UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended DecemberMarch 31, 20122013

or

For the transition period from                    to                    .

Commission File Number: 000-24248

LRAD 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).    x  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 31,May 2, 2013 was 32,399,199.

PART I. FINANCIAL INFORMATION

LRAD Corporation

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes

1

LRAD Corporation

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes

2

LRAD Corporation

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes

3

LRAD Corporation

Notes to Interim Condensed Consolidated Financial Statements (unaudited)

1. OPERATIONS

LRAD 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 and South America, Europe, the Middle East and Asia.

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

General

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q and applicable sections of Regulation S-X. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although, in the opinion of management, the interim financial statements reflect all adjustments necessary, and disclosures included therein are adequate, in order to make the financial statements not misleading. The condensed consolidated balance sheet as of September 30, 2012 was derived from the Company’s most recent audited financial statements. Operating results for the three and six month periodperiods are not necessarily indicative of the results that may be expected for the year. The interim condensed 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, 2012 included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (“SEC”) on December 4, 2012.

Principles of Consolidation

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

Fair Value Measurements

At DecemberMarch 31, 2012,2013, there was no difference between the carrying value and fair market value of the Company’s cash equivalents. For certain financial instruments, including accounts receivable, accounts payable and accrued liabilities, the carrying amounts approximate fair value due to their relatively short maturities.

Reclassifications

Where necessary, the prior year’s information has been reclassified to conform to the current year presentationpresentation.

3. INVENTORIES

Inventories consisted of the following:

4

4. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

5. INTANGIBLE ASSETS

Patents consisted of the following:

Each quarter, the Company reviews the ongoing value of its capitalized patent costs and reduces the value if any of its patents are no longer consistent with its business strategy, as noted in the above table.

5

6. ACCRUED LIABILITIES AND OTHER LIABILITIES—NONCURRENT

Accrued liabilities consisted of the following:

Other liabilities—liabilities - noncurrent consisted of the following:

Deferred Revenue

Deferred revenue at DecemberMarch 31, 20122013 and September 30, 2012 included $270,559, collected from a license agreement in advance of recognized revenue.

Warranty Reserve

Changes in the warranty reserve during the three and six months ended DecemberMarch 31, 20122013 and 20112012 were as follows:

7. INCOME TAXES

At DecemberMarch 31, 2012,2013, the Company had federal net operating losses (“NOLs”) and related state NOLs. In accordance with Financial Accounting Standards Board Accounting Standards Codification (“ASC”) Topic 740, “Accounting for Income Taxes” (“ASC 740”), the Company recorded 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 did not record a tax provision during the threesix months ended DecemberMarch 31, 20122013 as the Company expects its annual effective tax rate to be zero. In addition to the Company’s federal NOLs, it also made an election under Section 172(b)(1)(H) of the Internal Revenue Code of 1986 (“Section 172”), as amended per the American Recovery and Reinvestment Tax Act of 2009, to carry back its fiscal year ended September 30, 2008 applicable NOL for a period of 3 years, and carry forward the loss for up to 20 years, which offsets the Alternative Minimum Tax in the current tax year. In addition, the state of California has reinstated the NOL carryover deduction for taxable years beginning on or after January 1, 2012, which are expected to offset any state taxes during the 2013 fiscal year.

6

ASC 740 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.

8. COMMITMENTS AND CONTINGENCIES

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

The Company maintains cash and cash equivalent accounts with Federal Deposit Insurance Corporation (“FDIC”) insured financial institutions. Under provisions of the Dodd Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank Act”), unlimited FDIC insurance was provided for all funds in non-interest bearing transaction accounts through December 31, 2012. In addition, certain ofBeginning on January 1, 2013, the Company’s interest bearing collateral money market and savingsFDIC covers all deposit accounts are each insured up to $250,000 by the FDIC.per depositor for each insured bank. The Company’s exposure for amounts in excess of FDIC insured limits at DecemberMarch 31, 20122013 was approximately $13,400,000.$15,600,000. The Company has not experienced any losses in such accounts.

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. On July 24, 2012, the Company was served with a complaint filed in the Delaware Court of Chancery by Iroquois Master Fund Ltd. (“Iroquois”), a shareholder of the Company, against the Company’s board of directors, its Chief Executive Officer and Chief Financial Officer. The action is a purported derivative action which alleges breach of fiduciary duty and other claims against the individual defendants based on the issuance of stock options to them, which the plaintiff alleges were granted in violation of the terms of the Company’s 2005 Equity Incentive Plan. The Company was also named in the action as a nominal defendant against which no recovery is sought. The plaintiff seeks rescission or repricing of the stock options at issue and other damages, purportedly on behalf of the Company. The defendants filed a motion to dismiss the complaint. Rather than oppose the motion, the plaintiff filed an amended complaint on November 19, 2012. Defendants filed a motion to dismiss the amended derivative complaint on December 17, 2012 and the motion is in the process of being fully briefed to the Court.2012. The Company and the individual defendants seek dismissal of the complaint on the grounds that Plaintiffthe plaintiff has failed to comply with Delaware law in filing the complaint and becausecomplaint. The individual defendants seek dismissal on the additional grounds that the Complaint fails to state a legal claim under law.against them. A hearing on the defendants’ motion to dismiss the amended derivative complaint was held March 4, 2013. A ruling from the Court has not yet been received.

The Company received a notice and a Schedule 13D was filed by Iroquois with the SEC on January 17, 2013 announcing Iroquois’ intention to nominate a slate of five directors to stand for election at the Company’s 2013 Annual Meeting of Stockholders. The Company’s Nominating and Corporate Governance Committee will review and consider the nominations as well as qualified individuals who were submitted by other stockholders to serve on the Company’s Board of Directors.

At this time, the Company believes that a loss related to this matter is not probable and it has not recorded an accrual in its financial statements for the period ended March 31, 2013. The Company estimates that it is reasonably possible that it could incur a loss of between $0 and $600,000 after anticipated recoveries from the insurance company and potential adjustments to Iroquois’ claims.

Bonus Plan

The Company has an incentive bonus plan for fiscal year 2013 designed to motivate its employees to achieve the Company’s financial objectives. All of the Company’s employees are entitled to participate in the incentive plan. Target Bonus Amounts (“Target”) vary based on a percentage of the employee’s base salary which range from 10% to 50% of base salary and a bonus payment may be made at three levels, including at 50% of Target, at 100% of Target and at 200% of Target, depending upon the achievement by the Company of specified earnings per share goals. Included in such calculation is the cost of the incentive plan. For purposes of the earnings per share calculation, the number of shares outstanding will also be held constant as of October 1, 2012. During the threesix months ended DecemberMarch 31, 20122013 and 2011,2012, the Company did not record any bonus expense in connection with the respective 2013 or 2012 plans.

9. SHARE-BASED COMPENSATION

Stock Option Plans

At DecemberMarch 31, 2012,2013, the Company had one equity incentive plan, the 2005 Equity Incentive Plan (“2005 Equity Plan”). The 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 includes these new shares and shares reserved under prior plans, allowing for the issuance of up to 4,999,564 shares. At DecemberMarch 31, 2012,2013, there were options outstanding covering 3,353,3393,020,139 shares of common stock under the 2005 Equity Plan and an additional 1,055,2771,388,477 shares of common stock available for grant.

7

Stock Option Activity

The following table summarizes information about stock option activity during the threesix months ended DecemberMarch 31, 2012:2013:

Options outstanding are exercisable at prices ranging from $0.46 to $3.13 and expire over the period from 2013 to 2022 with an average life of 4.905.2 years. The aggregate intrinsic value of options outstanding and exercisable at DecemberMarch 31, 20122013 was $453,844$409,750 and $453,717,$409,730, respectively.

Share-Based Compensation

The Company recorded share-based compensation expense and classified it in the condensed consolidated statements of operations as follows:

The employee stock optionoptions granted in the threesix months ended DecemberMarch 31, 2013 and 2012 had a weighted-average estimated fair value of $.70 per share and $1.07 per share, respectively, using the Black-Scholes option pricing model with the following weighted-average assumptions (annualized percentages):

There were no stock options granted during the three months ended December 31, 2011. 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 an NOL carryforward as of DecemberMarch 31, 2012,2013, no excess tax benefit for the tax deductions related to share-based awards was recognized for the threesix months ended DecemberMarch 31, 20122013 and 2011.2012. As of DecemberMarch 31, 2012,2013, there was approximately $900,000$700,000 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 1.51.3 years.

8

10. STOCKHOLDERS’ EQUITY

Summary

The following table summarizes changes in the components of stockholders’ equity during the threesix months ended DecemberMarch 31, 2012:2013:

Stock Purchase Warrants

At DecemberMarch 31, 2012,2013, the Company had 1,627,945 shares purchasable under outstanding warrants at an exercise price of $2.67 which are exercisable through February 4, 2016.

11. (LOSS) INCOME (LOSS) PER SHARE

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

12. MAJOR CUSTOMERS

For the three months ended DecemberMarch 31, 2012,2013, revenues from three customers accounted for 20%, 15% and 14% of revenues, respectively, and for the six months ended March 31, 2013, revenues from two customers accounted for 28%24% and 13%11% of revenues, respectively, with no other single customer accounting for more than 10% of revenues. At DecemberMarch 31, 2012,2013, accounts receivable from threefour customers accounted for 26%34%, 25%14%, 12% and 14%10% 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 DecemberMarch 31, 2011,2012, revenues from threetwo customers accounted for 27%, 24%22% and 12%10% of revenues, respectively, and for the six months ended March 31, 2012, revenues from two customers accounted for 14% and 16% of revenues, with no other single customer accounting for more than 10% of revenues. At DecemberMarch 31, 2011,2012, accounts receivable from two customers accounted for 56%46% and 17%11% of total accounts receivable, respectively, with no other single customer accounting for more than 10% of the accounts receivable balance.

9

The discussion and analysis set forth below should be read in conjunction with the accompanying unaudited interim condensed consolidated 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, 2012.

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

LRAD Corporation develops and delivers highly intelligible, directed acoustic products that beam, focus and control sound over short and long distances. By placing sound only where needed, we not only enhance many typical speaker applications, but we offer novel sound applications that conventional speakers cannot achieve. We offer a variety of directional sound products, which meet a broad range of requirements from communicating with and deterring threats over distances up to 300 meters with our hand-held LRAD 100X to distances in excess of 3,500 meters with our LRAD 2000X. Since 1996, we have been at the forefront developing new acoustic innovations to project, focus, shape and control sound and we believe we have established a significant competitive advantage in our principal markets. Through increased focus and investment in worldwide sales and marketing activities our Long Range Acoustic Device^® or LRAD^® pioneered a new worldwide market for directional long-range acoustic hailing devices (“AHDs”).

In the quarter ended DecemberMarch 31, 2012, we had2013, revenues of $2,980,107were $3,189,810 compared to $3,611,635$2,400,441 in the quarter ended DecemberMarch 31, 2011.2012. U.S. Defense spending continued to be slow,delayed through the quarter as a result of sequestration and is expectedthe delayed passage of the FY13 continuing resolution. We expect some funding for domestic government and military purchases to remain slow through at least March 2013, when spending cuts or sequestration are expected to be addressed.begin in the fiscal quarter ending June 30, 2013. We continue to pursue international opportunities, as well as new markets as a result of our new LRAD 360X and LRAD 2000X products. Gross margin for the quarter was 50%43% of net revenues, compared to 48%55% of net revenues for the quarter ended DecemberMarch 31, 2011.2012. On a quarter over quarter basis, our revenues are expected to remain uneven.

Our LRAD-X product line uses directionality and focused acoustic output to clearly transmit critical information, instructions and warnings in excess of 3,500 meters. The LRAD-X product line features clear voice intelligibility and is available in a number of packages and form factors that meet the military’s stringent environmental requirements. 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 potential security threats. Our LRAD-X product line provides a complete range of systems from single user portable to permanently installed, remotely operated. Our LRAD products have been competitively selected over other commercially available systems by U.S. and several foreign militaries. Our LRAD-X product line includes the following:

10

Overall Business Outlook

We are experiencing positive response and increased acceptance of our products. We believe we have a solid technology and product foundation with our LRAD-X product line, and we have expanded our product line seeking to service new markets for greater business growth. We believe that we have strong market opportunities within the worldwide government and military sector, as well as increased commercial applications as a result of continued global threats to governments, commerce and law enforcement, and in wildlife preservation and control applications. Our selling network has expanded to include a number of key integrators and sales representatives within the United States and in a number of worldwide locations. However, we may continue to face challenges inthrough the balance of fiscal 2013 due to extreme international economic and geopolitical conditions.conditions in certain countries. A furtherweak recovery of financial markets and continued deterioration in financial markets andlack of confidence in major economies could disruptimpact the operation of our business. We anticipate continued uncertainty with U.S. Military spending due to ongoing budget delays in the passage of the FY14 Federal Budget and expected spending reductions.details of the Overseas Contingency Operations (OCO) budget. We continue to pursue large business opportunities, but it is difficult to anticipate how long it will take to close these opportunities, or if they will ultimately result in product sales.

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 on Form 10-K for the year ended September 30, 2012. 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 U.S., 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.

11

Comparison of Results of Operations for the Three Months Ended DecemberMarch 31, 20122013 and 20112012

Revenues

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

11

The decreaseincrease in revenues was primarily due to a decreasethe timing of the receipt and delivery of orders in U.S. Military orders.the quarter ended March 31, 2013 compared to the prior year. Uncertainty on defense spending is expected to continuecontinued through at least March 2013 when spending cuts orthe current quarter as a result of sequestration are expected to be addressed.and the delayed passage of the FY13 continuing resolution. Contract and other revenue for the three months ended DecemberMarch 31, 20122013 includes $197,031 for an annual maintenance agreement for units sold to a foreign military in fiscal 2011 that was not in place in the prior year. Due to the budgetary cycles of our customer base and the lack of established markets for our proprietary products, we expect continued uneven quarterly revenues in future periods.

At December 31, 2012, we had aggregate deferred revenue of $270,559 collected from a license agreement in advance of recognized revenue. This revenue component is subject to significant variability based on the timing, amount and recognition of new arrangements or payment terms.

Gross Profit

The decreaseincrease in gross profit in the quarter was primarily due to lower revenuesincreased revenue, partially offset by unfavorable product mix, and higher contracted annual maintenance costs compared to the costs for the first year warranty period related to a large foreign military sale in March 2011, offset by higher product margins as2011. In addition, the gross profit in the quarter ended March 31, 2012, included a percentagereduction in the warranty reserve upon completion of sales due to favorable product mix.the one year warranty period for the large foreign military order, which wasn’t repeated in the current year.

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 through which our products are sold in a given period. We continue to implement 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.

12

Selling, General and Administrative Expenses

Selling, general and administrative expenses reflected a $71,432$323,845 increase in legal and other professional fees related to the current lawsuit and responding to the threatened proxy contest and a $53,241 increase in non-cash share-based compensation, expense as a result of new option grants and a $49,020 increase in legal fees related to the recent lawsuit,partially offset by $4,536$94,036 decrease in commission expense to our contracted sales representatives, $32,760 decrease in travel expense, $26,424 decrease in fees due to our Annual Stockholder Meeting not being held during the quarter and $46,901 of other spending reductions.

We incurred non-cash share-based compensation expenses allocated to selling, general and administrative expenses in the three months ended DecemberMarch 31, 2013 and 2012 of $171,044 and 2011 of $189,831 and $118,399,$117,803, respectively.

We may expend additional resources on the marketing and selling of our products in future periods as we identify ways to optimize potential opportunities. Commission expenses will fluctuate based on the nature of our sales. In addition, we expect some additional legal expenses to increase at least throughcontinue in the secondthird fiscal quarter due to the recent lawsuit and proxy matters. This may result in increased selling, general and administrative expenses in the future.

12

Research and Development Expenses

Research and development expenses reflected a $19,961$26,458 increase in product development costs and $21,422 due to increased travel costs for projects with current or prospective customers, offset by $780$899 of other spending reductions.increases.

Included in research and development expenses for the three months ended DecemberMarch 31, 2013 and 2012 was $11,975 and 2011 was $12,248 and $14,006$14,137 of non-cash share-based compensation costs, respectively.

Each quarter, we review the ongoing value of our capitalized patent costs and in the third fiscal quarter we 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 sold a previously capitalized patent for its book value of $5,138 during the quarter ended December 31, 2012, compared to an impairment expense of $10,616 in the three months ended December 31, 2011.

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 the use of outside consulting, design and development firms. We continually improve our product offerings and we have further expanded the product line-up in 2013 and 2012 with new products, customizations and enhancements. Based on current plans, we expect research and development costs to continue in the current fiscal year on a basis comparable to the prior year.

Loss from Operations

The increase in the loss from operations was primarily attributable to the increase in operating expenses, partially offset by an increase in revenues and gross margin.

Net Loss

The increase in net loss was primarily due to an increase in operating expenses. We recognized $1,600 for income tax expense compared to a benefit of $7,015 in the quarter ended March 31, 2012.

13

Comparison of Results of Operations for the Six Months Ended March 31, 2013 and 2012

Revenues

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

Revenues increased by 2.6% compared to the same period in the prior year. Uncertainty on defense spending continued through the current quarter as a result of sequestration and the delayed passage of the FY13 continuing resolution. Contract and other revenue for the six months ended March 31, 2013 includes $394,062 for an annual maintenance agreement for units sold to a foreign military in fiscal 2011 that was not in place in the prior year. Due to the budgetary cycles of our customer base and the lack of established markets for our proprietary products, we expect continued uneven quarterly revenues in future periods.

At March 31, 2013, we had aggregate deferred revenue of $270,559 collected from a license agreement in advance of recognized revenue. This revenue component is subject to significant variability based on the timing, amount and recognition of new arrangements or payment terms.

Gross Profit

The decrease in gross profit year to date was primarily due to unfavorable product mix, higher contracted annual maintenance costs compared to the costs for the first year warranty period related to a large foreign military sale in March 2011, and a large reduction in the warranty reserve in the prior year upon completion of the one-year warranty period for the large foreign military order, compared to a small reduction in the current year. We also recorded a favorable reversal of inventory reserve in the prior year compared to a small reversal in the current year. These unfavorable variances were partially offset by favorable volume.

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 through which our products are sold in a given period. We continue to implement 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.

14

Selling, General and Administrative Expenses

Selling, general and administrative expenses reflected a $378,314 increase in legal and other professional fees related to the current lawsuit and responding to the threatened proxy contest, $124,673 increase in non-cash share-based compensation and $44,912 increase in consulting expenses, partially offset by a $95,489 decrease in commission expense to our contracted sales representatives, $42,445 decrease in salary and benefits, $31,507 decrease in travel expense, $29,292 decrease in audit fees and $56,285 of other spending reductions.

We incurred non-cash share-based compensation expenses allocated to selling, general and administrative expenses in the six months ended March 31, 2013 and 2012 of $360,875 and $236,202, respectively.

We may expend additional resources on the marketing and selling of our products in future periods as we identify ways to optimize potential opportunities. Commission expenses will fluctuate based on the nature of our sales. In addition, we expect legal expenses related to the lawsuit and proxy matters to continue into the third fiscal quarter. This may result in increased selling, general and administrative expenses in the future.

Research and Development Expenses

Research and development expenses reflected a $46,419 increase in product development costs, $28,419 increase in rent due to increased square footage in our new office facility and a $22,292 increase in travel costs, offset by $29,170 of spending reductions.

Included in research and development expenses for the six months ended March 31, 2013 and 2012 was $24,223 and $28,143 of non-cash share-based compensation costs, respectively.

In the six months ended March 31, 2013 and 2012, we reviewed the ongoing value of our capitalized intangible assets. As a result of this review, we reduced the value of these patents by $0 and $11,197 for the six months ended March 31, 2013 and 2012, respectively.

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 the use of outside consulting, design and development firms. We continually improve our product offerings and we further expanded the product line-up in 2013 and 2012 with new products, customizations and enhancements. Based on current plans, we expect research and development costs to continue in the current fiscal year on a basis comparable to the prior year.

(Loss) Income from Operations

The decrease in income from operations was primarily attributable to the decrease in revenues and gross margin,profit and an increase in operating expenses.

Other Income

During the three months ended December 31, 2012 we earned $4,747 less in interest income from our cash and cash equivalents balances compared to the three months ended December 31, 2011 as a result of a reduction in the interest rate in our interest bearing account.

Net (Loss) Income

The decrease in net income was primarily the result of lower revenues and gross margin in the quarter,profit, and an increase in operating expenses. We did not recognize any income tax expense during the three months ended December 31, 2012, compared to $9,715 in the quarter ended December 31, 2011.

Liquidity and Capital Resources

Cash and cash equivalents at DecemberMarch 31, 20122013 was $16,139,078,$15,783,685, compared to $13,859,505 at September 30, 2012. The change in cash and cash equivalents was primarily the result of a reduction in accounts receivable from strong year-end shipments in September 30, 2012, partially offset by an increase in inventory during the quarter based on the forecasted requirements. Other than cash and cash equivalents and expected future cash flows from operating activities in subsequent periods, we have no other unused sources of liquidity at this time.