UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended DecemberMarch 31, 20092010

or

For the transition period from            to.

Commission File Number: 000-24248

AMERICAN TECHNOLOGYLRAD CORPORATION

(Exact name of registrant as specified in its charter)

(858) 676-1112

(Registrant’s telephone number, including area code)

American Technology Corporation

(Former name, former address and former fiscal year, if changed since last report)

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 January 29,April 26, 2010 was 30,552,498.30,611,456.

AMERICAN TECHNOLOGYLRAD CORPORATION

INDEX

PART I. FINANCIAL INFORMATION

American TechnologyLRAD Corporation

CONSOLIDATED BALANCE SHEETS

See accompanying notes to interim consolidated financial statements

American TechnologyLRAD Corporation

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes to interim consolidated financial statements

American TechnologyLRAD Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to interim consolidated financial statements

American TechnologyLRAD Corporation

Notes to Interim Consolidated Financial Statements (unaudited)

1. OPERATIONS

American TechnologyLRAD 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 has a currently inactive wholly owned subsidiary, American Technology Holdings, Inc., through which the Company intendsformed 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, 2009 was derived from the Company’s most recent audited financial statements. Operating results for the threesix 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, 2009 included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (“SEC”) on December 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)(“ASC”) 815-40, “Derivatives and Hedging; Contracts in Entity’s Own Equity” (formerly Emerging Issues Task Force (“EITF”) 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 34 and 10).

3. RECENT ACCOUNTING PRONOUNCEMENTS

In April 2008, the FASB issued authoritative guidance, as codified in ASC 350-30, “Goodwill and other; General Intangibles Other Than Goodwill” (formerly FSP SFASFASB Staff Position Statement of Financial Accounting Standards (“SFAS”) 142-3). This 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. This guidance also requires expanded disclosure related to the determination of intangible asset useful lives. It is effective for fiscal years beginning after December 15, 2008. Earlier adoption was not permitted. The adoption of this guidance on October 1, 2009 did not have any impact on the Company’s consolidated financial statements.

In June 2008, the FASB issued authoritative guidance, as codified in ASC 815-40, “Derivatives and Hedging; Contracts in Entity’s Own Equity” (formerly Emerging Issues Task ForceEITF Issue No. 07-5). This guidance provides a 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)). The Company adopted this guidance effective October 1, 2009 and determined that warrants granted in 2006 were not equity-linked financial instruments, and accordingly, were derivative instruments. The Company has recorded the fair value of these instruments and the resulting cumulative effect of this change in accounting method, as of October 1, 2009 and has recorded the change in the fair value of these instruments for the three and six months ended March 31, 2010 as an unrealized gain in current earnings (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 not contemplating any business combinations it does not presently expect any impact of adoption on its consolidated financial statements.

In December 2007, the FASB issued authoritative guidance, as codified in ASC 810-10, “Consolidation” (formerly SFAS 160) that establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. This guidance clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated financial statements. This guidance is effective for the Company’s fiscal years beginning after December 15, 2008. The provisions of are applied prospectively upon adoption except for the presentation and disclosure requirements that are applied retrospectively. The Company has no non-controlling interests and accordingly the adoption of this guidance effective October 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

In September 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-13, “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. 00-21, “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 revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The Company 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 changeschanged 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 is not expected to have an impact on the Company’s financial position and results of operations since this accounting standard update provides only implementation and disclosure amendments.

In January 2010, the FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement described in Subtopic 820-10, for the purpose of improving these disclosures and increasing the transparency in financial reporting. This standard was effective for fiscal years beginning after December 15, 2010, and for interim periods within these fiscal years. The Company complied with this amendment in the current filing.

In February 2010, the FASB issued ASU No. 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.” The amendments in the ASU remove the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. The amendments in the ASU were effective upon issuance on February 24, 2010 and the Company complied with this amendment in the current filing.

In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition-Milestone Method (Topic 605): Milestone Method of Revenue Recognition.” This ASU provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. This ASU is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The Company is currently assessing the future impact of this new accounting update to its consolidated financial statements.

4. FAIR VALUE MEASUREMENTS

At DecemberMarch 31, 20092010, there was no difference between the carrying values of the Company’s cash equivalents and fair market value. For certain financial instruments, including accounts receivable, accounts payable, accrued expenses the carrying amounts approximate fair value due to their relatively short maturities.

On October 1, 2008, the Company adopted guidance issued by the FASB as 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 fair value measurement that enhances disclosure requirements for fair value measures. Financial instruments measured at fair value on a recurring basis as of DecemberMarch 31, 20092010 are classified based on the valuation 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 warrant from equity to a liability as of October 1, 2009. The warrant liability is being marked to market each quarter-end until they are completely settled. The Company used Level 2 inputs for its valuation methodology as their fair value was determined by using the Black-Scholes option pricing model based on various assumptions (see(See Note 10) consistent with the Company’s application of ASC 718..

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:

6. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

Included in office furniture and equipment at DecemberMarch 31, 20092010 and September 30, 2009 was $416,034 and $414,921, respectively, for purchased software, which is being amortized over three years. The unamortized portion of software at DecemberMarch 31, 20092010 and September 30, 2009 was $9,397$7,811 and $9,885, respectively.

Depreciation expense, excluding amortization of software, was $44,763$86,218 and $39,252$90,986 for the threesix months ended DecemberMarch 31, 20092010 and 2008,2009, respectively. Amortization of purchased software was $1,601$3,187 and $3,026$6,101 for the threesix months ended DecemberMarch 31, 20092010 and 2008,2009, respectively.

7. PATENTS

Patents consisted of the following:

Amortization expense for the Company’s patents was $26,516$52,098 and $27,553$54,661 for the threesix months ended DecemberMarch 31, 20092010 and 2008,2009, respectively.

Each quarter, the Company reviews the ongoing value of its capitalized patent costs. In the first quartersix months of fiscal 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 $40,996$49,808 and $36,453$75,744 during the threesix months ended DecemberMarch 31, 20092010 and 2008,2009, respectively.

8. INCOME TAXES

At DecemberMarch 31, 2009,2010, the Company had federal net operating losses (“NOLs”), related state NOLs and certain Federal and California research and development (“R&D”) tax credits but in accordance with ASC 740,Accounting for Income Taxesrecorded a full valuation allowance as it is more likely than not that some or all of the deferred tax assets will not be realized in the future.

The Company providedrecorded a tax provision of $85,498$95,729 during the quartersix months ended DecemberMarch 31, 20092010 based upon the estimated 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 operating losses for the 2009 tax year and a state tax R&D credit limitation of 50% of the tax liability.

The effective tax rate is lower 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 carryforwards.

ASC Topic 740,Accounting for Income Taxes,requires the Company to recognize in its financial statements uncertainties in tax positions taken that may not be sustained upon examination by the taxing authorities. If interest or penalties are assessed, the Company would recognize these charges as income tax expense. The Company has not recorded any income tax expense 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 deferred tax assets.

9. SHARE-BASED COMPENSATION

Stock Option Plans

At DecemberMarch 31, 2009,2010, the Company had twoone equity incentive plans.plan. 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 theincludes these new shares and shares currently reserved under prior plans, allowsallowing for the issuance of up to 4,999,564 shares. At DecemberMarch 31, 2009,2010, there were options outstanding covering 3,910,7423,787,409 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 that time. At December 31, 2009, there were options outstanding covering 70,000and 781,005 shares of common stock available for grant for a total of 4,568,414 currently available under the 20022005 Plan.

At December 31, 2009, there were options outstanding covering 32,000 shares of common stock from grants outside the stock option plans.

Stock Option Activity

The following table summarizes information about stock option activity during the threesix months ended DecemberMarch 31, 2009:2010:

Options outstanding are exercisable at prices ranging from $0.46 to $9.48$5.57 and expire over the period from 2010 to 20142015 with an average life of 2.542.37 years. The aggregate intrinsic value of options outstanding and exercisable at DecemberMarch 31, 20092010 was $916,162$894,807 and $610,652,$662,979, respectively.

Share-Based Compensation

The Company recorded $150,823$277,258 and $568,256$1,082,568 of share-based compensation expense for the threesix months ended DecemberMarch 31, 20092010 and 2008,2009, 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 threesix months ended DecemberMarch 31, 2010 and 2009 and 2008 was $1.00$1.06 and $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 DecemberMarch 31, 2009,2010, no excess tax benefit for the tax deductions related to share-based awards was recognized for the threesix months ended DecemberMarch 31, 20092010 and 2008. Additionally, as there were no options exercised in the three months ended December2009.

As of March 31, 2009 or 2008,2010, there was no incremental tax benefits 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 December 31, 2009, there was $300,000$200,000 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 1.11.0 years.

10. STOCKHOLDERS’ EQUITY

Summary

The following table summarizes changes in stockholders’ equity components during the threesix months ended DecemberMarch 31, 2009:2010:

The 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 instruments 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 DecemberMarch 31, 2009,2010, the estimated fair value of the warrant liability was reduced to $150,901$74,391, and other income of $597,016$673,526 was recognized during the threesix months ended DecemberMarch 31, 20092010 based on the change in fair value. The warrant fair valuevalues at DecemberMarch 31, 2009 (and2010 and October 1, 2009) was2009 were determined using the Black-Scholes valuation model using the closing price stock price at each date, a volatility raterates of 71% (October 1, 2009 ofand 96%), a risk free interest raterates of 0.17% (October 1, 2009 of0.19% and 0.27%), and a contractual lifelives equal to the remaining term of the warrants expiring August 7, 2010.6, 2010 as of each measurement date.

Stock Purchase Warrants

During the threesix months ended DecemberMarch 31, 2009,2010, 150,000 stock purchase warrants expired at a weighted average purchase price of $8.94. The number of shares purchasable under outstanding warrants at DecemberMarch 31, 20092010 was 1,948,204 at a purchase price of $2.67 that expire on August 7,6, 2010. These warrants contain antidilution rights if the Company sells securities for less than the exercise price. As noted above, on October 1, 2009, the remaining outstanding warrants have beenwere reclassified from equity to a warrant liability in connection with the Company’s adoption of ASC 815-40.

11. ACCRUED LIABILITIES

Accrued liabilities consisted of the following:

Warranty Reserve

Changes in the warranty reserve during the threesix months ended DecemberMarch 31, 20092010 and 20082009 were as follows:

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 potentially 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 the threesix months ended DecemberMarch 31, 20082009 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:

13. MAJOR CUSTOMERS

For the three and six months ended DecemberMarch 31, 2009,2010, revenues from two customersone customer each accounted for 60%36% and 12%50% of revenues, with no other single customer accounting for more than 10% of revenues. At DecemberMarch 31, 2009,2010, accounts receivable from one customerfour customers accounted for 75%16%, 12%, 11% and 11% of total accounts receivable with no other single customer accounting for more than 10% of the accounts receivable balance.

For the three and six months ended DecemberMarch 31, 2008,2009, revenues from three customers eachone customer accounted for 14%, 14%42% and 11%33% of revenues, respectively; with no other single customer accounting for more than 10% of revenues. At DecemberMarch 31, 2008,2009, accounts receivable from five customersone customer accounted for 17%, 16%, 11%, 10% and 10%56% 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 maintains cash and cash equivalent accounts with a major Federal Deposit Insurance Corporation (FDIC) guaranteed financial institution. Effective October 14, 2008, FDIC deposit insurance was changed to provide full deposit insurance coverage for non-interest bearing deposit transaction accounts through December 31, 2009. This full coverage for non-interest bearing accounts was subsequently extended through June 30, 2010. During the quartersix months ended DecemberMarch 31, 2009,2010, the Company’s cash was maintained in a non-interest bearing deposit transaction account and as a result was fully guaranteed under current FDIC coverage at DecemberMarch 31, 2009.2010. Future changes in the FDIC insurance provisions or changes in the nature of the accounts maintained by the Company could result in the Company maintaining account balances that are not fully insured by the 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 threesix months ended DecemberMarch 31, 20092010 we recorded accrued bonus expense of $113,562$218,218 in connection with the 2010 plan.

15. SUBSEQUENT EVENTS

Subsequent events have been evaluatedOn April 8, 2010, the Company announced a plan to separate its HSS sound technology business through Februarya pro-rata distribution to the Company’s stockholders of a wholly-owned subsidiary to which the Company’s HSS assets will be contributed. The Company has scheduled a special meeting of its stockholders on June 2, 2010 which wasto approve the date100% spin-off and plans to file a Form 10 registration statement detailing the financial history, capitalization and related information about the spin-off. The planned spin-off is subject to approval by the Company’s Financial Statements were issued.stockholders and final approval of the Board of Directors, as well as a number of additional conditions, including, among others:

The Company’s goal is to complete the planned spin-off later this calendar year, but no assurance can be provided as to the timing or that all conditions will be met.

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, 2009.

The following discussion provides an overview of our results of operations for the three and six months ended DecemberMarch 31, 20092010 and 2008.2009. 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. 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 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 that beam, focus and control sound over short and long distances. Our flagship product line is called a Long Range Acoustic Device^(R) or LRAD^(R). 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.

We have expanded our market penetration by developing new products to meet customer operational needs. Our LRADLRAD-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. Our product line includes the following:

These products have been well received by our military customers as 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, financialFinancial markets in the United States, Europe and Asia have been experiencingexperienced extreme disruption, 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 materially 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. TheseNegative economic developments affect businesses such as ours in a number of ways. The current tighteningTightening 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. EconomicNegative 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 FirstSecond Quarter of Fiscal 2010

For our firstsecond fiscal quarter ended DecemberMarch 31, 2009:2010:

Our results continue to fluctuate from a quarter to quarter basis. In fiscal 2009, our first fiscal quarter was not as strong, but we had a very strong second quarter based on the delivery of large orders from the U.S. Navy and Army. In fiscal 2010, we had a very strong first quarter driven by heavy sales to the U.S. Army Reserves. The second fiscal quarter was not as strong. Our quarters will continue to be uneven given the nature of our business and customer base, but as shown in our year to date ended March 31, 2010 results, our overall trend of revenue and net income continues to grow.

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 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, 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 Companywe 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 DecemberMarch 31, 2009,2010, the estimated fair value of the warrant liability was reduced to $150,901$74,391 and other income of $597,016$673,526 was recognized during the threesix months ended DecemberMarch 31, 20092010 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 DecemberMarch 31, 20092010 and 20082009

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.

Revenues for the three months ended DecemberMarch 31, 2009 were $5,345,869, representing a 114.4% increase from $2,493,243 in revenues for the three months ended December 31, 2008. Revenues for the three months ended December 31, 20092010 included $5,271,282$3,530,631 of product sales and $74,587$26,219 of contract, license and other revenues. Revenues for the three months ended DecemberMarch 31, 20082009 included $2,430,843$5,801,400 of product sales and $62,400$71,082 of contract, license and other revenues. The decrease in revenues was primarily attributable to a decline in LRAD revenues increased significantlydue to large orders from the U.S. Navy and Army in the firstprior year’s second fiscal quarter over prior year, primarily due to some larger orders forthat were not matched in the U.S. Army Reserves.quarter ended March 31, 2010. Our SoundSaber revenues also decreased during the quarter and our HSS revenues also increased and our SoundSaber product line decreased.increased. 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 DecemberMarch 31, 2009,2010, we had aggregate deferred license revenue of $273,954 representing amounts collected from anothera 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 December 31, 2009 was $3,058,568, or 57.2% of revenues, compared to $1,142,271, or 45.8% of revenues, for the three months ended December 31, 2008. The increasedecrease in gross profit is primarily due to increaseddecreased revenue in the quarter, increasedquarter. Gross profit as a percentage of revenue remained almost flat. Lower fixed absorption that resulted from lower revenue was offset by a reduction of fixed cost over the higher revenue,freight and decreased product cost resulting from improved pricing on higher quantity purchases.other overhead expenses .

Our products have varying gross margins, so product sales mix will materially affect gross profits. In addition, weour margins vary based on the sales channels the product is sold through in a given period. 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 December 31, 2009 decreased $388,759 to $1,198,201, or 22.4% of revenues, compared to $1,586,960, or 63.7% of revenues, for the three months ended December 31, 2008. The decrease in selling general and administrative expenses was primarily attributed to $388,496$354,569 of lower non-cash share-based compensation expense due to options becoming fully vested $95,405and $284,655 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 staffing. These reductions werelower commission expense, partially offset by $172,935 increased insidesales and outside commissions and $34,332marketing expenses of $53,799 primarily for demonstration units, $45,932 for accrued bonus expense.expense, and increased travel expenses of $33,623.

We incurred non-cash share-based compensation expenses related to ASC 718 allocated to selling, general and administrative expenses in the three months ended DecemberMarch 31, 2010 and 2009 of $106,757 and 2008 of $115,130 and $503,626,$461,325, 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.

Research and Development Expenses

Research and development expenses increased $99,453 to $551,921, or 10.3% of revenues, for the three months ended December 31, 2009, compared to $452,458, or 18.1% of revenues, for the three months ended December 31, 2009. ThisThe increase in research and development expense was primarily due to $77,810$34,344 for increased salaries and consulting expense, $42,372 for accrued bonuses, $21,843 for higher testing and prototype costs, and $43,739 for accrued bonuses, offset by $32,014$30,479 lower patent impairment charges and $18,869 of lower non-cash share-based compensation expense.

Included in research and development expenses for the three months ended DecemberMarch 31, 2010 and 2009 was $14,051 and 2008 was $14,054 and $46,068$32,920 of non-cash share-based compensation costs, respectively.

Each quarter, we review the ongoing value of our capitalized patent costs and in the firstsecond fiscal 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 $40,996$8,812 during the quarter ended DecemberMarch 31, 2009,2010, compared to an impairment of $36,453$39,291 in the three months ended DecemberMarch 31, 2008.2009.

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 2008 with enhanced performance and louder, more intelligible communications, and we have further expanded the line in 2009.2009 and 2010 with new products, customizations and enhancements. Based on current plans, and reduced engineering staffing, we expect research and development costs to continue in the current fiscal year comparable to last year.

Income (Loss) from Operations

IncomeThe decrease in income from operations was $1,308,446 for the three months ended December 31, 2009, compared to a loss from operations of $897,147 for the three months ended December 31, 2008. The increase is primarily attributable to the increasedecrease in gross profitrevenues, partially offset by lower selling, general and reduced non-cash share-based compensationadministrative expense.

Other Income (Expense)

During the three months ended DecemberMarch 31, 2009,2010, we earned $16,071$8,475 less interest income on our cash and cash equivalents balances compared to the three months ended DecemberMarch 31, 2008 due2009 because we have transferred our cash to lower interest rates.non-interest bearing, fully insured accounts. In the quarter ended DecemberMarch 31, 2009,2010, we recorded $597,016$76,510 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 DecemberMarch 31, 2008.2009.

Net Income

The decrease in net income was primarily the result of lower revenues in the quarter, partially offset by lower selling, general and administrative expenses and the unrealized gain on derivative revaluation related to warrant instruments. We recorded income tax expense of $10,231 in the quarter ended March 31, 2010. We had no income tax expense in the prior year.

Results of Operations for the Six Months Ended March 31, 2010 and 2009

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.

Revenues for the six months ended March 31, 2010 included $8,801,913 of product sales and $100,806 of contract, license and other revenues. Revenues for the six months ended March 31, 2009 included $8,232,243 of product sales and $133,482 of contract, license and other revenues. Sales increased in our LRAD and HSS product lines and decreased in our SoundSaber product line. We expect continued uneven quarterly revenues in future periods as we continue to develop the markets for our proprietary products.

At March 31, 2010, we had aggregate deferred license revenue of $273,954 representing amounts collected from a 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

The increase in gross profit is due to increased revenue in the first half, increased absorption of fixed cost over the higher revenue, decreased product cost resulting from improved pricing on higher quantity purchases, and reduced overhead expenses.

Our products have varying gross margins, so product sales mix will materially affect gross profits. In addition, our margins vary based on the sales channels the product is sold through in a given period. 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

The decrease in selling general and administrative expenses was primarily attributed to a decrease of $743,065 non-cash, share-based compensation expense, $118,055 for staffing and consultants, and $107,355 in sales commission expense, offset by a $78,158 increase for bonus expense.

We incurred non-cash share-based compensation expenses related to ASC 718 allocated to selling, general and administrative expenses in the six months ended March 31, 2010 and 2009 of $221,887 and $964,952, 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

The increase in research and development expense was primarily due to $99,654 of higher consulting, prototypes and testing costs related to product certifications and development and $84,526 for accrued bonuses, partially offset by a $50,883 reduction in non-cash share-based compensation expense.

Included in research and development expenses for the six months ended March 31, 2010 and 2009 was $28,105 and $78,988 of non-cash share-based compensation costs, respectively.

Each quarter, we review the ongoing value of our capitalized patent costs and in the first two 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 $49,808 during the six months ended March 31, 2010, compared to an impairment of $75,744 in the six months ended March 31, 2009.

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. 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

The increased income from operations is primarily attributable to the increase in revenues, improved gross profit margins and lower selling, general and administrative expenses.

Other Income (Expense)

During the six months ended March 31, 2010, we earned $93 of interest income on our cash and cash equivalents balances compared to $24,639 during the six months ended March 31, 2009 because we have transferred our cash to non-interest bearing, fully insured accounts. In the six months ended March 31, 2010, we recorded $673,526 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 six months ended March 31, 2009.

Net Income (Loss)

The increased net income forwas primarily the three months ended December 31, 2009 was $1,819,228, compared toresult of increased revenues, improved gross margins and a net loss of $881,029 for the three months ended December 31, 2008.reduction in selling, general and administrative expenses. We recorded income tax expense of $85,498$95,729 in the quartersix months ended DecemberMarch 31, 2009.2010. We had no income tax expense in the prior year.

Liquidity and Capital Resources

We experienced a small negativegenerated strong positive cash flow from operating activities in the quartersix months ended DecemberMarch 31, 2009.2010. We have financed our working capital requirements through cash generated from product sales and from financing activities. Cash and cash equivalents at DecemberMarch 31, 20092010 was $4,839,946$6,440,672 compared to $5,102,502 at September 30, 2009. The decreaseincrease in cash was primarily the result of increased accounts receivable due to increased revenuenet income during the quarter and payment of year-end bonuses for the year-ended September 30, 2009 during the threesix months ended DecemberMarch 31, 2009.

2010. Other than cash, inventory and our balance of accounts receivable, we have no other unused sources of liquidity 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 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 used inprovided by operating activities was $249,485$1,334,893 for the threesix months ended DecemberMarch 31, 20092010 compared to $149,020 used in$204,212 provided by operating activities for the threesix months ended DecemberMarch 31, 2008.2009. Net cash used inprovided by operating activities for the threesix months ended DecemberMarch 31, 20092010 included net income of $1,819,228,$1,983,051, increased by expenses not requiring the use of cash of $549,689 and decreased by a non-cash gain on derivative revaluation of $673,526. Cash was also provided by a $322,484 decrease in accounts receivable, a $509,700 decrease in inventory, and a $1,960 decrease in prepaid expenses. Operating cash usage during the six months ended March 31, 2010 included $451,129 from decreased accounts payable, $49,432 for increased warranty settlements and $857,904 for reduced accrued liabilities which included bonus payments in the quarter ended December 31, 2009. Net cash provided by operating activities for the six months ended March 31, 2009 included a net loss of $2,218, decreased by expenses not requiring the use of cash of $269,400$1,377,717 and a $226,701$289,426 increase in accounts payable. Operating cash usage during the threesix months ended DecemberMarch 31, 2009 included $951,209 from increaseda $1,230,725 increase in accounts receivable, $830,463 for reduced accrued liabilities which included the Company bonus payment, $132,192 from increased$66,160 increase in inventory, $86,752 from increased$13,429 increase in prepaid expenses, and a $25,398 increase in warranty settlements. Net cash used in operating activities for the three months ended 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 $881,029 net loss, decreased by expenses not requiring the use of cash of $687,252, a $186,418 decrease in accounts payable, a $152,559 decrease in accrued liabilities, a $4,168$11,513 increase in warranty settlements and a $345 increase$138,886 decrease in prepaid expense.accrued liabilities.

At DecemberMarch 31, 20092010, we had working capital of $8,180,978,$8,565,019, compared to working capital of $6,858,039 at September 30, 2009.

At DecemberMarch 31, 2009,2010, we had net accounts receivable of $2,414,431,$1,140,738, compared to $1,463,222 in accounts receivable at September 30, 2009. The level of trade accounts receivable at DecemberMarch 31, 20092010 represented approximately 4229 days of revenue, compared to 44 days of revenue for the quarter ended September 30, 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 or existing patents. Cash used in investing activities for equipment was $8,147$16,147 for the threesix months ended DecemberMarch 31, 20092010 and $99,600$118,048 for the threesix months ended DecemberMarch 31, 2008.2009. Cash used for investment in new patents was $4,924$9,394 for the threesix months ended DecemberMarch 31, 20092010 and $4,942$21,130 for the threesix months ended DecemberMarch 31, 2008.2009. We anticipate some additional expenditure for equipment and patents during the balance of fiscal year 2010.

Financing Activities

In the six months ended March 31, 2010, we received proceeds of $28,818 from the exercise of stock options. There was no cash provided by financing activities for the threesix months ended DecemberMarch 31, 2009 or 2008.

Recent Accounting Pronouncements

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

Item 3.

Item 3.

Qualitative and Quantitative Disclosures about Market Risk.

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 DecemberMarch 31, 2009.2010.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during our fiscal quarter ended DecemberMarch 31, 20092010 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.