5.4. INVENTORIES 

Inventories consisted of the following: 

5. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

6.6. ACCRUED LIABILITIES AND OTHER LIABILITIES—NONCURRENT

Accrued liabilities consisted of the following:

Payroll and related

Payroll and related at June 30, 2014 included $1,019,125 of accrued bonus and related payroll tax expenses and $691,241 of accrued third party sales commissions, compared to $0 and $393,026, respectively, at September 30, 2013.

Deferred Revenue 

Deferred revenue at March 31,June 30, 2014 included $408,056$594,173 for prepayments from customers in advance of product shipment compared to $18,532 at September 31, 2014.30, 2013.

Warranty Reserve

Changes in the warranty reserve during the three and sixnine months ended March 31,June 30, 2014 and 2013 were as follows:

7. INCOME TAXES

At March 31,June 30, 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 recorded only the minimum tax provision for California during the sixnine months ended March 31,June 30, 2014 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 anymost 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.

8.8. 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. 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 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 March 31,June 30, 2014 was approximately $18,200,000.$20,700,000. 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 sixnine months ended March 31,June 30, 2014, wethe Company accrued $338,151$1,019,125 for bonuses and related payroll tax expenses in connection with the 2014 plan. The Company did not record any bonus expense during the sixnine months ended March 31,June 30, 2013 in connection with the 2013 plan.

9.9. SHARE-BASED COMPENSATION

Stock Option Plans

At March 31,June 30, 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 March 31,June 30, 2014, there were options outstanding covering 2,809,0422,787,500 shares of common stock under the 2005 Equity Plan and an additional 740,592762,134 shares of common stock available for grant.

Stock Option Activity

The following table summarizes information about stock option activity during the sixnine months ended March 31,June 30, 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 6.15.9 years. The aggregate intrinsic value of options outstanding and exercisable at March 31,June 30, 2014 was $996,539$929,545 and $739,751,$734,908, 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 options granted in the sixnine months ended March 31,June 30, 2014 and 2013 had a weighted-average estimated fair value of $0.85 per share and $0.70$0.64 per share, respectively, using the Black-Scholes option pricing model with the following weighted-average assumptions (annualized percentages):

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 March 31,June 30, 2014, no excess tax benefit for the tax deductions related to share-based awards was recognized for the sixnine months ended March 31,June 30, 2014 and 2013. As of March 31,June 30, 2014, there was approximately $600,000$500,000 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 1.6 years.

10.10. STOCKHOLDERS’ EQUITY

Summary

The following table summarizes changes in the components of stockholders’ equity during the sixnine months ended March 31,June 30, 2014:

Stock Purchase Warrants

At March 31,June 30, 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 sixnine months ended March 31,June 30, 2014, the Company purchased 133,073256,082 shares at an average price paid per share of $1.87$1.86 for a total cost of $248,957.$476,494. At March 31,June 30, 2014, all repurchased shares were retired.

11. 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 March 31,June 30, 2014, revenues from one customer accounted for 25%50% of total revenues, and for the sixnine months ended March 31,June 30, 2014, revenues from one customer accounted for 14%23% of revenues, with no other single customer accounting for more than 10% of revenues. At March 31,June 30, 2014, accounts receivable from threetwo customers accounted for 29%, 17%53% 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,June 30, 2013, revenues from three customersone customer accounted for 20%, 15% and 14% of total revenues, respectively, and for the sixnine months ended March 31,June 30, 2013, revenues from two customers accounted for 24%19% and 11% of revenues, respectively, with no other single customer accounting for more than 10% of revenues. At March 31,June 30, 2013, accounts receivable from foursix customers accounted for 34%18%, 14%17%, 12%, 11%, 11% and 10%11% 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 6570 countries, for directional long-range acoustic hailing devices (“AHDs”).

Revenues in the quarter ended March 31,June 30, 2014, were $5,387,306,$8,004,088, compared to $3,189,810$2,157,644 in the quarter ended March 31,June 30, 2013. The increase in revenues was primarily due todriven by a $1.3$4 million order for LRAD-2000X and other units for perimeter and border security in the Middle East, a national$760,000 order for LRAD-500X and LRAD-1000X model units for internal security and police force in Southeast Asia, as well asNorthern Africa, a broad array of moderately sized$763,000 order for bird mitigation for an international mining concern and other orders for police and public safety, international defense and Navy, mass notification, perimeter security 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.drive our growth. 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. Gross margin was 51%very strong at 63% of net revenues in the quarter ended March 31,June 30, 2014, compared to 43%42% of net revenues in the prior year’s secondthird quarter. The increased margin was partially offset by increased commission expense reported in operating expenses as a larger share of revenues were commissionable. Operating expenses increased by $379,810$1.1 million or 21%53%, primarily due to an increase in our business development team salaries, consultantscommissions and travel and a bonus accrual based on forecasted performance targets,expense, partially offset by a decrease in legal expenses due to thea lawsuit in the 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. Unlike most of the current mass notification systems marketed today, which are primarily sirens, the LRAD 360 provides the same highly intelligible voice clarity as the rest of the LRAD product line. The 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 March 31, 2014June 30, 2014 and 20132013

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 broad variety of markets. Revenues includemarkets, including a $1.3$4 million order for perimeter and border security in the Middle East, a national$760,000 order for internal security and police force in Southeast Asia.Northern Africa and a $763,000 order for bird mitigation for an international mining concern. 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 March 31,June 30, 2014, we had aggregate deferred revenue of $408,056$594,173 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, favorable fixed overhead absorption, and favorable channel mix. The favorable gross profit is partially offset by a $701,733 increase in commission expense reported in operating expenses, as well as favorable product mix.there was a higher mix of direct customer sales where a commission is paid, rather than sales through our reseller network at lower reseller pricing.

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 $227,612$701,733 for commissions paid to our third party sales representatives, $456,825 for accrued bonus for meeting forecasted performance targets, $161,559$89,468 for consulting fees and salaries as a result of adding business development personnel, $90,509$57,390 for travel expense $35,041to support our increased international business, $41,202 for costs related to the annual stockholder meeting and increased boardmarketing expenses, primarily for trade shows, $25,350 for increased bank fees and $65,460$13,798 of other increases. These expenses were partially offset by a decrease of $319,475$397,315 for legal and other professional fees related to thea lawsuit in the prior year.year, $54,034 for costs related to the annual stockholder meeting which was held in fiscal Q3 last year and $53,370 for non-cash share-based compensation expense.

We incurred non-cash share-based compensation expenses allocated to selling, general and administrative expenses in the three months ended March 31,June 30, 2014 and 2013 of $163,385$125,407 and $171,044,$178,777, 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$171,851 for accrued bonus for meeting forecasted performance targets and $39,237$29,206 for increased salaries, partially offset by $8,324$2,218 of expense reductions.

Included in research and development expenses for the three months ended March 31,June 30, 2014 and 2013 was $23,814$19,427 and $11,975$11,798 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 SixNine Months Ended March 31, 2014June 30, 2014 and 20132013

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.