our customers. We have worked with our customer and this issue has been resolved.quantity purchases.

Our products have varying gross margins, so product sales mix will materially affect gross profits. In addition, we continue to make product updates and changes, including raw material and component changes that may impact product costs. With such product updates and changes we have limited warranty cost experience and estimated future warranty costs can impact our gross margins. We 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 for the three months ended June 30,December 31, 2009 decreased $334,857$388,759 to $1,395,777,$1,198,201, or 32%22.4% of revenues, compared to $1,730,634,$1,586,960, or 63%63.7% of revenues, for the three months ended June 30,December 31, 2008. The decrease in selling general and administrative expenses was primarily attributed to $165,880 in lower salaries and consulting expense, $97,017 due to$388,496 of lower non-cash share-based compensation expense $57,353due to options becoming fully vested, $95,405 for decreased audit fees because we did not require an audit of management’s report on the effectiveness of our internal control over financial reporting, and $91,226 for reduced marketing expenses, and $176,137 of travel and other cost savings,staffing. These reductions were partially offset by $161,530 increase in$172,935 increased inside and outside sales commissions.commissions and $34,332 for accrued bonus expense.

We incurred non-cash share-based compensation expenses related to SFAS No. 123(R)ASC 718 allocated to selling, general and administrative expenses in the three months ended June 30,December 31, 2009 and 2008 of $269,348$115,130 and $366,363,$503,626, respectively.

We may expend additional resources on marketing and selling our products in future periods as we identify ways to optimize our potential opportunity. This may result in increased selling, general and administrative expenses in the future. Commission expense will vary based on the sales channel and revenue levels.

Research and Development Expenses

Research and development expenses decreased $398,668increased $99,453 to $459,506,$551,921, or 10%10.3% of revenues, for the three months ended June 30,December 31, 2009, compared to $858,174,$452,458, or 31%18.1% of revenues, for the three months ended June 30, 2008.December 31, 2009. This decreaseincrease in research and development expense was primarily due to $162,800$77,810 higher testing and prototype costs and $43,739 for accrued bonuses, offset by $32,014 of consulting, prototypes and testing costs incurred in the prior year for the development of our new LRAD-X product line that were not incurred in the 2009 quarter, $175,038 for reducedlower non-cash share-based compensation expense, and $91,676 from the reduction in expenses incurred for impairment of patents.expense.

Included in research and development expenses for the three months ended June 30,December 31, 2009 and 2008 was $18,004$14,054 and $193,042$46,068 of non-cash share-based compensation costs, respectively. The prior year expense included a $145,375 adjustment to true-up the forfeiture rate.

Each quarter, we review the ongoing value of our capitalized patent costs and in the thirdfirst quarter identified some of these assets as being associated with patents that are no longer consistent with our business strategy. As a result of this review, we reduced the value of our previously capitalized patents by $13,151$40,996 during the quarter ended June 30,December 31, 2009, compared to an impairment of $104,827$36,453 in the three months ended June 30,December 31, 2008.

Research and development costs vary period to period due to the timing of projects, the availability of funds for research and development and the timing and extent of use of outside consulting, design and development firms. We completed the development of the LRAD-X product line in the third fiscal quarter of 2008 with enhanced performance and louder, more intelligible communications.communications, and we have further expanded the line in 2009. Based on current plans and reduced engineering staffing, we expect research and development costs to continue in the current fiscal year at a lower level thancomparable to last year.

Income (Loss) from Operations

Income from operations was $132,520$1,308,446 for the three months ended June 30,December 31, 2009, compared to a loss from operations of $1,544,486$897,147 for the three months ended June 30,December 31, 2008. The income from operationsincrease is primarily attributable to the increase in revenues, improved gross profit margins and reduced operating expenses.non-cash share-based compensation expense.

Other Income (Expense)

During the three months ended June 30,December 31, 2009, we earned $4,447 of$16,071 less interest income on our cash and cash equivalents balances compared to $24,581the three months ended December 31, 2008 due to lower interest rates. In the quarter ended December 31, 2009, we recorded $597,016 unrealized gain on derivative revaluation related to warrant instruments with repricing options, pursuant to ASC 815-40. We did not have a similar charge during the three months ended June 30, 2008 due to lower cash balances and lower interest rates.December 31, 2008.

Net Income (Loss)

The net income for the three months ended June 30,December 31, 2009 was $136,184, or $0.00 per share, an increase of $1,656,089 from$1,819,228, compared to a net loss of $1,519,905, or $0.05 per share,$881,029 for the three months ended June 30,December 31, 2008. The netWe recorded income was primarilytax expense of $85,498 in the result of increased revenues, improved gross profit margins and reduced operating expenses.quarter ended December 31, 2009. We had no income tax expense for either of the periods presented.

Results of Operations for the Nine Months Ended June 30, 2009 and 2008

Revenues

Revenues for the nine months ended June 30, 2009 were $12,769,765, representing a 74% increase from $7,332,250 in revenues for the nine months ended June 30, 2008. Revenues for the nine months ended June 30, 2009 included $12,521,443 of product sales and $248,322 of contract, license and other revenues. Revenues for the nine months ended June 30, 2008 included $6,888,597 of product sales and $443,653 of contract, license and other revenues. Sales increased in our LRAD product line and decreased in our HSS and SoundSaber product lines. We expect continued uneven quarterly revenues in future periods as we continue to develop the markets for our proprietary products.

For the nine months ended June 30, 2008, we recognized $162,500 in contract revenue representing ratable earned revenue under a six year license agreement. We did not record any similar contract revenue in the nine months ended June 30, 2009 as the contract expired in September 2008. At June 30, 2009, there was no revenue unearned under this agreement. At June 30, 2009, we had aggregate deferred license revenue of $275,509 representing amounts collected from another license agreement in advance of recognized earnings. This revenue component is subject to significant variability based on the timing, amount and recognition of new arrangements, if any.

Gross Profit

Gross profit for the nine months ended June 30, 2009 was $6,246,931, or 49% of revenues, compared to $2,929,304, or 40% of revenues, for the nine months ended June 30, 2008. The increase in gross profit was due to higher revenues, increased product margins due to reduced product cost and favorable mix and greater absorption of our fixed overhead expenses as a result of the higher revenues.

Our products have varying gross margins, so product sales mix will materially affect gross profits. In addition, we continue to make product updates and changes, including raw material and component changes that may impact product costs. With such product updates and changes we have limited warranty cost experience and estimated future warranty costs can impact our gross margins. We 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 for the nine months ended June 30, 2009 decreased $733,214 to $4,780,654, or 37% of revenues, compared to $5,513,868, or 75% of revenues, for the nine months ended June 30, 2008. The decrease in selling general and administrative expenses was primarily attributed to $383,064 in lower professional fees resulting from a change in audit firms, $394,002 from reduced staffing levels, $116,418 from reduced non-cash share-based compensation expense, $129,664 from lower marketing expenses and $366,650 from a reduction in travel and other expense, partially offset by an increase of $656,585 in outside sales commission expense.

We incurred non-cash share-based compensation expenses related to SFAS No. 123(R) allocated to selling, general and administrative expenses in the nine months ended June 30, 2009 and 2008 of $1,234,300 and $1,350,718, respectively.

We may expend additional resources on marketing and selling our products in future periods as we identify ways to optimize our potential opportunity. This may result in increased selling, general and administrative expenses in the future. Commission expense will also vary based on the sales channel and revenue levels.

Research and Development Expenses

Research and development expenses decreased $1,474,587 to $1,360,614, or 11% of revenues, for the nine months ended June 30, 2009, compared to $2,835,201, or 39% of revenues, for the nine months ended June 30, 2008. This decrease in research and development expense was primarily due to a reduction of $747,235 in consulting, prototypes and testing costs in the prior year for the development of our new LRAD-X product line. In addition, we had savings of $252,789 from reduced staffing levels and $221,453 from the reduction in expenses incurred for impairment of patents and $216,356 from reduced non-cash share-based compensation expense.

Included in research and development expenses for the nine months ended June 30, 2009 and 2008 was $96,992 and $313,348 of SFAS No. 123(R) non-cash share-based compensation costs, respectively. The prior year expense included a $145,375 adjustment to true-up the forfeiture rate.

Each quarter, we review the ongoing value of our capitalized patent costs and in the first three quarters identified some of these assets as being associated with patents that are no longer consistent with our business strategy. As a result of this review, we reduced the value of our previously capitalized patents by $88,895 during the nine months ended June 30, 2009, compared to an impairment of $310,348 in the nine months ended June 30, 2008.

Research and development costs vary period to period due to the timing of projects, the availability of funds for research and development and the timing and extent of use of outside consulting, design and development firms. We completed the development of the LRAD-X product line in the third fiscal quarter of 2008 with enhanced performance and louder, more intelligible communications. Based on current plans and reduced engineering staffing, we expect research and development costs to continue in the current fiscal year at a lower level than last year.

Income (Loss) from Operations

Income from operations was $105,663 for the nine months ended June 30, 2009, compared to loss from operations of $5,419,765 for the nine months ended June 30, 2008. The decreased loss from operations is primarily attributable to the increase in revenues, improved gross profit margins and lower operating expenses.

Other Income (Expense)

During the nine months ended June 30, 2009, we earned $29,086 of interest income on our cash and cash equivalents balances compared to $151,313 during the nine months ended June 30, 2008 due to lower cash balances and lower interest rates. During the nine months ended June 30, 2008, we recorded a $108,821 financing expense for estimated liquidated damages based on certain registration rights agreements compared to $783 of interest expense during the nine month ended June 30, 2009.

Net Income (Loss)

The net income for the nine months ended June 30, 2009 was $133,966, compared to a net loss of $5,377,273 for the nine months ended June 30, 2008. The significantly reduced loss was primarily the result of increased revenues, improved gross margins and lower operating expenses. We had no income tax expense for either of the periods presented.

Liquidity and Capital Resources

We generated positiveexperienced a small negative cash flow from operating activities and a net increase in cash and cash equivalents during the nine monthsquarter ended June 30, 2009 of $2,101,922 and $1,931,117, respectively. During this period, weDecember 31, 2009. We have financed our working capital requirements through cash and cash equivalents on hand at the beginning of the period,generated from product sales and from cash generated from operatingfinancing activities. Cash and cash equivalents at June 30,December 31, 2009 was $4,625,986$4,839,946 compared to $2,694,869$5,102,502 at September 30, 2008.2009. The net increasedecrease in cash was primarily the result of increased accounts receivable due to increased revenue during the quarter and cash equivalentspayment of year-end bonuses for the year-ended September 30, 2009 during this period resulted from net cash from operating activities and $1,500 from financing activities through the exercise of options, offset by $172,305 in net cash used in investing activities that related to purchases of equipment and patent costs paid.three months ended December 31, 2009.

Other than cash, and cash equivalents, inventory and our balance of accounts receivable, we have no other unused sources of liquidity as of June 30, 2009.at this time.

Principal factors that could affect the availability of our internally generated funds include:

Principal factors that could affect our ability to obtain cash from external sources include:

Based on our current cash position and our order backlog, and assuming currently planned expenditures and level of operations, we believe we have sufficient capital to fund operations for at least the next twelve months. However, we operate in a rapidly evolving and unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. Accordingly, there can be no assurance that we may not be required to raise additional funds through the sale of equity or debt securities or from credit facilities. Additional capital, if needed, may not be available on satisfactory terms, or at all.

Cash Flows

Operating Activities

Our net cash provided byused in operating activities was $2,101,922$249,485 for the ninethree months ended June 30,December 31, 2009 compared to cash$149,020 used of $3,002,373 fromin operating activities for the ninethree months ended June 30,December 31, 2008. Net cash provided byused in operating activities for the ninethree months ended June 30,December 31, 2009 included net income of $133,966, increased$1,819,228, decreased by expenses not requiring the use of cash of $2,056,090, $199,648 from decreased inventories$269,400 and $30,217 from reduceda $226,701 increase in accounts receivable.payable. Operating cash usage during the ninethree months ended June 30,December 31, 2009 included $163,627$951,209 from increased accounts receivable, $830,463 for increased warranty settlements, $132,373 decrease inreduced accrued liabilities $15,895 increase inwhich included the Company bonus payment, $132,192 from increased inventory, $86,752 from increased prepaid expenses and $6,104 decrease in accounts payable. Cash generated from operating activities for the nine months ended June 30, 2008 included $110,995 for decreased inventories, $114,709a $25,398 increase in accounts payable and $675,466 increase in accrued liabilities. Cashwarranty settlements. Net cash used in operating activities for the ninethree months ended June 30,December 31, 2008 included $384,137 in cash generated from decreased accounts receivable and $4,110 from decreased inventories. Operating cash usage during the three months ended December 31, 2008 included the $5,377,273$881,029 net loss, reduceddecreased by expenses not requiring the use of cash of $2,241,615,$687,252, a $678,387$186,418 decrease in accounts payable, a $152,559 decrease in accrued liabilities, a $4,168 increase in accounts receivable, $59,026warranty settlements and a $345 increase in prepaid expenses and $30,472 increase in warranty settlements.expense.

At June 30,December 31, 2009 we had working capital of $7,778,932,$8,180,978, compared to working capital of $6,105,286$6,858,039 at September 30, 2008.2009.

At June 30,December 31, 2009, we had net accounts receivable of $2,173,918,$2,414,431, compared to $2,210,526$1,463,222 in accounts receivable at September 30, 2008.2009. The level of trade accounts receivable at June 30,December 31, 2009 represented approximately 4542 days of revenue, compared to approximately 7244 days of revenue atfor the quarter ended September 30, 2008. Terms with individual customers vary greatly. We typically require thirty-day terms from our customers.2009. Our receivables can vary significantly due to overall sales volumes and due to quarterly variations in sales and timing of shipments to and receipts from large customers and the timing of contract payments.

Investing Activities

We use cash in investing activities primarily for the purchase of tooling, computer equipment and software and investment in new patents. Cash used in investing activities for equipment was $143,635$8,147 for the ninethree months ended June 30,December 31, 2009 and $99,355$99,600 for the ninethree months ended June 30,December 31, 2008. Cash used for investment in new patents was $28,670$4,924 for the ninethree months ended June 30,December 31, 2009 and $160,173$4,942 for the ninethree months ended June 30,December 31, 2008. We anticipate some additional expenditure for equipment and patents during the balance of fiscal year 2009.2010.

Financing Activities

CashThere was no cash provided by financing activities for the three and nine months ended June 30,December 31, 2009 was $1,500, which consisted of net cash proceeds from the exercise of stock options. There was no cash provided by or used in financing activities for the nine months ended June 30, 2008.

Recent Accounting Pronouncements

A discussion of the new pronouncements can be found in Note 3 to our interim consolidated financial statements.

Not applicable.

We are required to maintain disclosure controls and procedures designed to ensure that material information related to us, including our consolidated subsidiaries, is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of June 30,December 31, 2009.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during our fiscal quarter ended June 30,December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Our process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies which may be identified during this process.

PART II. OTHERII.OTHER INFORMATION

We may at times be involved in litigation in the ordinary course of business. We will also, from time to time, when appropriate in management’s estimation, record adequate reserves in our financial statements for pending litigation. Currently, there are no pending material legal proceedings to which we are party or to which any of our property is subject.

Not applicable.

None.

Not applicable.

None.None

None.None

32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Thomas R. Brown, Principal Executive Officer and Katherine H. McDermott, Principal Financial Officer.*

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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