UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended DecemberMarch 31, 20132014

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.    ☒  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  ☒    No

The number of shares of Common Stock, $0.00001 par value, outstanding on January 29,May 1, 2014 was 33,133,380.33,061,925.

PART I. FINANCIAL INFORMATION

LRAD Corporation

CONDENSED CONSOLIDATED BALANCE SHEETS

		December 31, 2013 (Unaudited)				September 30, 2013
ASSETS
Current assets:
Cash		$	18,086,313			$	15,805,195
Accounts receivable, less allowance of $0 and $3,772for doubtful accounts			1,901,232				4,958,532
Inventories, net			5,344,853				4,587,750
Prepaid expenses and other			512,721				1,003,875
Total current assets			25,845,119				26,355,352
Property and equipment, net			328,535				237,377
Intangible assets, net			50,162				51,650
Prepaid expenses and other - noncurrent			867,641				914,516
Total assets		$	27,091,457			$	27,558,895
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	568,968			$	1,596,409
Accrued liabilities			1,239,459				1,054,968
Total current liabilities			1,808,427				2,651,377
Other liabilities - noncurrent			146,777				146,109
Total liabilities			1,955,204				2,797,486
Commitments and contingencies (Note 8)
Stockholders' equity:
Preferred stock, $0.00001 par value; 5,000,000 shares authorized;none issued and outstanding			-				-
Common stock, $0.00001 par value; 50,000,000 shares authorized;33,205,373 and 32,900,705 shares issued and outstanding, respectively			332				329
Treasury stock, at cost, 19,796 shares			(37,420	)			-
Additional paid-in capital			87,715,532				87,434,834
Accumulated deficit			(62,542,191	)			(62,673,754	)
Total stockholders' equity			25,136,253				24,761,409
Total liabilities and stockholders' equity		$	27,091,457			$	27,558,895

See accompanying notes

LRAD Corporation

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		Three months ended December 31,
		2013				2012
Revenues:
Product sales		$	3,556,062			$	2,762,345
Contract and other			266,568				217,762
Total revenues			3,822,630				2,980,107
Cost of revenues			1,878,079				1,494,284
Gross profit			1,944,551				1,485,823
Operating expenses:
Selling, general and administrative			1,424,544				1,172,475
Research and development			393,541				421,921
Total operating expenses			1,818,085				1,594,396
Income (loss) from operations			126,466				(108,573	)
Other income			5,197				8,197
Income (loss) from operations before income taxes			131,663				(100,376	)
Income tax expense			100				-
Net income (loss)		$	131,563				(100,376	)
Net income per common share
Basic		$	0.00			$	0.00
Diluted		$	0.00			$	0.00
Weighted average common shares outstanding:
Basic			33,028,646				32,399,199
Diluted			33,473,582				32,399,199

 

See accompanying notes

LRAD Corporation

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		Three months ended December 31,
		2013				2012
Operating Activities:
Net income (loss)		$	131,563			$	(100,376	)
Adjustments to reconcile net income (loss) to net cashprovided by operating activities:
Depreciation and amortization			35,203				30,716
Provision for doubtful accounts			(3,772	)			(200	)
Warranty provision			14,361				(9,445	)
Inventory obsolescence			(4,414	)			(29,701	)
Share-based compensation			149,814				205,978
Loss on sale or impairment of patents			-				5,138
Changes in operating assets and liabilities:
Accounts receivable			3,061,072				3,249,384
Inventories			(752,689	)			(1,050,152	)
Prepaid expenses and other			491,154				84,902
Prepaid expenses and other - noncurrent			46,875				46,875
Accounts payable			(1,027,441	)			(204,313	)
Warranty settlements			(11,362	)			(4,275	)
Accrued and other liabilities			182,160				113,452
Net cash provided by operating activities			2,312,524				2,337,983
Investing Activities:
Capital expenditures			(124,793	)			(76,655	)
Patent costs paid			(80	)			(983	)
Net cash used in investing activities			(124,873	)			(77,638	)
Financing Activities:
Repurchase of common stock			(99,597	)			-
Proceeds from exercise of stock options			193,064				19,228
Net cash provided by financing activities			93,467				19,228
Net increase in cash			2,281,118				2,279,573
Cash, beginning of period			15,805,195				13,859,505
Cash, end of period		$	18,086,313			$	16,139,078
Supplemental Disclosure of Cash Flow Information
Cash paid (refunded) for taxes		$	100			$	(40,324	)

See accompanying notes

LRAD Corporation

Notes to 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 Company’s unaudited condensed consolidated financial statements included herein have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In our opinion, the accompanying statements reflect adjustments necessary to present fairly the financial position, results of operations, and cash flows for those periods indicated, and contain adequate disclosure to make the information presented not misleading. Adjustments included herein are of a normal, recurring nature unless otherwise disclosed in the footnotes. The condensed consolidated 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, 2013 included in the Company’s Annual Report on Form 10-K, as filed with the SEC on November 21, 2013. Results of operations for interim periods are not necessarily indicative of the results of operations for a full year.

Principles of Consolidation

The Company has a currently inactive wholly owned subsidiary, LRAD International Corporation, 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.

Reclassifications

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

3. RECENT ACCOUNTING PRONOUNCEMENTS

In July 2013, the Financial Accounting Standards Board (“FASB”) issued guidance requiring a liability related to an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. The presentation of unrecognized tax benefits as a reduction of a deferred tax asset is consistent with an entity’s analysis of the realizability of its deferred tax assets and, as a result, is not expected to change an entity’s assessment of realizability. For public companies, this guidance is effective on a prospective basis for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The Company does not expect the adoption ofWe adopted this guidance willfor the interim period beginning January 1, 2014. Such adoption did not have a material impact on our financial statementsstatements.

4. INVENTORIES

Inventories consisted of the following:

		December 31, 2013				September 30, 2013
Raw materials		$	4,303,861			$	3,941,203
Finished goods			1,160,901				605,240
Work in process			193,196				358,826
			5,657,958				4,905,269
Reserve for obsolescence			(313,105	)			(317,519	)
		$	5,344,853			$	4,587,750

 

 5. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

		December 31, 2013				September 30, 2013
Office furniture and equipment		$	775,301			$	769,799
Machinery and equipment			727,094				607,803
Leasehold improvements			55,298				55,298
			1,557,693				1,432,900
Accumulated depreciation			(1,229,158	)			(1,195,523	)
		$	328,535			$	237,377

6. ACCRUED LIABILITIES AND OTHER LIABILITIES—NONCURRENT

Accrued liabilities consisted of the following:

Deferred Revenue 

Deferred revenue at March 31, 2014 included $408,056 for prepayments from customers in advance of product shipment compared to $18,532 at September 31, 2014.

Warranty Reserve

Changes in the warranty reserve during the three and six months ended DecemberMarch 31, 20132014 and 20122013 were as follows:

7. INCOME TAXES

At DecemberMarch 31, 2013,2014, the Company had federal net operating losses (“NOLs”) and related state NOLs. In accordance with FASB 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 arecorded only the minimum tax provision for California during the threesix months ended DecemberMarch 31, 20132014 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 2014 fiscal year.

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 accounts with Federal Deposit Insurance Corporation (“FDIC”) insured financial institutions, which provided unlimited FDIC insurance for all funds in non-interest bearing transaction accounts through December 31, 2012. Beginning on January 1, 2013, theinstitutions. The FDIC coverage includes all deposit accounts up to $250,000 per depositor for each insured bank. In addition, the Company’s security account is protected by coverage offered by the Securities Investor Protection Corporation (“SIPC”) up to $500,000, which is inclusive of up to $250,000 of protection for claims for cash. The Company’s exposure for amounts in excess of these insured limits at DecemberMarch 31, 20132014 was approximately $17,800,000.$18,200,000. 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. 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 2014 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 be held constant as of October 1, 2013. During the threesix months ended DecemberMarch 31, 20132014, we accrued $338,151 for bonuses and 2012,related payroll tax expenses in connection with the 2014 plan. The Company did not record any bonus expense during the six months ended March 31, 2013 in connection with the respective 2014 or 2013 plans.plan.

9. SHARE-BASED COMPENSATION

Stock Option Plans

At DecemberMarch 31, 2013,2014, 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, 2013,2014, there were options outstanding covering 2,712,0002,809,042 shares of common stock under the 2005 Equity Plan and an additional 837,634740,592 shares of common stock available for grant.

Stock Option Activity

The following table summarizes information about stock option activity during the threesix months ended DecemberMarch 31, 2013:2014:

Options outstanding are exercisable at prices ranging from $0.93 to $3.13 and expire over the period from 2014 to 2023 with an average life of 6.26.1 years. The aggregate intrinsic value of options outstanding and exercisable at DecemberMarch 31, 20132014 was $643,465$996,539 and $497,002,$739,751, respectively.

Share-Based Compensation

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

		Three months ended December 31,						��
		2013				2012
Cost of revenue		$	2,058			$	3,899
Selling, general and administrative			131,176				189,831
Research and development			16,580				12,248
Total		$	149,814			$	205,978

 

 The employee stock options granted in the threesix months ended DecemberMarch 31, 20132014 and 20122013 had a weighted-average estimated fair value of $0.85 per share and $0.70 per share, respectively, using the Black-Scholes option pricing model with the following weighted-average assumptions (annualized percentages):

		Three months ended December 31,
		2013					2012
Volatility		65.0%	-	76.0%				81.0	%
Risk-free interest rate		0.6%	-	2.0%				0.9	%
Forfeiture rate			10.0%					10.0	%
Dividend yield			0.0%					0.0	%
Expected life in years		3.2	-	6.5				6.4

 

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, 2013,2014, no excess tax benefit for the tax deductions related to share-based awards was recognized for the threesix months ended DecemberMarch 31, 20132014 and 2012.2013. As of DecemberMarch 31, 2013,2014, there was approximately $800,000$600,000 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 1.71.6 years.

10. STOCKHOLDERS’ EQUITY

Summary

The following table summarizes changes in the components of stockholders’ equity during the threesix months ended DecemberMarch 31, 2013:2014:

		Common Stock								Treasury				Additional Paid-in				Accumulated				Total Stockholders'
		Shares				Amount				Stock				Capital				Deficit				Equity
Balances, September 30, 2013			32,900,705			$	329							$	87,434,834			$	(62,673,754	)		$	24,761,409
Issuance of common stock upon exercise of stock options, net			357,476				4								193,060								193,064
Share-based compensation expense															149,814								149,814
Repurchase of common stock			(33,012	)			(1	)							(62,176	)							(62,177	)
Treasury shares			(19,796	)						$	(37,420	)											(37,420	)
Net income																			131,563				131,563
Balances, December 31, 2013			33,205,373			$	332			$	(37,420	)		$	87,715,532			$	(62,542,191	)		$	25,136,253

Stock Purchase Warrants

At DecemberMarch 31, 2013,2014, 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.

Share Buyback Program

In July 2013, the Board of Directors approved a share buyback program under which the Company may repurchase up to $3 million of its outstanding common shares. In November 2013, the Board of Directors authorized the repurchase of an additional $1 million of the Company’s outstanding common shares. The repurchase authorization expires December 31, 2014. During the quartersix months ended DecemberMarch 31, 2013,2014, the Company purchased 52,808133,073 shares at an average price paid per share of $1.89$1.87 for a total cost of $99,597.$248,957. At DecemberMarch 31, 2013, 33,012 of these2014, all repurchased shares were retired, and 19,796 were reported as treasury shares.retired.

11. INCOME (LOSS) PER SHARE

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

		Three Months Ended December 31,
		2013				2012
Basic
Income (loss) available to common stockholders		$	131,563			$	(100,376	)
Weighted average common shares outstanding			33,028,646				32,399,199
Basic income (loss) per common share		$	0.00			$	0.00
Diluted
Income (loss) available to common stockholders		$	131,563			$	(100,376	)
Weighted average common shares outstanding			33,028,646				32,399,199
Assumed exercise of dilutive options and warrants			444,936				-
Weighted average dilutive shares outstanding			33,473,582				32,399,199
Diluted income (loss) per common share		$	0.00			$	0.00
Potentially dilutive securities outstanding at period end excluded fromthe diluted computation as the inclusion would have been antidilutive:
Options			1,751,500				2,617,857
Warrants			1,627,945				1,627,945
Total			3,379,445				4,245,802

 

12. MAJOR CUSTOMERS

For the three months ended DecemberMarch 31, 2013,2014, revenues from one customer accounted for 11%25% of total revenues, and for the six months ended March 31, 2014, revenues from one customer accounted for 14% of revenues, with no other single customer accounting for more than 10% of revenues. At DecemberMarch 31, 2014, accounts receivable from three customers accounted for 29%, 17% and 16% 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 March 31, 2013, revenues from three customers accounted for 20%, 15% and 14% of total revenues, respectively, and for the six months ended March 31, 2013, revenues from two customers accounted for 24% and 11% of revenues, respectively, with no other single customer accounting for more than 10% of revenues. At March 31, 2013, accounts receivable from four customers accounted for 31%34%, 19%14%, 11%12% and 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 December 31, 2012, revenues from two customers accounted for 28% and 13% of total revenues, respectively, with no other single customer accounting for more than 10% of revenues. At December 31, 2012, accounts receivable from three customers accounted for 26%, 25% and 14% of total accounts receivable, respectively, with no other single customer accounting for more than 10% of the accounts receivable balance.

The discussion and analysis set forth below should be read in conjunction with the accompanying unaudited 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, 2013.

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 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

Our Company 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. In 2007, we completely redesigned our LRAD products, introducing the LRAD-X product line, with improved quality and functionality. Through increased focus and investment in worldwide sales and marketing activities, our Long Range Acoustic Device^® or LRAD pioneered a new worldwide market, selling into over 65 countries, for directional long-range acoustic hailing devices (“AHDs”).

Revenues in the quarter ended DecemberMarch 31, 2013,2014, were $3,822,630,$5,387,306, compared to $2,980,107$3,189,810 in the quarter ended DecemberMarch 31, 2012.2013. The increase in revenues was primarily due to strong sales for oil platforms and vessels as well as in the public safety and security sectors. In addition, a $1.3 million order for a national police force in Southeast Asia, was scheduled to ship in the first fiscal quarter, but was delayed due toas well as a supply issuebroad array of moderately sized orders for police and will now ship in the second fiscal quarter. The international market continues to be a large opportunity for us, particularly in the public safety, international defense and Navy, mass notification, perimeter security sectors.and maritime applications. We launched our newly designed mobile mass notification system which includes a self-contained, ruggedized trailer with an LRAD-360X unit mounted on a 30 foot telescoping mast. This product will provide mobility to our mass notification and emergency warning applications. International revenues continue strong with approximately 75% of year to date revenue from international markets. We continue to pursue funding opportunities for our products with the U.S. Army as the 2014 U.S. Department of Defense (“DOD”) appropriations bill is being finalized and the 2015 DOD appropriations bill is being developed. In addition, we have increased selling efforts in the mass notification market where our regular and smaller-sized LRAD 360X omnidirectional products provide an effective solution. Gross margin was 51% of net revenues in the quarter ended DecemberMarch 31, 2013,2014, compared to 50%43% of net revenues in the prior year firstyear’s second quarter. Operating expenses increased by $223,689$379,810 or 14%21%, primarily due to an increase in our business development team salaries, consultants and travel and a bonus accrual based on forecasted performance targets, partially offset by a decrease in legal expenses due to allow us to support our expanded selling efforts, particularlythe lawsuit in the mass notification market.prior year. 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 more than 3,500 meters. The LRAD-X product line features improved voice intelligibility and meets the military’s stringent environmental requirements in a number of packages and form factors.Through the use of powerful voice commands, prerecorded messages in multiple languages, and deterrent tones, the LRAD creates large safety zones while determining the intent and influencing the behavior of an intruder. We continue to expand our LRAD-X product line to provide a complete range of systems from single operator 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 current LRAD-X product line includes the following:   

In 2012, to meet the needs of the growing worldwide mass notification market, and taking advantage of our LRAD technology, we designed and developed the LRAD 360. MostUnlike most of the current mass notification systems marketed today, which are primarily sirens. In addition to a loud deterrent tone,sirens, the LRAD 360 provides the same highly intelligible voice clarity as the rest of the LRAD product line. However, itThe LRAD 360 is designed to transmit highly intelligible voice communications and warnings over a 360-degree area, unlike the more directional LRAD products. We are in the process of developing a product line to meet this market and have launched the following products to date:

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 to service new markets and customers 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. We intend to continue to expand our selling efforts internationally, especially in the Middle East and South America where we believe there is greater opportunity for the sale of our products. We also plan to continue to expand our presence in the mass notification market with our LRAD 360X product line. Our selling network has expanded through the addition of business development employees as well as continuing to improve and increase our relationships with key integrators and sales representatives within the United States and in a number of worldwide locations. However, we may continue to face challenges in fiscal 2014 due to continuing international economic and geopolitical conditions in certain regions. We anticipate continued uncertainty with U.S. Military spending due to ongoing defense budget delays and spending reductions as the U.S. government tries to reduce our national debt. 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 ever ultimately come to fruition.

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, 2013. 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.

Comparison of Results of Operations for the Three Months Ended DecemberMarch 31, 20132014 and 20122013

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.

		Three months ended
		December 31, 2013								December 31, 2012
						% of Net								% of Net				Increase/(Decrease)
		Amount				Revenue				Amount				Revenue				Amount				%
Revenues:
Product sales		$	3,556,062				93.0%			$	2,762,345				92.7%			$	793,717				28.7%
Contract and other			266,568				7.0%				217,762				7.3%				48,806				22.4%
			3,822,630				100.0%				2,980,107				100.0%				842,523				28.3%
Cost of revenues			1,878,079				49.1%				1,494,284				50.1%				383,795				25.7%
Gross profit			1,944,551				50.9%				1,485,823				49.9%				458,728				30.9%
Operating Expenses:
Selling, general and administrative			1,424,544				37.3%				1,172,475				39.3%				252,069				21.5%
Research and development			393,541				10.3%				421,921				14.2%				(28,380	)			(6.7%	)
			1,818,085				47.6%				1,594,396				53.5%				223,689				14.0%
Income (loss) from operations			126,466				3.3%				(108,573	)			(3.6%	)			235,039				216.5%
Other Income			5,197				0.1%				8,197				0.2%				(3,000	)			(36.6%	)
Income (loss) from operations before income taxes			131,663				3.4%				(100,376	)			(3.4%	)			232,039				231.2%
Income tax expense			100				0.0%				-				0.0%				100			na
Net income (loss)		$	131,563				3.4%			$	(100,376	)			(3.4%	)		$	231,939				231.1%

 

The increase in revenues was primarily due to strong international sales for oil platforms and vessels as well as public safety orders. In addition,across a broad variety of markets. Revenues include a $1.3 million order for a national police force in Southeast Asia was scheduled to ship in the first fiscal quarter, but was delayed due to a supply issue and will now ship in the second fiscal quarter.Asia. Uncertainty on U.S. defense spending continued through the current quarter. 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 DecemberMarch 31, 2013,2014, we had aggregate deferred revenue of $171,666$408,056 for prepayments from customers in advance of product shipment.

Gross Profit

The increase in gross profit in the quarter was primarily due to increased revenue.revenue as well as favorable product mix.

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.

Selling, General and Administrative Expenses

Selling, general and administrative expenses reflected an increase of $219,983$227,612 for accrued bonus for meeting forecasted performance targets, $161,559 for consulting fees and salaries as a result of hiring additionaladding business development personnel, $51,832$90,509 for commissiontravel expense, $35,041 for costs related to third party representatives, $32,543 for trade shows, $31,806 forthe annual stockholder meeting and increased travelboard fees and $3,336 for$65,460 of other reductions.increases. These expenses were partially offset by a decrease of $58,655 for non-cash share-based compensation expense due to fully vested stock options and $28,776$319,475 for legal fees.and other professional fees related to the lawsuit in the prior year.

We incurred non-cash share-based compensation expenses allocated to selling, general and administrative expenses in the three months ended DecemberMarch 31, 2014 and 2013 of $163,385 and 2012 of $131,176 and $189,831,$171,044, 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.

Research and Development Expenses

Research and development expenses decreasedincreased compared to the prior year primarily due to favorable travel expenses.$88,191 for accrued bonus for meeting forecasted performance targets and $39,237 for increased salaries, partially offset by $8,324 of expense reductions.

Included in research and development expenses for the three months ended DecemberMarch 31, 2014 and 2013 was $23,814 and 2012 was $16,580 and $12,248$11,975 of non-cash share-based compensation costs, 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 have further expanded the product line-up in 2014 and 2013 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.

Net Income

The increase in net income was primarily due to the increase in revenues and gross margin, partially offset by an increase in operating expenses.

Comparison of Results of Operations for the Six Months Ended March 31, 2014 and 2013

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.

 The increase in revenues was primarily due to strong international sales across a number of markets, including oil platforms and vessels, police and public safety, international defense and Navy, mass notification, perimeter security and maritime applications. Uncertainty on U.S. defense spending continued through the current period. 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, 2014, we had aggregate deferred revenue of $408,056 for prepayments from customers in advance of product shipment.

Gross Profit

The increase in gross profit in the period was primarily due to increased revenue, favorable product mix, and increased fixed overhead absorption, partially offset by an increase in warranty expense as a result of a higher reserve related to increased shipments.

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.

Selling, General and Administrative Expenses

Selling, general and administrative expenses reflected an increase of $381,542 for consulting fees and salaries as a result of adding business development personnel, $227,612 for accrued bonus for meeting forecasted performance targets, $122,315 for travel expense, $61,012 for commission expense to third party representatives, $41,349 for costs related to the annual stockholder meeting and consultantsincreased board fees and $93,511 of other increases. These expenses were partially offset by a decrease of $348,252 for legal and other professional fees related to the lawsuit in the prior year and $66,314 for lower non-cash share-based compensation expense.

We incurred non-cash share-based compensation expenses allocated to selling, general and administrative expenses in the six months ended March 31, 2014 and 2013 of $294,561 and $360,875, 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.

Research and Development Expenses

Research and development expenses increased compared to the prior year primarily due to $88,191 for accrued bonus for meeting forecasted performance targets, $45,990 for increased salaries, and $9,118 of other unfavorable expenses. These expenses were partially offset by reductions of $32,776 for development costs and $19,799 for travel.

Included in research and development expenses for the six months ended March 31, 2014 and 2013 was $40,394 and $24,223 of non-cash share-based compensation costs, 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 have further expanded the product line-up in 2014 and 2013 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.

Net Income

The increase selling efforts.in net income was primarily due to the increase in revenues and gross margin, partially offset by an increase in operating expenses.

Liquidity and Capital Resources

Cash at DecemberMarch 31, 20132014 was $18,086,313,$18,532,262, compared to $15,805,195 at September 30, 2013. The change in cash was primarily the result of a reduction in accounts receivable from strong year-end shipments in September 30, 2013, partially offset by a decrease in accounts payable as we paid for the inventory purchases required for fourth quarter shipments and an increase in inventory based on forecasted requirements. Other than cash and expected future cash flows from operating activities in subsequent periods, we have no unused sources of liquidity at this time.