**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**




**FORM
      10-K**




**ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**


**For
      the fiscal year ended September 30, 2005**




**Commission
      File Number 0-24248**









**AMERICAN
      TECHNOLOGY CORPORATION**


(Exact
      name of registrant as specified in its charter)




**DELAWARE**
            
            **87-0361799**(State
                or other jurisdiction of
            
            (I.R.S.
                EmployerIncorporation
                or organization)
            
            Identification
                No.)**13114
                Evening Creek Drive South, San Diego,
                California**
            
            **92128**(Address
                of principal executive offices)
            
            (Zip
                Code)




Registrant's'
      telephone number, including area code:  (858) 679-2114




**SECURITIES
      REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:** None





**SECURITIES
      REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:**


Common
      Stock, $.00001 par value per share




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 in 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 [X] No [  ]




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of Registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. [  ]




Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      Rule
      12b-2 of the Act).   Yes [X]   NO [  ]





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act).   Yes [ ]   NO [X]




The
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates of the registrant (based on the closing price as reported on
      the
      NASDAQ Capital Market on March 31, 2005) was $142,517,969.*




The
      number of shares of Common Stock, $.00001 par value, outstanding on December
      14
      2005, was 24,308,215.




**DOCUMENTS
      INCORPORATED BY REFERENCE**


Portions
      of the registrant's Definitive Proxy Statement to be filed with the Commission
      pursuant to Regulation 14A in connection with the registrant's 2006 Annual
      Meeting of Stockholders, to be filed subsequent to the date hereof, are
      incorporated by reference into Part III of this report. Such Definitive Proxy
      Statement will be filed with the Securities and Exchange Commission not later
      than 120 days after the conclusion of the registrant's fiscal year ended
      September 30, 2005.




* Excludes
      the Common Stock held by executive officers, directors and stockholders whose
      ownership exceeds 5% of the Common Stock outstanding at March 31, 2005. This
      calculation does not reflect a determination that such persons are affiliates
      for any other purpose.







**TABLE
                OF CONTENTS**Page**PART
                I**ITEM
                1.
            Business
            1Overview
            1Recent
                Customers and Partners
            2OperatingSegment
                Reporting
            2Our
                Technology and Products
            4Strategy
            5Manufacturing
                and Suppliers
            6Selling,
                Marketing and
                Customers
            6Warranties
            6Competition
            7Seasonality
            7Government
                Regulation and Environmental
                Matters
            7Intellectual
                Property Rights and Proprietary
                Information
            9Research
                and Development
            11Executive
                Officers
            11Employees
            12ITEM
                2.
            Properties
            13ITEM
                3.
            Legal
                Proceedings
            13ITEM
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            13**PART
                II**ITEM
                5.
            Market
                for Registrant’s Common Equity,
                RelatedStockholder
                Matters and Issuer Purchases of Equity
                Securities
            13ITEM
                6.
            Selected
                Financial Data
            14ITEM
                7.
            Management's
                Discussion and Analysis of Financial
                Conditionand
                Results of Operations
            14ITEM
                7A.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            36ITEM
                8.
            Financial
                Statements and Supplementary
                Data
            36ITEM
                9.
            Changes
                in and Disagreements with Accountants onAccounting
                and Financial Disclosure
            36ITEM
                9A.
            Controls
                and Procedures
            36ITEM
                9B.
            Other
                Information
            39**PART
                III**ITEM
                10.
            Directors
                and Executive Officers of the
                Registrant
            40ITEM
                11.
            Executive
                Compensation
            40ITEM
                12.
            Security
                Ownership of Certain Beneficial Owners and
                Managementand
                Related Stockholder Matters
            40ITEM
                13.
            Certain
                Relationships and Related
                Transactions
            40ITEM
                14.
            Principal
                Accounting Fees and Services
            40**PART
                IV**ITEM
                15.
            Exhibits,
                Financial Statement Schedules and Reports on Form
                8-K
            41Financial
                Statements and Financial Statement
                Schedules
            F-1SignaturesExhibit
                  Index




i
 Table
            of Contents





**PART
      I**




**Forward
      Looking Statements**


*This
      report contains certain statements of a forward-looking nature relating to
      future events or the future performance of our company.  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, including
      the
      matters set forth below under the caption* “ *Risk
      Factors,* ” *which could cause actual results to differ materially from those indicated
      by
      such forward-looking statements.*




**Item
      1.  Business**




**Overview**





American
      Technology Corporation has been researching and developing new sound and
      acoustic sound technologies over the last ten years, and we have successfully
      commercialized proprietary directed sound reproduction products based on our
      technologies. We believe that our innovative proprietary sound technologies
      and
      products dramatically improve the quality of sound and acoustics in a manner
      not
      attainable through conventional sound speakers, thereby opening up new markets
      for our products.





We
      have
      44 patents issued worldwide covering our various sound technologies, of which
      33
      are patents issued in the United States. We also have 144 pending patent
      applications world-wide, of which 33 are pending patent applications in the
      United States.





Our
      four
      major product platforms and underlying technologies are listed
      below:




HSS ®





Our
      HyperSonic sound, or HSS, products are based on our proprietary parametric
      speaker technology that creates sound “in the air.” Sound is generated along an
      air column using ultrasonic frequencies above the normal range of hearing.
      The
      HSS sound beam is highly directional and maintains sonic clarity and
      intelligibility over longer distances than traditional loudspeakers. Our HSS
      products beam sound to the intended audience and not elsewhere. We believe
      our
      substantial intellectual property portfolio and pioneering HSS products support
      our leadership position in the field of parametric non-linear acoustics for
      sound reproduction.





LRADTM




Our
      Long
      Range Acoustic Device or LRAD products are breakthrough long-range hailing,
      warning and notification devices that utilize a directed acoustic beam that
      we
      developed to communicate at operational ranges with authority and superior
      intelligibility in high ambient noise environments. We developed the LRAD1000
      in
      2002. Although designed for use in a variety of applications by the U.S.
      military, federal instrumentalities, state and local government entities and
      commercial users, the initial application for this product following the bombing
      of the USS Cole in 2002 was in helping the U.S. Navy maintain and enforce a
      protection barrier for all Naval vessels. Our family of LRAD products, which
      we
      market through the U.S. Department of Defense as “The Sound of Force
      ProtectionTM”, are currently in use by the various branches of the U.S. armed
      forces, and support the applications for the Department of Homeland Security,
      police and fire departments, and other public safety organizations. LRAD has
      also proven to be an important asset in hailing, warning and notification in
      the
      commercial context: in November 2005, the cruise ship Seabourn Spirit reportedly
      used an LRAD in helping to thwart an attempted pirate attack off the coast
      of
      Somalia.




Our
      LRAD
      products incorporate our proprietary technology that produces variable intensity
      acoustical sound intended for use in long-range and medium-range delivery of
      directional sound information. LRAD can be thought of as a supercharged
      megaphone, focusing a directional acoustic beam with a range of 500 meters
      or
      more. We market these products as directed hailing, notification and warning
      systems to government, military and commercial customers.




In
      2005,
      we introduced our LRAD500, a smaller 20-inch diameter directed acoustic beam
      device that has multiple applications for smaller ships and yachts,
      shorter-range checkpoints, access denial, armored vehicles and law
      enforcement.




1
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            of Contents




NeoPlanar®




Our
      NeoPlanar thin film magnetic speaker technology provides high clarity throughout
      the audio range for public address, emergency notification and high-end sound
      applications. Our NeoPlanar products are based on our proprietary technology
      incorporating a thin film magnetic speaker that produces sound of high quality,
      low distortion and high volume. NeoPlanar products are targeted for inclusion
      in
      high-end consumer sound products, public address and mass notification systems.
      NeoPlanar technology also powers our Sound SentinelTM products that are capable
      of delivering intelligible audio in excess of 500 meters, communicating
      effectively over high ambient noise, controlling unnecessary noise pollution
      and
      addressing rapid multi-language communications targeted to replace horn devices
      and other public address systems. Our SoundSaberTM line of hardened NeoPlanar
      panels provide vastly improved intelligibility in challenging acoustic
      environments such as hangar bays, industrial buildings, airports and other
      facilities.




SoundVectorTM





Our
      SoundVector technology is a patent-pending economical and scaleable directional
      sound technology for replacing sound pollution generating omni-directional
      alarm
      signals, sirens, hazard signals and other directed warnings or tones. We
      executed our first commercial license of this technology during fiscal
      2005.





We
      believe we are uniquely equipped to provide our technologies and products in
      rapidly growing markets for new sound applications not capable of being met
      by
      conventional sound devices or loudspeakers. Moreover, the development of other
      low-cost products gaining wide acceptance in mass markets such as low-cost
      plasma and flat panel screens offer, in our view, significant growth
      opportunities for our HSS focused sound solutions for in-store advertising
      and
      digital signage markets. We also believe that the growth in defense, homeland
      security and border patrol security, as well as related risk management spending
      by commercial customers, provides a growing market for our sound products to
      be
      used for intelligible communication and notification over long distances.





**Recent
      Customers and Strategic
      Partners**





In
      2005,
      we entered into the following agreements and arrangements:




·
            In
                April 2005, we began a business relationship with global security
                provider
                ADT Security Systems, Inc., a unit of Tyco Fire and Security, consisting
                of an initial order for $356,000 of Sound Sentinel
                panels.


·
            In
                July 2005, we entered into an agreement with In-Store Broadcasting
                Network
                (IBN) for the future delivery of 12,000 HSS H450 units for digital
                in-store media networks located in first tier
                retailers.


·
            In
                July 2005, ADT began active marketing and promotion of mass notification
                systems containing Sound Sentinel panels to businesses, public safety
                agencies and other organizations.


·
            In
                July 2005, we entered into a design and manufacturing licensing agreement
                with ECCO Group, the world's largest manufacturer of backup alarms
                for
                commercial vehicles. The agreement covers the initial licensing and
                product development of our SoundVector technology for ECCO and its
                affiliates for backup vehicle alarms.


·
            In
                August 2005, weentered
                into a distribution agreement with ActiveLight, Inc. for our HSS
                product
                line. ActiveLight is a leading value-added distributor of advanced
                displays, dynamic signage solutions, and projection
                equipment.





**Operating
      Segment Reporting**





We
      organize our business into two reporting segments by the end-user markets we
      serve: 1) the commercial market,—referred to as the Commercial Group, and 2) the
      government and military market—referred to as the Government Group. Both groups
      market our array of products and technologies.





Information
      regarding revenues and gross profit (loss) by operating segment is included
      in
      Note 13 to our financial statements included with this report.




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            of Contents





In
      the
      Commercial Group, we have concentrated our efforts in the following vertical
      markets:





**Digital
      Signage** -
      Digital Signage enables advertisers to deliver more focused and effective
      advertisements. Digital Signage solutions generally consist of the replacement
      of static or passive signs or displays with video screen devices such as cathode
      ray tube, or CRT, plasma, liquid crystal display, or LCD, or light-emitting
      diode, or LED containing still or motion video images. The image content,
      usually advertising or informational, can be changed via network control of
      each
      individual sign. Directed audio is used to contain or focus the audio within
      a
      defined space - generally to the person or persons in that defined space, to
      eliminate objections to the audio content from local workers, and to lower
      the
      overall audio noise level in a confined space. We sell our HSS products to
      digital signage integrators that integrate and install digital signage
      advertising solutions for in store networks for large national and international
      retailers. In-store networks and in-store digital signage installations are
      growing in size. In 2004, over 5,000 stores aired the PRN Network with
      approximately 680 million shopping visits per month As of August 2005, IBN
      reports over 17,000 partner stores with over 256.9 million individual shopper
      visits per month. In August 2005, IBN announced an agreement to install in-store
      digital-signage networks in more than 2,500 Kroger-owned stores in the U.S.
      In
      July 2005, we entered into an agreement with In-Store Broadcasting Network
      (IBN)
      for the future delivery of 12,000 HSS H450 units for digital in-store media
      networks located in first tier retailers.





**Museums
      and Educational Displays** -
      Directed audio is used in museums and similar facilities to focus audio
      information in targeted areas without distracting other
      patrons.  Directed audio is also used to allow multiple audio programs
      to be played within a confined space. Our HSS and NeoPlanar products are
      marketed for these applications.




**Trade
      Show and Conventions** - Trade
      shows and conventions require directed audio to lessen the overall room noise,
      attract patrons, focus instructional audio to individual displays, and contain
      audio programs within defined booth spaces. Our HSS and NeoPlanar products
      are
      marketed for these applications.




**Kiosks** - Retail
      point of purchase or information kiosks require directed audio to contain sound
      within the immediate space of the kiosk and to maintain some privacy for each
      individual listener.





**Infrastructure
      and Asset Protection -** Commercial
      customers owning and operating oil pipelines, commercial shipping vessels,
      cruise ships and large facilities such as manufacturing and distribution centers
      and shipping ports, need to protect such assets and to communicate important
      information to employees and customers. Our comprehensive suite of directed
      acoustic products provide maximum protection and superior sound
      quality.





Our
      Government Group principally markets our LRAD products to government and
      military customers in the United States and worldwide. Customers include the
      U.S. Department of Defense, U.S. Navy, U.S. Marine Corps, U.S. Army and U.S.
      Coast Guard and various state and city police and public safety
      departments.





The
      landscape of the global defense industry continues to evolve as events such
      as
      those of September 11, 2001, Operation Iraqi Freedom and the worldwide
      phenomena of terrorist attacks demand alternative strategic defense initiatives.
      The defense requirements of the United States have shifted from defending
      against Cold War era threats to focusing on the management of one or more
      regional conflicts, homeland security and proactive threat identification.
      As a
      result of this shift towards low intensity conflicts and military operations
      other than war, the defense industry is influenced by several key factors which
      also may impact our Government Group, including, but not limited
      to:





·
            New
                funding that is available to implement new technologies to meet modern
                threats;


·
            Increased
                focus on force protection through threat identification, and non-lethal
                capabilities;


·
            Increased
                reliance by domestic prime contractors on others to provide subsystems
                and
                components; and


·
            U.S.
                military development of lighter and faster defense platforms that
                are able
                to react quickly to regional conflict. These highly mobile, rapidly
                deployable forces are relying on advanced technologies to provide
                a full
                awareness of the battlefield, improve communication and evaluate
                threats.





We
      believe military branches, government agencies, allied forces and maritime
      and
      commercial entities will increasingly employ LRAD systems for long range hailing
      and warning as part of their force or site protection strategies.




Our
      shares of common stock trade through the NASDAQ Capital Market under the symbol
      “ATCO.”  Our address is 13114 Evening Creek Drive South, San Diego,
      California, 92128, our telephone number is 858-679-2114, and our internet
      website is located at www.atcsd.com. We make available, free of charge through
      our website, our annual report on Form 10-K, quarterly reports on Form 10-Q,
      current reports on Form 8-K, reports filed by our directors, executive officers
      and certain significant shareholders pursuant to Section 16 of the Securities
      Exchange Act and all amendments to those reports filed or furnished pursuant
      to
      Section 13(a) or 15(d) of the Exchange Act of 1934 as soon as reasonably
      practical after the reports are electronically filed with or furnished to the
      Securities and Exchange Commission.  The information on our website is
      not incorporated by reference into this report nor is it part of this
      report.




3
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            of Contents





**Our
      Technology and Products**




HyperSonic
      Sound (HSS)


We
      have
      pioneered a new paradigm in sound production based on well-known principles
      of
      physics. The common speaker types in use today such as dynamic, electrostatic,
      ribbon and other transducer-based designs, are direct radiating, and are
      fundamentally a piston action, directly pumping air molecules into motion to
      create audible sound waves we hear. Parametric or nonlinear acoustics, on the
      other hand, use changing pressures in air to produce sound
      indirectly.




HSS
      employs ultrasonic frequencies to carry content, such as music and voice, into
      the air. Proprietary ultrasonic emitters, or transducers, which convert
      electrical energy to high frequency acoustical energy, produce these ultrasonic
      frequencies beyond the range of hearing.  We have developed the
      ability to use such devices in lieu of loudspeakers to emit a custom-generated
      ultrasonic wave with the proper difference frequency characteristics to produce
      audible sound within and throughout a tightly formed beam. With our HSS
      technology, audible sound is not created on the surface of the ultrasonic
      emitter--a significant departure from a direct radiating
      loudspeaker.  Instead, the audible sound is generated in the air
      itself and is focused and directed. For example, using our HSS products, if
      the
      acoustic beam is directed towards a wall, the sound first emanates from the
      surface of the wall - not from the emitter, as it would be with a conventional
      loudspeaker. Or, or if the HSS acoustic beam is directed to a person, the sound
      is created at the person. HSS directionality allows sound to be focused or
      “beamed” in space or diffused from a surface in a variety of ways to produce
      desired effects. Also, the sound does not spread at the same rate over distance
      as it does with traditional speakers. This unique feature provides greater
      sound
      clarity and intelligibility at selected distant points with less energy than
      traditional speakers, creating the ability to communicate directed sound at
      very
      long distances.




With
      the
      rapid growth of directed advertising such as digital signage, point-of-purchase
      and in-store TV networks, we believe there is a trend towards sound clutter
      and
      noise pollution where conventional sound products and speakers are used.
      In-store display advertising tends to irritate customers if too intrusive or
      loud, and annoy workers due to the repetition. We have employed our HSS sound
      with plasma displays to achieve focused, controlled sound such that only those
      customers situated in specified locations are targeted and nearby customers
      and
      store clerks do not hear the message. We believe this ability to focus sound
      will be a driving feature of HSS systems. We believe our HSS technology offers
      a
      number of advantages:




·
            Delivery
                of more effective advertisements to store
                patrons;


·
            Ability
                to create a beam of sound and place it only where it’s
                intended;


·
            Elimination
                of the need for a speaker
                enclosure;


·
            Reduction
                of the effect of room acoustics on sound
                quality;


·
            Ability
                to manipulate or selectively position or diffuse the source of
                sound;


·
            Ability
                to deliver a beam of sound over longer distances than conventional
                speakers, such as down a grocery store
                aisle;


·
            Ability
                to penetrate other competing sounds;
                and


·
            Elimination
                of feedback from live microphones.





We
      expect
      additional HSS applications to become evident as our products become more widely
      known.





Long
      Range Acoustic Device (LRAD)


Our
      Long
      Range Acoustic Device, or LRAD, technology is a breakthrough directed acoustic
      beam device for long-range hailing and warning. LRAD was developed in
      parallel with the release of Naval Vessel Protection Zone requirements to
      enforce a 500-yard Exclusion Zone and 100-yard Protection Zone around U.S.
      naval
      warships both in the U.S. and in the foreign ports and restricted waters. When
      used in military applications, LRAD products provide the critical long-range
      communication and, when properly operated, provide an intense but not harmful
      ability to warn away friendlies, classify non-compliants as hostile and support
      decisions concerning escalation of responses. LRAD is unique in part
      because it permits our customers to deliver a measured response in first hailing
      and communicating and then as a warning and deterrent, if necessary. LRAD
      supports the difficult missions of waterside force protection against small
      boats, crowd control, area denial of personnel, clearing buildings and search
      and seizure operations, and border patrol. LRAD permits military troops and
      public safety officials to maintain distance between themselves and a potential
      threat, providing time to inform and change behavior and to save lives on both
      sides of the device.





Our
      LRAD
      products deliver voice and tone clarity in a 15° - 30° beam at distances over
      500 meters, using only two amps of current. In addition to microphone
      input, our LRAD products can communicate prerecorded phrases in various
      languages via the built-in MP3 player or an optional Phraselator ® (Phraselator
® is a registered trademark of Marine Accoustics, Inc.). A remote pan and tilt
      option allows the LRAD operator to remotely change the direction of the device
      at extended distances from the device, which in turn increases safety and the
      time to diffuse tense situations.




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            of Contents





In
      August
      2005, we introduced a smaller version of the LRAD, the LRAD500 that features
      reduced size and weight for easier transport and vehicle or aircraft mounting.
      The LRAD500 allows police to provide clear instructions to crowds, fire crews
      to
      communicate to persons in buildings, maritime vessels to communicate with small
      vessels, security personnel to communicate in multiple languages at distance,
      airport managers to scare away birds that could pose a danger to aircraft,
      agents to provide instructions from airborne craft including helicopters, and
      many other activities.





Through
      intense direct sales and marketing efforts, successful product deployments,
      extensive media coverage and product demonstrations, we believe that LRAD
      products are achieving brand awareness within the U.S. Department of Defense.
      LRAD systems are currently in operational use in maritime, checkpoint,
      vehicular, airborne, and integrated system applications by the U.S. Navy, U.S.
      Marine Corps, U.S. Army and U.S. Coast Guard as well as on board commercial
      ships. The U.S. Navy, U.S. Marine Corps. and U.S. Army have reported
      favorable feedback from LRAD deployments in Operation Iraqi Freedom. LRAD
      products also support applications for the Department of Homeland Security,
      other government and law enforcement agencies and customers where there is
      a
      need to protect critical high-value commercial infrastructure such as buildings,
      bridges, tunnels, dams, power plants, pipelines, airports, sea ports,
      communications towers and other important commercial facilities. An LRAD system
      has recently proven to be effective in helping to provide security for
      commercial shipping and cruise lines.





NeoPlanar
      Speakers


Our
      NeoPlanar technology is a thin film planar magnetic type speaker that uses
      novel
      films, magnetic materials and a manufacturing process that we believe provides
      improved cost/performance benefits. Traditional planar magnetic speakers have
      been limited in range, expensive, or have used materials with limited power
      handling ability. Our NeoPlanar technology provides the ability to build
      cost-effective light-weight, flat and thin speakers with high power output
      providing exceptional clarity over long distances.





SoundVector


Our
      SoundVector technology
      is a patent-pending economical and scaleable directional sound technology
      designed to replace noisy omni-directional alarm signals, sirens, hazard signals
      and other directed warnings or tones. Our advanced development group created
      this technology, and we executed our first commercial license of this technology
      in fiscal 2005 for vehicle backup alarms.





Other
      Proprietary Technologies and Products


We
      have
      other sound inventions, technologies and products in various stages of
      development including our PureBass® Woofer technology for low frequency
      speakers, our Stratified Field Technology, or SFT®, that employs a thin form,
      non-magnetic film to produce high quality sound, our Sound Cluster customized
      horn array that automatically adjusts to an ambient noise environment and other
      technologies and products in various stages of development.




**Strategy**





We
      believe we are building a leadership position in the field of directed or
      focused sound for both short-range and long-range communication with high
      clarity. Our overall strategy is to build on this leading position by offering
      a
      variety of products for an increasing range of applications. In executing our
      strategy, we are building a worldwide distribution channel consisting of
      partners and resellers that have significant expertise and experience selling
      integrated communications solutions into the various markets and segments that
      we are pursuing.





We
      believe there are OEM and licensing opportunities for our innovative
      technologies dealing with focused or directed sound. In
      August
      2001, we entered into a non-exclusive license agreement with Harman
      International Industries to manufacture and use NeoPlanar technology in the
      OEM
      automotive market. During fiscal 2005, Harman advised us that they intend to
      utilize NeoPlanar technology in future products; however, to date, we have
      not
      earned any license revenue from the manufacture of Harman products utilizing
      our
      technology **.**





In
      April
      2005, we began a working relationship with the global security provider ADT
      Security Systems, Inc., a unit of Tyco Fire and Security, which included an
      opening order of $356,000 for Sound Sentinel panels. In July 2005, ADT began
      active marketing and promotion of ADT’s Mass Notification systems containing
      Sound Sentinel panels to businesses, public safety agencies and other
      organizations.





We
      have
      established a distribution arrangement with ADS, Inc. as a reseller of our
      LRAD
      products via a prime vendor contract vehicle to end users in various branches
      of
      the military such as the U.S. Navy, U.S. Marine Corps, U.S. Army and the
      Department of Homeland Security. Our strategy is to add additional agents or
      distributors for military and government business.




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            of Contents





**Manufacturing
      and Suppliers**





We
      believe maintaining quality manufacturing capacity is essential to the
      performance of our products and the growth of our business.





We
      presently employ contract manufacturers for production of HSS and LRAD
      components and sub-assemblies. We
      manufacture and assemble NeoPlanar products for both commercial and government
      systems in our Carson City, Nevada facility. During
      fiscal 2005 we ceased using a contract manufacturer for the production of our
      HSS and LRAD products. We
      presently employ an outside manufacturer for a portion of the assembly of some
      of our products and complete final assembly, test and ship of all products
      from
      either our San Diego or Carson City facilities. As product volume builds, we
      intend to contract more work to outside contract manufacturers for such services
      as final assembly and test, and full turnkey product manufacturing of some
      of
      our products.




We
      have
      refined our internal business processes to improve how we design, test and
      qualify product designs.  We continue to implement more rigorous
      manufacturing and quality processes to track production and field
      failures.




We
      have
      identified suppliers for film and other key parts, but some are on a sole source
      basis. Although other suppliers are believed to be available, the disruption
      and
      cost of changing suppliers, if required, could have a material adverse effect
      on
      our financial condition and results of operations.





**Selling,
      Marketing and Customers**





We
      market
      and sell products and services through our sales force based in San Diego,
      California with field offices located in Maine, Florida, Washington, and
      independent sales representatives in the United Kingdom, and Hong Kong. Our
      administrative offices are located in San Diego, California.





For
      the
      fiscal year ended September 30, 2005, revenues from one customer in the
      Government Group, ADS, Inc., accounted for 69% of revenues with no other single
      customer accounting for more than 10% of revenues. For
      the
      fiscal year ended September 30, 2004, sales to two Government Group customers,
      ADS, Inc. and General Dynamics, Armaments and Technical Products, Inc.,
      accounted for 47 %
      and 11 %
      of
      revenues, respectively, with no other single customer accounting for more than
      10% of revenues.  ADS, Inc. is a reseller of our products via a prime
      vendor contract vehicle to end users in various branches of the military such
      as
      the U.S. Navy, U.S. Marine Corps, U.S. Army and the Department of Homeland
      Security.





For
      the
      fiscal years ended September 30, 2005, 2004 and 2003, LRAD product revenues
      were
      $8,821,367, $3,907,291, and $ 261,106 respectively, which represented 87%, 68% and
      20% of
      revenues in each of the respective years. For the fiscal year ended September
      30, 2003, HSS product revenues were $507,445, and 39% of revenues. No other
      product group represented more than 15% of revenues in any year.





Our
      revenues have to date relied on a few major customers. The loss of any
      customer could have a material adverse effect on our financial condition,
      results of operations and cash flows.  However, our goal is to
      diversify sound technology revenues in future periods.




Our
      order
      backlog for products that are deliverable in the next 12 months was
      approximately $4,155,000 at September 30, 2005. Backlog orders are subject
      to
      cancellation or rescheduling by our customers.




Information
      regarding our revenues by geographic area is set forth in Note 13 to
      our financial statements included with this report.





**Warranties**





We
      generally warrant our products to be free from defects in materials and
      workmanship for a period up to one year from the date of purchase, depending
      on
      the product. The warranty is generally a limited warranty, and in some instances
      imposes certain shipping costs on the customer. To date we have been providing
      direct warranty service, but in the future we may establish warranty service
      through OEM customers or others. Some of our agreements require OEM customers
      to
      stock certain quantities of product for use as warranty replacements.
      International market warranties are generally similar to the U.S.
      market.




In
      fiscal
      2003, due to performance failures of some of our first generation of HSS systems
      resulting primarily from a vacuum emitter component, we agreed to replace
      emitters on approximately 700 HSS Generation I units. We completed this
      replacement program during fiscal 2005. At September 30, 2005, we had a warranty
      reserve of $248,981, and our cost of performing warranty service during our
      fiscal year ended September 30, 2005 totaled $ 154,667.




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**Competition**





**** Our
      technologies and products compete with those of other companies. The consumer,
      commercial and government audio industry markets are fragmented and competitive
      and include numerous manufacturers with audio products that vary widely in
      price, quality and distribution channels. Manufacturers of consumer and
      commercial speakers include Harman International, Boston Acoustics and many
      others. Suppliers of government audio industry speakers include IML Sound
      Commander, Technomad Inc, ATI, Dynalec, Henschel and others. Many of our present
      and potential future competitors have, or may have, substantially greater
      resources to devote to further technological and new product developments.
      We
      believe we compete primarily on the originality of our concepts, the uniqueness
      and quality of our technology and designs, the ease and cost of manufacturing
      and of implementing our technologies, the ability to meet customer needs to
      differentiate their products, the strength of our intellectual property and
      the
      strength of licensee and contract supply arrangements. We may not, however,
      be
      competitive with the existing or future products, technologies or services
      of
      our competitors.




We
      believe HSS is the leading parametric speaker with limited direct competition
      to
      date. Although others have attempted to use parametric speaker concepts to
      produce sound, we do not believe they have progressed to the point of
      cost-effective and directly competitive commercial products compared to HSS.
      Holosonic Research Labs, Inc. produces a parametric speaker called the Audio
      Spotlight. Sennheiser Electronics has announced a parametric speaker product
      called the AudioBeam Master. These companies employ electrostatic and
      piezoelectric emitter devices, which we believe are less efficient and more
      expensive than our proprietary emitters. However, these parametric speaker
      competitors or others may introduce products with features and performance
      competitive to our products.




We
      will
      continue to aggressively seek patent protection for our intellectual property.
      Companies such as Brown Innovations and others have employed domes and other
      techniques to try to focus or contain sound for directed sound applications
      such
      as point-of-sale. We do not believe these methods are directly competitive
      to
      HSS in ease of use, cost and performance.




We
      also
      believe our NeoPlanar technology is novel and has distinct market attributes
      compared to existing and competing flat panel and traditional speaker designs.
      We believe our NeoPlanar technology produces high intelligibility and
      reliability for a range of consumer, commercial and government applications.
      Other companies that are focusing marketing efforts in the flat panel market
      segment include, but are not limited to: (i) high-end electrostatic flat
      panel manufacturers such as Martin Logan and others, and (ii) NXT Plc and
      its licensees employing the NXT flat panel technology, which uses a magnetic
      actuator to produce vibrations over a rigid panel. We are not aware of companies
      offering flat panel technology to the government market comparable to our
      government NeoPlanar products, but others
      may introduce
      products with features and performance competitive to our government NeoPlanar
      products.




We
      believe our SoundVector directed acoustic technology is novel with distinct
      technical and market attributes attributable to the backup alarm and other
      alert
      and warning tone markets. While we believe the demonstrated directivity of
      our
      warning tones is an important technical and performance advantage, we compete
      with traditional speakers and horns used in these existing markets. Others
      may
      modify existing products or offer new products with features and performance
      competitive to our SoundVector technology.




There
      are
      also continuing attempts by a large number of competitors to innovate new
      methods of sound reproduction to overcome limitations of traditional
      loudspeakers. It is possible that alternate technologies and systems that would
      be directly competitive with our sound technology have been developed but are
      unknown to us. Such systems may also currently be in development, and may be
      developed by others in the future.




**Seasonality**





We
      have
      not experienced any significant seasonality trends to date. Seasonality trends
      may occur in the future. Government business tends to be seasonal due to the
      U.S. Government procurement cycle, with the quarter ending September 30 usually
      producing relatively higher sales and the quarter ending December 31 usually
      producing relatively lower sales.  Our Government Group business has
      not experienced this seasonality to date, but we may experience increased
      seasonality in the future.




**Government
      Regulation and Environmental
      Matters**





Certain
      of our electronic products are subject to various regulations and are required
      to meet the specifications of agencies such as the Federal Communications
      Commission (FCC). We believe we are in substantial compliance with all current
      applicable regulations, and that we have all material governmental permits,
      licenses, qualifications and approvals currently required for our
      operations.




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Our
      HSS
      technology is subject to control under the Radiation Control for Health and
      Safety Act of 1968, and the associated regulations promulgated by the Food
      and
      Drug Administration (FDA), as an electrical emitter of ultrasonic vibrations.
      Under the terms of such regulations, we were required to provide an abbreviated
      report to the FDA describing the technology, which we submitted in August 2001.
      The FDA may respond to such report and request changes or safeguards to the
      technology, but it has not done so to date. We will also be required to notify
      the FDA in writing should an HSS product be found to have a defect relating
      to
      safety of use due to the emission of electronic product radiation. We do not
      believe our HSS technology poses any human health risks. However, it is possible
      that we, or one of our OEM customers or licensees, could be required to modify
      the technology, or a product incorporating the technology, to comply with
      requirements that may be imposed by the FDA.




Our
      products are being produced to standard product safety requirements for sale
      in
      the United States and to similar requirements for sale in Europe and Canada.
      We
      expect to meet the electrical and other regulatory requirements for electronic
      systems or components we sell throughout the world.




Some
      of
      our products may be subject to certain export controls by the U.S. government
      in
      accordance with various statutory authorities (including, for example the
      Trading with the Enemy Act of 1917, the Arms Export Control Act of 1976, the
      Export Administration Act of 1979 or the International Emergency Economic Powers
      Act), regulations and related executive orders. These controls affect the
      export of products and services to foreign customers and foreign business
      partners, in addition to exports to foreign persons generally (including our
      employees who are foreign persons or foreign regulatory bodies).




Generally
      speaking, there are three U.S. regulatory systems in place to implement these
      export control laws:




The
      first
      main regulatory system is administered by the U.S. Department of Treasury,
      Office of Foreign Asset Control (OFAC), which administers and enforces economic
      and trade sanctions based on U.S. foreign policy and national security goals
      against targeted individuals and specifically identified foreign
      countries.  None of our current business dealings or business plans
      implicates the OFAC regulations.




The
      second main regulatory system is administered by the U.S. Department of State,
      Directorate of Defense Trade Controls (DDTC), which administers the
      International Traffic in Arms Regulations (ITAR).  The ITAR requires
      licenses for the export of any product, service or technology that is
      specifically designed or adapted for a military application and is listed on
      the
      United States Munitions List.  Since our products are directional
      speaker systems designed for both commercial and government use, we do not
      believe that our technologies will fall under ITAR restrictions.  This
      belief has recently been confirmed by cognizant government officials. However,
      it is possible that some of our products may be deemed to have been specifically
      designed or adapted for military application and, if so, would be regulated
      under the ITAR in the future . If
      our
      products, services or technology are regulated under the ITAR, we will be
      required to submit an application for and obtain an export license to DDTC
      before exporting ITAR-controlled products, services or technology.




The
      third
      main regulatory system is administered by the U.S. Department of Commerce,
      Bureau of Industry and Security (BIS), which administers the Export
      Administration Regulations (EAR).  The EAR requires licenses only for
      certain products, services or technology that potentially have both commercial
      and military uses. Whether a license is required involves analysis of the
      end use of the product, as well as the destination country for the product,
      service or technology.  We believe that products such as HSS, LRAD and
      NeoPlanar are subject to the EAR because they have commercial applications
      and,
      unless specifically customized for military applications, were not, in their
      standard configurations, specifically designed for military
      use.  Application of the EAR is generally routine, and every company
      doing business in an international market must comply with these regulations.




As
      a
      defense contractor or subcontractor, our contract costs may be subject to audit
      and review by the U.S. Government. Routine audits and investigations are
      conducted from time to time to determine if performance and administering of
      U.S. Government contracts are compliant with applicable contractual
      requirements, and procurement and other applicable Federal statutes and
      regulations. Under present U.S. Government procurement regulations, if indicted
      or adjudged in violation of procurement or other Federal civil laws, a
      contractor or subcontractor, such as us, could be subject to fines, penalties,
      repayments or other damages. U.S. Government regulations also provide that
      certain findings may lead to suspension or debarment from eligibility for awards
      of new U.S. Government contracts for up to three years. Suspension or
      debarment may also limit a company's ability to obtain future subcontracts,
      to
      receive task orders on certain existing contracts, or to have options exercised
      on existing contracts.  Additionally, if a company is suspended or
      debarred, the U.S. Government can suspend or revoke the company's foreign export
      privileges.  We are not currently subject to any suspension or
      debarment proceedings, nor are we the subject of any investigation by the U.S.
      Government.




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**Intellectual
      Property Rights and Proprietary
      Information**





We
      operate in an industry where innovations, investment in new ideas and protection
      of resulting intellectual property rights are important to success. We rely
      on a
      variety of intellectual property protections for our products and technologies,
      including patent, copyright, trademark and trade secret laws, and contractual
      obligations, and we pursue a policy of vigorously enforcing such
      rights.




We
      have a
      substantial base of intellectual property assets. We have 33 patents issued
      in
      the U.S. and 44 patents issued worldwide.  We also have approximately
      33 patents pending in the U.S. and 144 patents pending worldwide on our
      proprietary sound technologies. Our issued patents expire between 2006 and
      2022.
      We are preparing and intend to file other sound technology patent applications.
      We target our patent coverage to provide protection in the major manufacturing
      and commercial centers of the world.




In
      addition to such factors as innovation, technological expertise and experienced
      personnel, we believe that a strong patent position is important to compete
      effectively in the sound reproduction industry. We believe this is especially
      important to protect our leadership position in parametric acoustics (HSS).
      The
      following table lists some of our key HSS patents and patent applications and
      the inventions they cover:


**Key
                Patent and Patent Application Titles**
            
            **Coverage**Acoustic
                Heterodyne Device and Method
            
            Virtual
                loudspeaker projection, controlling virtual projection attributes
                and
                direction with a computer driver and in ear applications for
                HSSPiezoelectric
                Film Sonic Emitter
            
            Piezoelectric
                film based emittersParametric
                Loudspeaker w/ Electro-Acoustical
              One
                stage Diaphragm Transducer
            
            All
                film type transducers for HSSModulator
                Processing for a Parametric Loudspeaker
            
            Advanced
                distortion correctionParametric
                Loudspeaker with Improved Phase Characteristics
            
            Ideal
                tuning of parametric carriers formaximum
                efficiencyPower
                Amplification for Parametric Loudspeakers
            
            All
                high efficiency switch-mode power amplifiersfor
                HSSModulator-Amplifier
            
            Specialized
                integration of very high efficiency power amplification
              and
                modulation electronics for HSSParametric
                Virtual Speaker and Surround Sound System
            
            HSS
                for virtual surround soundPre-encoded
                Signals for Playback though a
              Parametric
                Loudspeaker System
            
            Pre
                recorded HSS processing forreduced
                processingcost
                and
              hardwareDynamic
                Carrier System for Parametric Arrays
            
            Reduced
                power consumption and increasedefficiency
                in HSS




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The
      following table lists some of our other key sound patents and patent
      applications and the inventions they cover:


**Key
                Patent Title**
            
            **Coverage**A
                High Intensity Directional Electro-acoustic Sound Generating Systemfor
                Communications Targeting
            
            High
                Intensity Directional Acoustic Array
              Long
                Range Acoustic Device - LRADTMSingle
                End Planar Magnetic Speaker
            
            a)
                Single Ended, Planar Magnetic loudspeaker w/highenergy
                magnets
              b)
                High speed/low cost planar film diaphragmproduction
              c)
                Specialized film for use in planar magneticloudspeakersImproved
                Sing-Ended Planar Magnetic Speaker
            
            Single
                ended planar magnetic loudspeaker with high energy magneticsPlanar
                Magnetic Speakers with Secondary Magnetic structure
            
            Higher
                output, high fidelity planar magnetic transducerAcoustically
                Asymmetric Band-Pass Loudspeaker
              with
                Multiple Acoustic Filters
            
            a)
                Low distortion/High Powered Subwoofer
              b)
                Increased bandwidth subwooferDynamic
                Power Sharing in a Multi-ChannelSound
                System
            
            Power/cost
                savings, increased output in surroundsound/home
              theater
                systems




We
      have
      an ongoing policy of filing patent applications to seek protection for novel
      features of our products and technologies. Prior to the filing and granting
      of
      patents, our policy is to disclose key features to patent counsel and maintain
      these features as trade secrets prior to product introduction. Patent
      applications may not result in issued patents covering all important claims,
      and
      could be denied in their entirety.




We
      are
      investing significant management, legal and financial resources toward our
      technology patents. The electronics industry is characterized by frequent
      litigation regarding patent and other intellectual property rights. Others,
      including academic institutions and competitors, hold numerous patents in
      electronics and sound reproduction. Although we are not aware of any existing
      patents that would materially inhibit our ability to commercialize our sound
      technology; others may assert claims in the future. Such claims, with or without
      merit, may have a material adverse effect on our financial condition or results
      of operations.




The
      validity of our existing patents has not been adjudicated by any court.
      Competitors may bring legal action to challenge the validity of our existing
      or
      future patents or may attempt to circumvent the protection provided by such
      patents.  The failure to obtain patent protection or the loss of
      patent protection on our existing and future technologies or the circumvention
      of our patents by competitors could have a material adverse effect on our
      ability to compete successfully.




We
      generally take advantage of the Patent Convention Treaty procedures for patent
      protection in foreign countries. This procedure is more cost efficient, but
      results in a delay in the application and issuance of foreign patents; however,
      any resulting foreign patents, if and when issued, enjoy the same priority
      date
      as U.S. counterparts.




We
      also
      file for trade name and trademark protection when appropriate. We are the owner
      of federally registered trademarks including HYPERSONIC®, HSS®, SFT®, STRATIFIED
      FIELD®, PMT®, NEOPLANAR®, PUREBASS® and SHAPING THE FUTURE OF SOUND®. Trade
      names or trademarks may not be successfully maintained, defended or protected.




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Our
      policy is to enter into nondisclosure agreements with each employee and
      consultant or third party to whom any of our proprietary information is
      disclosed. These agreements prohibit the disclosure of confidential information
      to others, both during and subsequent to employment or the duration of the
      working relationship. These agreements may not prevent disclosure of
      confidential information or provide adequate remedies for any
      breach.




We
      are
      obligated to pay a $2.50 per unit royalty on one electronic component for our
      HSS product. We are also obligated to pay Elwood G. Norris, our Chairman, a
      2%
      royalty on net sales from certain of our technologies, of which only HSS is
      a
      current offering of our company. The royalty obligation continues until at
      least
      March 1, 2007, and for any longer period during which we sell products or
      license technologies subject to any patent assigned to us by Mr. Norris. No
      royalties were paid or recorded under this agreement in the fiscal years ended
      September 30, 2005, 2004, or 2003, as these royalties were immaterial and were
      waived by Mr. Norris. We may owe royalties in future periods based on actual
      sales or technology revenues.




**Research
      and Development**





The
      sound
      reproduction market is subject to rapid changes in technology and designs with
      frequent improvements and new product introductions. We believe our future
      success will depend on our ability to enhance and improve existing technologies
      and to introduce new technologies on a competitive basis. Accordingly, we have
      in the past, and we expect in the future, to engage in significant research
      and
      development activities.





For
      the
      fiscal years ended September 30, 2005, 2004, and 2003 we spent $4,621,532,
      $2,988,784 and $2,437,591, respectively, on company-sponsored research and
      development, and $-0-, $-0- and $55,760, respectively, on
      customer-sponsored research and development. Future levels of research and
      development expenditures will vary depending on the timing of further new
      product development and the availability of funds to carry on additional
      research and development on currently owned technologies or in other
      areas.




**Executive
      Officers**





The
      current executive officers of American Technology Corporation and their ages
      and
      business experience for the last five years are set forth below.




***Elwood
      G. Norris,*** **** age
      67,
      has been a Director of our company since August 1980. Mr. Norris served as
      Chief Executive Officer from October 2000 until February 2003. He currently
      serves as Chairman of the Board, an executive position.  He served as
      President from August 1980 to February 1994.  Mr. Norris managed our
      research and development activities as Chief Technology Officer through December
      2000. From 1988 to November 1999, he was a director and Chairman of e.Digital
      Corporation, a public company engaged in electronic product development,
      distribution and sales. During that period, he also held various other executive
      officer positions at e.Digital. From August 1989 to October 1999, he served
      as
      director and held various executive officer positions with Patriot Scientific
      Corporation, a public company engaged in the development of microprocessor
      technology. He is an inventor with 47 U.S. patents, primarily in the fields
      of
      electrical and acoustical engineering. He is the inventor of our HyperSonic
      Sound and other technologies. In April 2005, he was named as the 2005 recipient
      of the $500,000 Lemelson-MIT Prize for his many inventions including HyperSonic
      Sound.




***John
      R. Zavoli*** ,
      age 46,
      was appointed to our board of directors on June 14, 2005 and was appointed
      as
      President and Chief Operating Officer in November 2005 and Interim Chief
      Financial Officer in December 2005. Mr. Zavoli was the president, chief
      executive officer and chief financial officer of Path 1 Network Technologies
      Inc. (AMEX: PNO), a San Diego-based provider of IP broadcast video transport
      and
      routing systems through September 2005. Mr. Zavoli joined Path 1 in October
      2002
      and was appointed president and chief executive officer and elected as a
      director in March 2004. Before joining Path 1, from November 2001 through
      September 2002, Mr. Zavoli served as chief financial officer and general counsel
      with NHancement Technologies (later re-named Appiant Technologies). From June
      1987 through July 1992, he held various senior level financial and legal
      positions with Digital Equipment Corporation (now Hewlett-Packard). Mr. Zavoli
      is a former partner with PricewaterhouseCoopers LLP, where he consulted high
      tech clients in global operations, taxation, fiscal management, mergers and
      acquisitions and other related issues. Mr. Zavoli obtained his B.S. in
      Accounting from the University of Illinois in 1981, a J.D.,from The John
      Marshall Law School in 1986, and an LL.M. from Boston University School of
      Law
      in 1990.




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***Karen
      Jordan*** ,
      age 35,
      joined our Company in November 2005 as Director of Finance, and in December
      2005
      was appointed as Chief Accounting Officer. From July 2003 to November 2005,
      Ms.
      Jordan was a self-employed bankruptcy executive, managing the Estates of LCS
      Management, Inc. and LCS West, Inc. From January 2001 to July 2003, Ms. Jordan
      was Corporate Controller with LifeCare Solutions, Inc., a provider of integrated
      home healthcare products and services. From June 1996 to January 2001, Ms.
      Jordan held various positions with Quidel Corporation, a developer and
      manufacturer of diagnostic tests for detection of a variety of medical
      conditions and illnesses. At the time Ms. Jordan left Quidel Corporation, she
      held the position of Assistant Controller. Ms. Jordan is a Fellow Chartered
      Accountant in Ireland. Ms. Jordan received her Associate Chartered Accountant
      license from the Institute of Chartered Accountants in Ireland.




***Bruce
      Gray*** ,
      age 50,
      joined our company as Vice President of Sales and Marketing for our Commercial
      Group in March 2005. In November 2005, Mr. Gray was appointed as our Vice
      President, Commercial Group. From November 2001 through March of 2005, Mr.
      Gray
      served as Chief Executive Officer of Ethertronics Corporation, which developed
      and manufactured antenna systems for the mobile wireless market. From November
      1998 through October 2001, Mr. Gray served as Senior Vice President of Sales
      and
      Marketing for Novatel Wireless. He has also held executive sales management
      positions at Uniden, Sensormatic, US Robotics and Alcoa Electronics. Mr. Gray
      holds a Bachelor of Science in Engineering from the University of South Alabama
      and a Master of Business Administration degree from the University of San Diego.
      Mr. Gray has previously served on the Board of Directors of Ethertronics
      Corporation, Ethertronics Trading Company Ltd., and TechnoCom
      Corporation.





***James
      Croft, III*** **,** age **** 52 ****** joined
      our company in October 1997 as Vice President of Engineering. In
      December 2000 he was appointed Chief Technology Officer. As part of the
      Company’s March 2003 reorganization, Mr. Croft was appointed Senior Vice
      President of Research and Development. In August 2005 he was appointed as Chief
      Technology Officer and Vice President of Development. From October 1992 to
      October 1997 he was an executive with Carver Corporation, then a publicly
      traded high-end audio supplier. He was appointed Vice President of Marketing
      and
      Product Development for Carver Corporation in March 1993 and Vice President
      Research and Development in February 1995. From 1990 through
      October 1992 Mr. Croft held various positions at Dahlquist, Inc., a
      loudspeaker manufacturer, including Vice President of Research and Development.
      Mr. Croft is also a member of the Board of Directors of Definitive Audio, Inc.,
      a Seattle audio specialty retailer that he co-founded in 1975 and managed until
      1985.




***Alan
      J. Ballard,*** age 50,
      joined our company in January 2004, and has held various positions in our
      Government Group, including Senior Director of U.S. Military Sales, Government
      and Force Protection Group. In November 2005, our board of directors approved
      the appointment of Mr. Ballard as our Vice President, Government and Military
      Division. From January 2001 to December 2003, Mr. Ballard was a senior engineer
      and project manager with Bath Iron Works, a subsidiary of General Dynamics
      Corporation. Prior to joining Bath Iron Works, he was an officer in the United
      States Navy with over 23 years of service prior to his retirement in September
      2000. Mr. Ballard has a B.S. in civil engineering from Old Dominion
      University.




***Rose
      Tomich-Litz,*** age 47,
      joined our company in November 2005 as our Vice President, Operations. Ms.
      Tomich-Litz has over 17 years of experience in operations. From December 2002
      to
      June 2004, Ms. Tomich-Litz was Vice President, Operations with Promicro Systems,
      a manufacturer and distributor of custom computers and servers. Prior to joining
      Promicro Systems, from June 2000 to January 2002, she was Vice President,
      Operations with Prisa Networks, a manufacturer and distributor of storage area
      network management software. Ms. Tomich-Litz holds an M.B.A. and a B.S. in
      Business Administration from San Diego State University.




**Employees******





At
      September 30, 2005, we employed a total of 46 people. Of such employees, 11
      were
      in research and development, 9 were in production, quality assurance and
      materials control, 11 were in general and administrative and 15 were in
      marketing, sales and licensing.  We also lease technical personnel
      from time to time on an as needed basis and use outside consultants for various
      services.  We have not experienced any work stoppages and are not a
      party to a collective bargaining agreement, and we consider our relations with
      our employees to be favorable.




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**Item
      2.  Properties.**




Our
      executive offices and our research and development facilities for our Commercial
      Group and Government Group are located at 13114 Evening Creek Drive South,
      San
      Diego, California.  We presently occupy approximately 23,548 square
      feet, and our monthly rent payments are approximately $28,257. This lease
      expires January 31, 2006, and we have entered into a new sublease for
      approximately 23,698 rentable square feet located at 15378 Avenue of Science,
      San Diego, California 92118 for a term commencing January 1, 2006 and expiring
      May 31, 2011. We have agreed to pay $29,623 per month (i.e., $1.25 per rentable
      square foot) during the term. In addition to the monthly base rental expense,
      we
      will be responsible for certain costs and charges specified in the sublease,
      including our proportionate share of the building operating expenses and real
      estate taxes. In addition, the sublease provides that we have a right of first
      refusal on additional space in the building, which contains a total of 68,910
      square feet including our premises. We believe the new space will be adequate
      for our needs for the foreseeable future.




We
      rent,
      on a monthly basis, office space utilized for development and production of
      our
      NeoPlanar technology for our Company, located at 3170 Research Way, Unit 81,
      Carson City, Nevada. We occupy approximately 2,200 square feet with a
      monthly payment of $1,246 excluding utilities.




Our
      East
      Coast sales office for the Government Group is located at 5 Main Street,
      2 nd Floor,
      Topsham, Maine. We occupy approximately 1,700 square feet of space and our
      monthly payments are $2,592 excluding utilities. Our current lease for this
      space expires on December 31, 2005 and we are currently in negotiations to
      renew
      this lease.




**Item
      3.  Legal Proceedings.**




We
      may at
      times be involved in litigation in the ordinary course of business. We will
      also, from time to time, when appropriate in management’s estimation, record
      adequate reserves in our financial statements for pending litigation.




**Item
      4.  Submission of Matters to a Vote of Security
      Holders.**





None.







**PART
      II**




**Item
      5.  Market for Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities.**





**Market
      Information**





Our
      common stock is traded and quoted on NASDAQ Capital Market under the symbol
      “ATCO”. The market for our common stock has often been sporadic and
      limited.





The
      following table sets forth the high and low bid quotations for our common stock
      for the fiscal years ended September 30, 2004 and 2005:





**Bid
                Quotations****High**
            
            **Low**Fiscal
                Year Ending September 30, 2004First
                Quarter
            
            $6.19
            
            $4.01Second
                Quarter
            
            $6.07
            
            $4.05Third
                Quarter
            
            $7.77
            
            $5.50Fourth
                Quarter
            
            $6.70
            
            $4.38Fiscal
                Year Ending September 30, 2005First
                Quarter
            
            $11.38
            
            $5.50Second
                Quarter
            
            $11.55
            
            $7.75Third
                Quarter
            
            $9.28
            
            $5.36Fourth
                Quarter
            
            $6.75
            
            $4.96





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The
      above
      quotations reflect inter-dealer prices, without retail markup, markdown or
      commission and may not represent actual transactions.





We
      had
      1085 holders of record of our common stock at December 14, 2005 with shares
      issued and outstanding. We have never paid a cash dividend on our common stock
      or preferred stock and do not expect to pay dividends in the foreseeable
      future.




**Recent
      Sales of Unregistered Securities**





During
      the quarter ended September 30, 2005, we issued 37,500 shares of common stock
      upon the exercise of warrants issued to investors in private placement
      financings in 2001, and received aggregate proceeds of $75,000 in connection
      with the exercise of such warrants. These issuances were in reliance on the
      exemption from registration set forth in Section 4(2) of the Securities Act
      and
      Rule 506 promulgated thereunder.





**Item
      6.  Selected Financial Data.**




The
      following selected financial data has been derived from our audited consolidated
      financial statements and the related notes. This information should be read
      in
      conjunction with Item 7 of this report - "Management’s Discussion and Analysis
      of Financial Condition and Results of Operations," and with our consolidated
      financial statements and the related notes set forth at the pages indicated
      in
      Item 15(a) of this report.




For
                the fiscal years ended September 30,2005
            
            2004
            
            2003
            
            2002
            
            2001**Statement
                of Operations:**Net
                revenues
            
            $
            10,195,546
            
            $
            5,752,549
            
            $
            1,315,426
            
            $
            1,010,752
            
            $
            855,342Gross
                profit (loss)
            
            $
            4,571,185
            
            $
            2,282,728
            
            $
            (228,651
            )
            $
            326,908
            
            $
            277,066Net
                loss
            
            $
            (9,086,707
            )
            $
            (5,960,436
            )
            $
            (8,227,013
            )
            $
            (8,220,132
            )
            $
            (5,046,219
            )Net
                loss available to common stockholders
            
            $
            (10,883,133
            )
            $
            (7,325,785
            )
            $
            (10,636,241
            )
            $
            (8,503,044
            )
            $
            (5,166,941
            )Net
                loss per share-basic and diluted
            
            $
            (0.50
            )
            $
            (0.37
            )
            $
            (0.67
            )
            $
            (0.60
            )
            $
            (0.38
            )Weighted
                average number of shares-basic and diluted
            
            
            21,570,002
            
            
            19,603,265
            
            
            15,857,569
            
            
            14,193,508
            
            
            13,563,101As
                of September 30,2005
            
            
            2004
            
            
            2003
            
            
            2002
            
            
            2001Working
                capital
            
            $
            9,726,309
            
            $
            3,472,984
            
            $
            8,484,210
            
            $
            554,713
            
            $
            892,040Total
                assets
            
            $
            15,208,870
            
            $
            7,645,291
            
            $
            11,744,371
            
            $
            3,789,634
            
            $
            3,837,284Long-term
                obligations
            
            $
            1,564,000
            
            $
            12,131
            
            $
            23,097
            
            $
            3,153,012
            
            $
            -Total
                stockholders' equity (deficit)
            
            $
            10,142,338
            
            $
            5,192,915
            
            $
            9,728,171
            
            $
            (884,882
            )
            $
            2,993,495








**Item
      7.  Management's Discussion and Analysis of Financial
      Condition and Results of Operations.**




This
      discussion should be read in conjunction with the information presented in
      other
      sections of this report on Form 10-K, including “Item 1. Business,” “Item 6.
      Selected Financial Data,” and “Item 8. Financial Statements and Supplementary
      Data.” This discussion contains forward-looking statements which are based on
      our current expectations and industry experience, as well as our perception
      of
      historical trends, current market conditions, current economic data, expected
      future developments and other factors that we believe are appropriate under
      the
      circumstances. These statements involve risks and uncertainties that could
      cause
      actual results to differ materially from those suggested in the forward-looking
      statements.





**Overview**





We
      are an
      innovator of proprietary directed sound technologies and products.





Our
      various technologies are high risk in nature. Our future is largely dependent
      upon the success of our proprietary sound technologies. We invest significant
      funds in research and development and on patent applications related to our
      technologies. Unanticipated technical or manufacturing obstacles can arise
      at
      any time, disrupt product sales or licensing activities, and result in lengthy
      and costly delays. Our products may not achieve market acceptance sufficient
      to
      sustain operations or achieve future profits. See “Risk Factors”
below.




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We
      incurred net losses of $9,086,707, $5,960,436 and $8,227,013 in the fiscal
      years
      ended September 30, 2005, 2004 and 2003, respectively.  We have substantial
      research and development and selling, marketing and general administrative
      expenses, and our margins from the sale of our products have not yet been
      sufficient to offset these costs.  We may incur additional operating losses
      during fiscal 2006.  Based on our cash position, and assuming currently
      planned expenditures and level of operations, we believe we have sufficient
      capital resources for the next twelve months. Our operating plans are based
      on us continuing to increase revenues and generate positive cash flows from
      operations.  See “Liquidity and Capital Resources”, below. If required, we
      have significant flexibility to adjust the level of research and development
      and
      selling and administrative expenses based on the availability of resources.
      However, reductions in expenditures could delay development and adversely affect
      our ability to generate future revenues.




For
        our
        first assessment of the effectiveness of our internal controls over financial
        reporting required under section 404 of the Sarbanes-Oxley Act of 2002, we
        identified various material weaknesses in our internal controls over financial
        reporting, and associated weaknesses in our disclosure controls and procedures,
        as discussed more fully in Item 9A, below. We have undertaken efforts to
        remediate these material weaknesses and to improve overall our internal controls
        over financial reporting and our associated disclosure controls and
        procedures.


**Recent
      Developments**





In
      October 2005, Kalani Jones resigned from his positions as our president and
      chief operating officer and as a member of our board of directors. John Zavoli,
      a member of our board of directors, was appointed as our new president and
      chief
      operating officer. Mr. Zavoli commenced his service in these new positions
      in
      November 2005. Mr. Zavoli previously served as an independent director on our
      board of directors, and as a member of the Compensation Committee and the Audit
      Committee. As a result of his appointment as president and chief operating
      officer, Mr. Zavoli no longer qualifies as an independent director under
      applicable Nasdaq standards, and he resigned from the Audit Committee and the
      Compensation Committee upon his acceptance of an officer position. Our board
      of
      directors presently consists of five directors, three of whom are independent
      directors under applicable Nasdaq standards.





Michael
      A. Russell, our former chief financial officer, resigned from his employment
      on
      December 16, 2005. Mr. Russell's resignation on December 16, 2005 constituted
      notice of termination of his employment arrangement with our company.





On
      December 16, 2005, our board of directors appointed John R. Zavoli as the
      interim chief financial officer to replace Mr. Michael A. Russell. Mr. Zavoli's
      employment terms did not change as a result of this appointment.





On
      December 16, 2005, Karen Jordan was appointed as chief accounting officer.
      Ms.
      Jordan joined our company in November 2005 as director of finance. Ms. Jordan's
      employment is terminable at-will by the Company or by Ms. Jordan for any reason,
      with or without notice.





**Business
      Outlook**





We
      achieved record revenues of $10.2 million for the fiscal year ended September
      30, 2005, a 77% increase from prior year’s revenues of $5.75 million. Our
      operating loss for our fiscal year ended September 30, 2005 increased over
      fiscal year 2004 primarily as a result of increased operating expenses including
      research and development and sales and marketing costs. In fiscal year 2006,
      we
      anticipate that revenues will continue to grow primarily due to the introduction
      of our HSS H450 product and increased acceptance of our LRAD and NeoPlanar
      products. We expect our research and development expenses to decrease in fiscal
      year 2006 as a result of the completion of major engineering projects in fiscal
      year 2005 and a reduction in the number of employees engaged in product and
      technology development. However, even with such anticipated reduced research
      and
      development costs, our sales and marketing expenses may increase as we focus
      on
      expanding our sales and marketing efforts for our existing products, thereby
      offsetting any benefit of cost reduction from other areas of our
      business.





We
      believe we have a solid technology and product foundation for business growth
      over the next several years. The dramatic growth and acceptance of digital
      signage requiring the use of our directed sound products and the continuing
      global threats to both governments and commerce where our LRADTM products have
      proven to be effective at hailing and notification for force protection provide
      market opportunities for our directed sound solutions.





**Critical
      Accounting Policies and Estimates**





We
      have
      identified the policies below as critical to our business operations and the
      understandings of our results of operations. Our accounting policies are more
      fully described in our financial statements located in Item 8 of Part II,
“Financial Statements and Supplementary Data.” The impact and any associated
      risks related to these policies on our business operations is discussed
      throughout Management’s Discussion and Analysis of Financial Condition and
      Results of Operations when such policies affect our reported and expected
      financial results.




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The
      methods, estimates and judgments we use in applying our accounting policies,
      in
      conformity with generally accepted accounting principles in the United States,
      have a significant impact on the results we report in our financial statements.
      We base our estimates on historical experience and on various other assumptions
      that we believe to be reasonable under the circumstances. The estimates affect
      the carrying values of assets and liabilities. Actual results may differ from
      these estimates under different assumptions or conditions. We believe that
      the
      following discussion addresses our most critical accounting policies, which
      are
      those that are most important to the portrayal of our financial condition and
      results of operations and require our most difficult, subjective, and complex
      judgments, often as a result of the need to make estimates about the effect
      of
      matters that are inherently uncertain.





*Revenue
      Recognition.* We
      currently derive our revenue primarily from two sources: (i) component and
      product sale revenues and associated engineering and installation, which we
      refer to collectively as Product Sales and (ii) contract and license fee
      revenue.  Product Sales revenues are recognized in the periods that
      products are shipped to customers, FOB shipping point or destination, per
      contract, if a signed contract exists, the fee is fixed and determinable,
      collection of resulting receivables is probable and there are no remaining
      obligations. Revenues from engineering contracts are recognized based on
      milestones or completion of the contracted services. Revenues from up-front
      license and other fees and annual license fees are evaluated for multiple
      elements but are generally recognized ratably over the specified term of the
      particular license or agreement. Revenues from ongoing per unit license fees
      are
      earned based on units shipped by the licensee incorporating our patented
      proprietary technologies. Revenues are recognized in the period when the
      ultimate customer accepts the product and collectibility is reasonably assured.





*Valuation
      of Inventory.* Our
      inventory is comprised of raw materials, assemblies and finished products that
      we intend to sell to our ** customers *.* We ** must
      periodically make judgments and estimates regarding the future utility and
      carrying value of our inventory.  The carrying value of our inventory
      is periodically reviewed and impairments, if any, are recognized when the
      expected future benefit from our inventory is less than its carrying
      value.  For the fiscal year ended September 30, 2005, we reviewed the
      carrying value of our inventory and increased the reserve for obsolescence
      to
      $691,206, consisting of raw materials and finished goods that were associated
      with our older generation of products, and raw materials that are considered
      to
      be slow-moving.




*Valuation
      of Intangible Assets.* Intangible
      assets include purchased technology and patents that are amortized over their
      estimated useful lives. We must make judgments and estimates regarding the
      future utility and carrying value of intangible assets. The carrying values
      of
      such assets are periodically reviewed and impairments, if any, are recognized
      when the expected future benefit to be derived from an individual intangible
      asset is less than its carrying value.  In fiscal year ended September
      30, 2005, we reviewed the carrying value of our intangible assets and reduced
      the carrying value of these assets. Our judgments and estimates regarding
      carrying value and impairment of intangible assets have an impact on our
      financial statements.




*Warranty
      Reserve.* We
      establish a warranty reserve based on anticipated warranty claims at the time
      product revenue is recognized. These warranties require us to make estimates
      regarding the amount and costs of warranty repairs we expect to make over a
      period of time. Factors affecting warranty reserve levels include the number
      of
      units sold, anticipated cost of warranty repairs, and anticipated rates of
      warranty claims. We evaluate the adequacy of the provision for warranty costs
      each reporting period. See Note 9 to our financial statements for additional
      information regarding warranties.




*Valuation
      of Derivative Instruments* .
      In
      accordance with the interpretive guidance in EITF Issue No. 05-4, “The Effect of
      a Liquidated Damages Clause on a Freestanding Financial Instrument Subject
      to
      EITF Issue No. 00-19, ‘Accounting for Derivative Financial Instruments Indexed
      to, and Potentially Settled in, a Company’s Own Stock’ and EITF Issue No. 00-19,
      we value certain warrants we have issued in connection with various equity
      financings that we have completed as a derivative liability. We must make
      certain assumptions and estimates to value our derivative liability
      periodically. Factors affecting the amount of this liability include changes
      in
      our stock price and other assumptions. The change in value is non-cash income
      or
      expense and the changes in the carrying value of derivatives can have a material
      impact on our financial statements. In the fiscal year ended September 30,
      2005,
      we recognized an unrealized gain on derivative revaluation of $1.2 million.
      The
      derivative liability associated with warrants may be reclassified into
      stockholders’ equity upon warrant exercise, expiration or other events, and the
      timing of such events may be outside our control.





*Guarantees
      and Indemnifications* .  Under
      our bylaws, we have agreed to indemnify our officers and directors for certain
      events. We also enter into certain indemnification and liquidated damage
      agreements in the normal course of our business. We have no liabilities recorded
      for such indemnities.




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We
      undertake indemnification obligations in the ordinary course of business related
      to our products and the issuance of securities. Under these arrangements, we
      may
      indemnify other parties such as business partners, customers, underwriters,
      and
      investors for certain losses suffered, claims of intellectual property
      infringement, negligence and intentional acts in the performance of services,
      and violations of laws including certain violations of securities laws. Our
      obligation to provide such indemnification in such circumstances would arise
      if,
      for example, a third party sued a customer for intellectual property
      infringement and we agreed to indemnify the customer against such claims. We
      are
      unable to estimate with any reasonable accuracy the liability that may be
      incurred pursuant to our indemnification obligations. Some of the factors that
      would affect this assessment include, but are not limited to, the nature of
      the
      claim asserted, the relative merits of the claim, the financial ability of
      the
      parties, the nature and amount of damages claimed, insurance coverage that
      we
      may have to cover such claims, and the willingness of the parties to reach
      settlement, if any. Because of the uncertainty surrounding these circumstances,
      our indemnification obligations could range from immaterial to having a material
      adverse impact on our financial position and our ability to continue in the
      ordinary course of business.





*Deferred
      Tax Asset.* We
      have
      provided a full valuation reserve related to our substantial deferred tax
      assets. In the future, if sufficient evidence of our ability to generate
      sufficient future taxable income in certain tax jurisdictions becomes apparent,
      we may be required to reduce our valuation allowances, resulting in income
      tax
      benefits in our statement of operations. We evaluate quarterly the
      realizability of the deferred tax assets and assess the need for a valuation
      allowance. Utilizing the net operating loss carry forwards in future years
      could
      be substantially limited due to restrictions imposed under federal and state
      laws upon a change in ownership or control.





*Legal
      Proceedings.*   We
      are
      currently involved in certain legal proceedings.   For any legal
      proceedings that we are involved in, we estimate the range of liability relating
      to pending litigation, where the amount and range of loss can be
      estimated.  We record our best estimate of a loss when the loss is
      considered probable.  Where a liability is probable and there is a
      range of estimated loss with no best estimate in the range, we record the
      minimum estimated liability related to the claim.  As additional
      information becomes available, we assess the potential liability related to
      our
      pending litigation and revise our estimates.  As of September 30, 2005
      and 2004, we recorded accruals of $71,900 and $150,000 for contingent liability
      associated with our legal proceedings.  Revisions in our estimates of
      the potential liability could materially impact our results of
      operations.




**Segment
      Information**





Our
      Commercial Products Group (Commercial Group) sells and licenses HSS, LRAD,
      NeoPlanar and our other products and technologies into commercial markets for
      directed sound in consumer, commercial and professional applications. Our
      Government & Military Group (Government Group) markets LRAD, NeoPlanar and
      our other products to government and military customers for expanding force
      protection and commercial security markets. Although the segments did not become
      separately managed until the last quarter of fiscal year 2003, data for all
      of
      fiscal 2003 has been segmented for comparison purposes.





Presented
      below is a summary of revenues by business segment:





**Years
                Ended September 30,**
            
            **2005**
            
            **2004**
            
            **2003**Revenues:Commercial
                Group
            
            $
            891,745
            
            $
            933,373
            
            $
            861,091Government
                Group
            
            $
            9,303,801
            
            $
            4,819,176
            
            $
            454,335$
            10,195,546
            
            $
            5,752,549
            
            $
            1,315,426




Presented
      below is the gross profit or loss by business segment.





**Years
                Ended September 30,**
            
            **2005**
            
            **2004**
            
            **2003**Gross
                Profit (Loss):Commercial
                Group
            
            $
            (924,019
            )
            $
            (534,174
            )
            $
            (501,748
            )Government
                Group
            
            $
            5,495,204
            
            $
            2,816,902
            
            $
            273,097$
            4,571,185
            
            $
            2,282,728
            
            $
            (228,651
            )




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**Comparison
      of Results of Operations** **for Fiscal Years Ended September 30, 2005 and 2004**





***Revenues***





Revenues
      increased $4.4 million, or 77%, in the fiscal year ended September 30, 2005
      to
      $10,195,546 compared to $5,752,549 for the fiscal year ended September 30,
      2004.
      Fiscal year 2005 revenues included $10,013,215 of product sales and $182,331
      of
      contract and license revenue. Fiscal year 2004 revenues included $5,581,936
      of
      product sales and $170,613 of contract and license revenues. The increase in
      fiscal year 2005 revenues resulted primarily from a 126% increase in LRAD
      product revenues to $8,821,366 from $3,907,291 in 2004.





*Commercial
      Group Revenues* - The
      Commercial Group reported net revenues of $891,745 in the fiscal year ended
      September 30, 2005, representing a 4% decrease from net revenues of $933,373
      in
      fiscal year 2004. Sound product revenues were $812,328 and $933,373, and
      contract and license revenues were $79,417 and -$0- in fiscal years 2005 and
      2004, respectively. The decrease in sound product revenues in fiscal year 2005
      resulted primarily from decreased HSS sales of older generation product in
      anticipation of the shipment of a new generation of HSS product that commenced
      in the fourth quarter of fiscal year 2005. During most of fiscal year 2005,
      we
      developed and tested our new generation of our HSS products, and sales of HSS
      product in fiscal year 2005 were limited to certain older systems. We expect
      increased Commercial Group HSS and other sound product revenues in the fiscal
      year ending September 30, 2006.





In
      the
      fiscal year ended September 30, 2005, we entered into a license agreement which
      contained multiple elements. Based on our evaluation of the agreement under
      the
      guidance of EITF Issue No. 00-21 we determined this arrangement does not qualify
      for multiple element accounting and revenue will be recognized ratably
      over the three year term of the agreement. In
      fiscal
      year 2005, we recognized $54,167 in contract revenue representing the
      ratable earned revenue under the three year agreement. At September 30,
      2005, $95,833 remained unearned under this agreement and has been recorded
      as
      deferred revenue. At September 30, 2005, we had aggregate deferred license
      revenue of $395,833 representing amounts collected from Commercial Group license
      agreements in advance of recognized earnings. Although we anticipate additional
      license revenues in fiscal year 2006 from existing and new arrangements, this
      revenue component is subject to significant variability based on the timing,
      amount and recognition of new arrangements, if any.





*Government
      & Military Group* -
      Government & Military Group net revenues for the fiscal year ended September
      30, 2005, were $9,303,801 compared to $4,819,176 in fiscal year 2004,
      representing a 93% increase. Fiscal year 2005 revenues included LRAD product
      revenues of $8,821,366, NeoPlanar product revenues of $379,521 and contract
      and
      license revenues of $102,914. Fiscal year 2004 revenues included LRAD revenues
      of $3,907,291, NeoPlanar revenues of $265,520, other product revenues of
      $484,827, and contract and license revenues of $161,538. The increase in LRAD
      revenues in fiscal year 2005 was primarily the result of shipments associated
      with a $4.9 million order received in December 2004 from ADS, Inc. for delivery
      of LRAD units to the US Army. Our marketing efforts, successful product
      deployments and extensive product demonstrations have contributed to increased
      market awareness and customer acceptance of the force protection capabilities
      of
      our LRAD products. We expect LRAD revenues to grow in fiscal year 2006 due
      to
      these factors and the introduction of our new portable LRAD500.




***Gross
      Profit***





Gross
      profit for the fiscal year ended September 30, 2005 was $4,571,185, or 45%
      of
      revenues, compared to $2,282,728, or 40% of revenues, for fiscal year 2004.
      The
      increase in gross profit in fiscal year 2005 was principally the result of
      the
      increased sales of our higher margin LRAD products, partially offset by
      increased reserves for inventory obsolescence. We increased our inventory
      valuation reserve by $389,334 in the fourth quarter of fiscal 2005. The fourth
      quarter increase resulted from HSS parts that became obsolete upon completion
      of
      the design of our H450 HSS product, and from LRAD parts which are no longer
      required due to our shift in emphasis from large, remote controlled
      installations to standard and portable installations. This fourth quarter
      obsolescence adjustment contributed to an overall negative gross margin in
      the
      fourth quarter.




Gross
      loss for our Commercial Group was $924,019 and $534,174, in fiscal years 2005
      and 2004, respectively, primarily as a result of insufficient margins earned
      on
      product sales to offset the allocation of manufacturing overhead to this segment
      of our business. Gross profit for our Government Group was $5,495,204 in the
      fiscal year ended September 30, 2005, or 59% of revenue, compared to $2,816,902
      in fiscal year 2004 or 58% of revenue. Gross profit percentage is highly
      dependent on sales prices, volumes, purchasing costs and overhead allocations.




18
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Our
      products have varying gross margins, so product sales mix will materially affect
      gross profits. In addition, we continue to make product updates and changes,
      including raw material and component changes that may impact product costs.
      We
      do not believe that historical gross profit margins should be relied upon as
      an
      indicator of future gross profit margins.




***Selling,
      General and Administrative Expenses***





Selling,
      general and administrative expenses for the fiscal year ended September 30,
      2005
      increased $4,000,825 to $9,333,436 or 91% or revenues, compared to $5,309,547,
      or 92% of revenues, in fiscal year 2004. The increase in selling general and
      administrative expenses year on year were primarily attributed to $702,482
      for
      increased personnel and related expenses; $776,093 for increased consulting,
      accounting and auditing expenses primarily as a result of the Sarbanes-Oxley
      Act
      of 2002; $723,572 for increased legal fees primarily associated with the costs
      of an abandoned equity line financing, increased SEC reporting cost and
      litigation costs; and $752,077 for increased travel, commissions, demonstration
      equipment and trade show activity due to and resulting in higher sales.




We
      incurred non-cash compensation expenses in fiscal years ended September 30,
      2005
      and 2004 of $21,780 and $65,863, respectively, from extending the exercise
      period of options for certain terminated employees on 7,250 and 28,438 shares,
      respectively, of common stock, due to stock trading restrictions. In fiscal
      year
      2005, we also recorded $57,619 for option expense relating to options for 68,125
      shares held by an officer of the Company who transitioned from employee to
      consultant, and $6,160 of non-cash compensation expense for the value of 10,000
      options granted to a non-employee. During fiscal years 2005 and 2004, we
      reviewed the ongoing value of our capitalized patent expenses and identified
      some of these assets as being associated with patents that are no longer
      consistent with our business strategy. As a result of this review, we reduced
      the value of our previously capitalized patents for the fiscal year ended
      September 30, 2005 and 2004 by $40,916 and $37,798, respectively.




We
      may
      expend additional resources on marketing our products in future periods which
      may increase selling, general and administrative expenses. During fiscal year
      2005, we incurred a significant amount of outside consultant costs and audit
      fees to comply with the Sarbanes-Oxley Act (particularly Section 404), relating
      to management assessment of internal control over financial reporting. We expect
      to incur significant additional audit fees and other costs in fiscal year 2006
      to comply with the Sarbanes-Oxley Act and to improve our internal control over
      financial reporting and procedures in our accounting organization. We do not
      currently have an estimate of these future costs, but we anticipate we will
      increase spending for increased staffing, outside consultants and legal and
      audit costs.




***Research
      and Development Expenses***





Research
      and development expenses increased $1,632,748 to $4,621,532, or 45% of revenues,
      in fiscal year 2005, compared to $2,988,784, or 52% or revenues, in fiscal
      year
      2004. The increase in research and development expenses year on year is
      primarily due to a $1,345,752 increase in personnel and related expenses of
      which $245,183 was non-cash compensation associated with an extension of time
      to
      exercise stock options, and a $281,236 increase in prototype component
      acquisition, fabrication and testing for new products developed during fiscal
      year 2005.





Research
      and development costs vary period to period due to the timing of projects,
      the
      availability of funds for research and development and the timing and extent
      of
      use of outside consulting, design and development firms. We completed and
      introduced significant new products in our fiscal year 2005, including our
      HSS
      H450 product and our portable LRAD500. With the completion of these major
      projects, and based on current plans and reduced engineering staffing, we expect
      fiscal year 2006 research and development costs to be lower than fiscal year
      2005.




**Loss
      From Operations**




Loss
      from
      operations was $9,383,783 in the fiscal year ended September 30, 2005, compared
      to a loss from operations of $6,015,603 in fiscal year 2004. The increase in
      fiscal year 2005 loss from operations resulted primarily from the increase
      in
      research and development and increased selling, general and administrative
      expenses as we increased the development effort on our H450 and LRAD products
      and sales and marketing expenses. We also incurred significant expense in
      evaluating our system of internal controls for compliance with the
      Sarbanes-Oxley Act of 2002.




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***Other
      Income (Expense)***





In
      fiscal
      year 2005, we earned $84,510 of interest income on our cash balances, incurred
      $93,457 of interest expense and incurred $743,977 of non-cash interest expense
      associated with the acceleration of the write off of the debt discount
      associated with warrants issued as part of our December 2004 note financing.
      Other income for fiscal year 2005 included $1,233,259 of unrealized gain on
      derivative revaluation, including $183,259 related to the decrease in the fair
      value of a warrant issued in connection with our December 2004 equity financing
      line, and $1,050,000 related to the decrease in the fair value of warrants
      issued in connection with our July 2005 sale of common stock and warrants (see
      “Financing Activities” below). In the fiscal year ended September 30, 2005, we
      recognized a warrant impairment charge of $183,259 representing remaining
      warrant derivative instrument liability, after crediting prepaid transaction
      costs, when we terminated the equity financing line and the warrant in July
      2005.





At
      September 30, 2005 our short term and long term derivative liability was
      $1,846,000. We must make certain assumptions and estimates to value our
      derivative liability periodically. Factors affecting the amount of this
      liability include changes in our stock price and other assumptions. The change
      in value is non-cash income or expense and the changes in the carrying value
      of
      derivatives can have a material impact on our financial statements each period.
      The derivative liability associated with our
      July
      2005 sale of common stock and warrants may
      be
      reclassified into stockholders’ equity upon warrant exercise, expiration or
      other events, and the timing of such events may be outside our
      control.





In
      fiscal
      year ended September 30, 2004, we earned $58,056 of interest on our cash
      balances and incurred $2,889 of interest expense.




**Net
      Loss**




The
      net
      loss for fiscal year 2005 was $9,086,707, compared to a net loss of $5,960,436
      in fiscal year 2004. We
      had no
      tax federal income tax expense for each of the last three fiscal years due
      to
      net losses.





***Net
      Loss Available to Common Stockholders***





Net
      loss
      available to common stockholders was increased during fiscal years ended
      September 30, 2005 and 2004 in computing net loss per share by imputed deemed
      dividends based on the value of warrants issued in connection with convertible
      preferred stock. The net loss available to common stockholders was also
      increased each year by an additional deemed dividend computed from a discount
      provision in our convertible preferred stock. The imputed deemed dividends
      were
      not contractual obligations to pay such imputed dividends. Net loss available
      to
      common stockholders was further increased by a 6% accretion (similar to a
      dividend) on outstanding preferred stock. These amounts aggregated $1,796,426
      in
      fiscal year 2005 (which included $1,739,054 of accelerated accretion due to
      the
      conversion of all remaining Series D and Series E Preferred stock during the
      year) and $1,365,349 in fiscal year 2004 increasing the net loss in each year.
      Accordingly, the net loss available to common stockholders was $10,883,133
      and
      $7,325,785 in fiscal years 2005 and 2004, respectively.




**Comparison
      of Results of Operations** **for Fiscal Years Ended September 30, 2004 and 2003**




**Revenues**




Revenues
      for the fiscal year ended September 30, 2004 were $5,752,549, 337% higher than
      fiscal year 2003 revenues of $1,315,426. The increase in revenues in fiscal
      year
      2004 was primarily from increased sales of LRAD products to government
      customers. Fiscal year 2004 revenues included $5,581,936 of product revenues
      and
      $170,613 of contract and license revenues. Fiscal year 2003 revenues included
      $1,070,645 of product sales and $244,781 of contract and license revenues.
      Fiscal year 2003 revenues included sales of $95,370 of portable consumer
      products--a product line that we no longer offer for sale. Sound products
      provided the balance of fiscal 2003 product revenues and all of fiscal 2004
      product revenues





*Commercial
      Group* - Fiscal
      year 2004 net revenues of $933,373 increased 8% increase over net revenues
      of
      $861,091 in fiscal year 2003. Sound product revenues were $933,373 in fiscal
      year 2004, with no contract and license revenues. In fiscal year 2003, sound
      product revenues totaled $594,703, consumer portable product sales, were $95,730
      and contract and license revenues were $170,658. We no longer sell consumer
      portable products. The increase in sound product revenues in fiscal 2004 was
      primarily the result of increased HSS sales offset in part by reduced NeoPlanar
      sales. During most of fiscal year 2004, we developed and tested a new HSS
      product line, and HSS sales were limited to certain older systems.




20
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*Government
      & Military Group* - Net
      revenues for fiscal year 2004 increased 961% to $4,819,176, compared to $454,335
      in fiscal year 2003. Fiscal year 2004 revenues included LRAD revenues of
      $3,907,291, NeoPlanar revenues of $265,520, other product revenues of $484,827
      and contract and license revenues of $161,538. Fiscal year 2003 revenues
      included LRAD revenues of $261,106, NeoPlanar revenues of $124,674 and contract
      and license revenues of $68,555. The increase in LRAD revenues in fiscal year
      2004 was primarily the result of increased market acceptance of our LRAD1000
      product.




**Gross
      Profit**




Gross
      profit for the fiscal year ended September 30, 2004 was $2,282,728, or 40%
      of
      revenues, compared to a gross loss in fiscal 2003 of $228,651. The gross loss
      in
      2003 primarily resulted from a $319,500 special warranty reserve for
      discontinued HSS units.





Gross
      loss for our Commercial Group was $534,174 and $501,748 in fiscal years 2004
      and
      2003, respectively, primarily as a result of insufficient margins earned on
      product sales to offset the allocation of manufacturing overhead to this segment
      of our business. Gross loss for our commercial group in fiscal year 2003 was
      also affected by the special warranty reserve of $319,500 recorded as a result
      of a high failure rate of our HSS Generation I emitter design.





Gross
      profit for our Government Group was $2,816,902 in fiscal year 2004, or 58%
      of
      revenues, compared to $273,097, or 60% of revenues, in fiscal year 2003.




**Selling,
      General and Administrative Expenses**




Selling,
      general and administrative expenses were $5,309,547, or 92% of revenues, in
      fiscal year 2004, an increase of $445,836 from $4,863,711, or 370% of revenue,
      in fiscal year 2003. Legal and professional costs decreased $1,316,323 to
      $852,644 in fiscal year 2004 compared to $2,168,967 in fiscal year 2003.
      Included in legal and professional costs in fiscal year 2004 was an estimated
      settlement cost accrual of $150,000 associated with a legal action with a former
      licensee. Included in legal and professional costs in fiscal year 2003 were
      settlement costs and accruals of $1,233,754 related to legal settlements and
      a
      buyout of NeoPlanar royalties due. Personnel costs increased from $1,562,852
      in
      fiscal year 2003 to $2,449,739 in fiscal 2004 as a result of increased
      headcount.





In
      fiscal
      year 2004, we incurred $65,863 of non-cash compensation expense from extending
      the exercise period of options to certain terminated employees due to stock
      trading restrictions. In fiscal year 2003, we incurred $410,816 of non-cash
      compensation from the issuance of 109,844 common shares related to purchased
      technology and $179,995 for the issuance of stock options and warrants to
      non-employees.




**Research
      and Development Expenses**




Research
      and development expenses increased in fiscal year 2004 over fiscal year 2003.
      Fiscal year 2004 research and development expenses were $2,988,784 of which
      salaries, benefits and consultant expenses accounted for $2,015,828 or 67%.
      Fiscal year 2003 expenses totaled $2,493,351, including $315,636 of NeoPlanar
      technology amortization. Salaries and benefits and consultant costs accounted
      for $1,780,345, or 71% of research and development expenses in fiscal year
      2003.




**Loss
      From Operations**




Loss
      from
      operations for the fiscal year ended September 30, 2004 was $6,015,603, compared
      to a loss from operations of $7,561,200 in fiscal year 2003, This reduction
      in
      loss from operations was due in part to the improvement of $2,511,379 in gross
      profit in fiscal year 2004 compared to fiscal year 2003, partially offset by
      higher operating expenses.





***Other
      Income (Expense)***





In
      fiscal
      year 2004, we earned $58,056 of interest income on our cash balances and
      incurred $2,889 of interest expense. In fiscal 2003, we earned $23,293 of
      interest income and we incurred interest expense of $686,639, which included
      non-cash amortization of debt discount of $405,000, and $169,753 of interest
      paid in common stock. During fiscal year 2003, our outstanding long-term debt
      was converted to equity resulting in substantial reduction in interest
      expense.





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**Net
      Loss**




The
      net
      loss for fiscal year 2004 was $5,960,436 compared to a net loss of $8,227,013
      in
      fiscal 2003.




**Net
      Loss Available to Common Stockholders**




Net
      loss
      available to common stockholders was increased during fiscal years 2004 and
      2003
      in computing net loss per share by imputed deemed dividends based on the value
      of warrants issued in connection with convertible preferred stock. The net
      loss
      available to common stockholders was also increased in fiscal years 2004 and
      2003 by an additional deemed dividend computed from a discount provision in
      our
      convertible preferred stock. The imputed deemed dividends are not contractual
      obligations to pay such imputed dividends. Net loss available to common
      stockholders is further increased by the 6% accretion (similar to a dividend)
      on
      outstanding preferred stock. These amounts aggregated $1,365,349 in fiscal
      year
      2004 and $2,409,228 in fiscal year 2003 increasing the net loss in each year.
      Accordingly, the net loss available to common stockholders was $7,325,785 and
      $10,636,241 in fiscal years 2004 and 2003, respectively.





**Liquidity
      and Capital Resources**





We
      continue to experience significant negative cash flow from operating activities
      including developing, introducing and marketing our proprietary sound
      technologies.  We have financed our working capital requirements
      through cash generated from products sales and from financing activities. Cash
      at September 30, 2005 was $10,347,779 compared to $4,178,968 at September 30,
      2004.  The increase in cash was primarily the result of financings
      described below, offset by the operating loss and cash used to support other
      operating activities.





In
      December 2004, we sold for cash in a private offering, an aggregate of
      $2,000,000 of unsecured subordinated promissory notes due December 31, 2006.
      These notes were repaid in July 2005. See “Financing Activities”
below.





In
      December 2004, we entered into a Committed Equity Financing Facility (CEFF)
      with
      Kingsbridge Capital Ltd., pursuant to which Kingsbridge committed, subject
      to
      certain significant limiting conditions, to purchase up to $25 million of our
      common stock to support future growth.  As part of the arrangement, we
      issued a warrant to Kingsbridge to purchase 275,000 shares of our common stock
      at a price of $8.60 per share. CEFF and the warrant were cancelled in July
      2005
      and there was an unrealized gain of $183,259 for the change in value of the
      warrant from issuance to cancellation. There was a corresponding warrant
      impairment expense of $183,259 at termination.





In
      July
      2005, we sold 2,868,851 shares of common stock at a purchase price of $4.88
      per
      share. The gross proceeds from this financing were approximately $14 million.
      We
      incurred financing and closing costs of approximately $828,176, primarily
      comprised of brokerage fees and legal costs. We used approximately $2.0 million
      of the proceeds to discharge the principal balance and accrued interest on
      the
      unsecured subordinated promissory notes above. See
      “Financing Activities” below.





Other
      than cash and our balance of accounts receivable, we have no other unused
      sources of liquidity at this time. We expect to incur additional operating
      losses as a result of expenditures for research and development, marketing
      and
      sales costs and general and administrative costs for our sound products and
      technologies.  The timing and amounts of these expenditures and the
      extent of our operating losses will depend on many factors, some of which are
      beyond our control.





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


·
            government
                spending levels;


·
            introduction
                of competing technologies;


·
            failure
                of sales from our Government Group or Commercial Group to meet planned
                projections;


·
            product
                mix and effect on margins; and


·
            product
                acceptance in new markets.





Principal
      factors that could affect the availability to obtain cash from external sources
      include:


·
            volatility
                in the capital markets; and


·
            market
                price and trading volume of our common
                stock.




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Based
      on
      our current cash position and our product backlog that is shippable in the
      next
      twelve months of $4.2 million and assuming currently planned expenditures and
      level of operations, we believe we have sufficient cash for operations for
      the
      next twelve months. We believe increased sales of LRAD, HSS and NeoPlanar
      products will continue to contribute cash in fiscal 2006. We believe that any
      investment capital we may require will be available to us, but there can be
      no
      guarantee that we will be able to raise funds on terms acceptable to us, or
      at
      all. We have flexibility to adjust the level of research and development and
      selling and administrative expenses based on the availability of resources.
      However, reductions in expenditures could delay development and adversely affect
      our ability to generate future revenues.





***Cash
      Flows***





*Operating
      Activities*


Our
      net
      cash used in operating activities was $8,801,922 for the fiscal year ended
      September 30, 2005 compared to $6,030,043 for the fiscal year ended September
      30, 2004 and $5,457,369 for the fiscal year ended September 30, 2003. For the
      fiscal year ended September 30, 2005, the increased net loss was the primary
      reason for the increased cash used in operating activities. The fiscal year
      2005
      net loss of $9,086,707 included certain non-cash expenses totaling $2,703,920,
      such as $444,566 in depreciation and amortization, a $784,150 increase in the
      provision for obsolete inventory, $324,582 in options granted for compensation
      and $723,000 amortization of debt discount. The net loss was also reduced by
      a
      net unrealized gain of $1,233,259 on derivative revaluation. In addition, in
      fiscal year 2005, cash used in operating activities included an increase of
      $1,932,502 in inventories, an increase of $56,021 in accounts receivable, a
      decrease in warranty reserve of $154,667 and an increase of $44,920 in prepaid
      expenses offset in part by a $1,002,234 increase in accounts payable and accrued
      liabilities.





At
      September 30, 2005, we had working capital of $9,726,309, compared to working
      capital of $3,472,984 at September 30, 2004. This increase was primarily a
      result of the financings described above, partially offset by cash used for
      operations. Net working capital, excluding cash and short-term debt, was a
      deficit of $609,339 at September 30, 2005. This represents a decrease
      of $85,678 from the net working capital deficit at September 30, 2004 of
      $695,017. The decrease in the deficit in net working capital primarily resulted
      from increases in inventory balances offset in part by increases in accounts
      payable and other accrued liabilities.





At
      September 30, 2005, we had trade accounts receivable
      of $880,276.  This compares to $926,747 in trade accounts
      receivable at September 30, 2004. The level of trade accounts receivable at
      September 30, 2005 represented approximately 32 days of revenues. Terms with
      individual customers vary greatly. We typically require thirty-day terms from
      our customers. Our receivables can vary dramatically due to overall sales
      volumes and due to quarterly variations in sales and timing of shipments to
      and
      receipts from large customers and the timing of contract payments.





*Investing
      Activities*


We
      use
      cash in investing activities primarily for the purchase of laboratory and
      computer equipment and software and investment in new patents. Cash used in
      investing activities for capital expenditures was $480,926, $395,932 and
      $108,246, in the fiscal years ended September 30, 2005, 2004 and 2003,
      respectively. Cash used for investment in new patents was $275,587, $346,818
      and
      $112,007 in the fiscal years ended September 30, 2005, 2004 and 2003,
      respectively. We anticipate continued capital expenditures for patents in fiscal
      2006.





*Financing
      Activities*


During
      the fiscal years ended September 30, 2005, 2004 and 2003, we financed
      our working capital requirements primarily through the sale of common and
      preferred stock and warrants, promissory notes and the exercise of stock options
      and warrants. In fiscal year 2005, we received $13,171,824 of net cash proceeds
      from the sale of common stock and warrants (net of offering costs), and
      $2,566,389 of proceeds from the exercise of options and warrants. In fiscal
      year
      2004, we received cash proceeds from the exercise of options and warrants and
      from promissory notes of $1,111,317. In fiscal year 2003, we received $500,000
      from the sale of senior secured promissory notes, $2,432,500 of cash proceeds
      from the sale of Series E Preferred Stock and warrants exercisable for common
      stock, proceeds of $10,000,000 from the sale of common stock and warrants and
      $1,614,227 from the exercise of options.








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            of Contents





The
      following paragraphs summarize additional information regarding our fiscal
      2005
      financing transactions.




In
      December 2004, we sold for cash in a private offering an aggregate of $2,000,000
      of unsecured subordinated promissory notes due December 31, 2006. In connection
      with the financing, we also issued five-year warrants to purchase an aggregate
      of 150,000 shares, 75,000 of which have an exercise price of $9.28 per share,
      and 75,000 of which have an exercise price of $8.60 per share. A trust
      affiliated with Elwood G. Norris, our Chairman and the beneficial owner of
      19.5%
      of our common stock before the financing, purchased a note in the principal
      amount of $500,000 and received a warrant exercisable for 37,500 shares with
      an
      exercise price of $9.28 per share. In July 2005, we redeemed the notes and
      paid
      all interest due using proceeds from the financing described below.




In
      July
      2005, we sold 2,868,851 shares of common stock at a purchase price of $4.88
      per
      share. We also issued warrants in two series to the investors to purchase
      1,581,919 shares of common stock. The “A” Warrants are exercisable for an
      aggregate of 717,213 shares of common stock at an exercise price of $6.36 per
      share until July 18, 2009. The “B” Warrants are exercisable for an aggregate of
      864,706 shares of common stock at an exercise price of $7.23 per share until
      March 28, 2006. The
      gross
      proceeds from this financing were approximately $14 million. We incurred
      financing and closing costs of approximately $828,176, primarily comprised
      of
      brokerage fees and legal costs. We used approximately $2.0 million of the
      proceeds to discharge the principal balance of and accrued interest on the
      unsecured subordinated promissory notes above.




We
      have
      agreed to submit the July 2005 financing to a vote of our stockholders for
      approval prior to June 2006. We further agreed that, subject to certain
      exceptions, if during the next year we sell shares of our common stock, or
      options or warrants to purchase shares of our common stock, in a private
      placement or in a public offering using a Form S-3, the purchasers will have
      certain rights of first refusal to participate in the financing. We have also
      agreed to indemnify the purchasers for certain losses including a penalty of
      up
      to $140,000 per month (maximum of $70,000 per month through December 2005),
      with
      no contractual maximum, should the registration statement not remain effective
      for the securities.




The
“A”
      Warrants and “B” Warrants contain provisions that would adjust the exercise
      price, and in inverse proportion adjust the number of shares subject to the
      warrant, in the event we pay or effect stock dividends or splits, or in the
      event we sell shares of our common stock at a purchase price, or options or
      warrants to purchase shares of our common stock having an exercise price, less
      than the exercise price of the applicable warrant. The “A” Warrants also feature
      a net exercise provision, which enables the holder to choose to exercise the
      warrant without paying cash by surrendering shares subject to the warrant with
      a
      market value equal to the exercise price. This right is available only if a
      registration statement covering the shares subject to the “A” Warrants is not
      available. We have the right to redeem the “B” Warrants if the closing price of
      the shares of our common stock is $10.00 or greater for 15 consecutive trading
      days and the holder does not exercise within 20 days after we give notice of
      redemption.





**Off-Balance
      Sheet Arrangements**




We
      do not
      have any off-balance sheet arrangements, financings or other relationships
      with
      unconsolidated entities or other persons.




**Contractual
      Commitments and Commercial Commitments**





The
      following table summarizes our contractual obligations at September 30, 2005,
      and the effect such obligations are expected to have on our liquidity and cash
      flow in future periods:





**Payments
      Due by Period**




**Contractual
                Obilgations**
            
            **Total**
            
            **Less
                than 1 Year**
            
            **1-3
                Years**
            
            **4-5
                Years**
            
            **After
                5 Years**Capital
                leases
            
            $
            12,806
            
            $
            12,806
            
            $
            -
            
            $
            -
            
            $
            -Operating
                leases
            
            $
            2,082,417
            
            $
            491,737
            
            $
            730,500
            
            $
            712,065
            
            $
            148,115Purchase
              committments
            
            $
            304,250
            
            $
            304,250
            
            $
            -
            
            $
            -
            
            $
            -Total
                contractual cash obligations
            
            $
            2,399,473
            
            $
            808,793
            
            $
            730,500
            
            $
            712,065
            
            $
            148,115




24
 Table
            of Contents




**New
      Accounting Pronouncements**




In
      June
      2005, the Financial Accounting Standards Board, which we refer to as the “FASB”,
      issued SFAS No. 154, “Accounting Changes and Error Corrections”, applying
      to all voluntary accounting principle changes as well as the accounting for
      and
      reporting of such changes. SFAS No. 154 replaces APB Opinion No. 20,
“Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in
      Interim Financial Statements.” SFAS No. 154 is effective for accounting
      changes and corrections of errors made in fiscal years beginning after
      December 15, 2005. We do not expect SFAS No. 154 to affect our financial
      condition or results of operations.





In
      March
      2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for
      Conditional Asset Retirement Obligations.” FIN 47 clarifies that an entity must
      record a liability for a “conditional” asset retirement obligation if the fair
      value of the obligation can be reasonably estimated. The provision is effective
      no later than the end of fiscal years ending after December 15, 2005. We do
      not expect FIN 47 to affect our financial condition or results of operations.





In
      December 2004, the FASB finalized SFAS No. 123R Share-Based Payment, amending
      SFAS No. 123, effective beginning our first quarter of fiscal 2006. SFAS 123R
      requires the Company to expense stock options based on grant date fair value
      in
      its financial statements. Further, the SFAS 123R requires additional accounting
      related to the income tax effects and additional disclosure regarding the cash
      flow effects resulting from share-based payment arrangements. In March 2005,
      the
      U.S. Securities and Exchange Commission (the “SEC”) issued Staff Accounting
      Bulletin (“SAB”) No. 107, which expresses views of the SEC staff regarding the
      interaction between SFAS 123R and certain SEC rules and regulations, and
      provides the staff’s views regarding the valuation of share-based payment
      arrangements for public companies. The Company is considering the guidance
      of
      this SAB in the adoption of SFAS 123R. The effect of expensing stock options
      on
      results of operations using a Black-Scholes option-pricing model is presented
      in
      these financial statements above under Stock Based Compensation. Under SFAS
      123R, we must determine the appropriate fair value model to be used for valuing
      share-based payments, the amortization method for compensation cost and the
      transition method to be used at date of adoption. The transition methods include
      prospective and retroactive adoption options. We expect to utilize the
      prospective method which requires that compensation expense begin being recorded
      for all unvested stock options and restricted stock at the beginning of the
      first quarter of adoption of SFAS 123R. We are evaluating the requirements
      of
      SFAS 123R and expect the adoption of SFAS 123R will have a material impact
      on
      results of operations and earnings (loss) per share. We have not determined
      whether the adoption will result in amounts similar to the current pro-forma
      disclosures under SFAS 123.




In
      December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary
      Assets, an Amendment of APB Opinion No. 29”, which is effective for
      non-monetary exchanges occurring in fiscal periods beginning after June 15,
      2005. SFAS
      No. 153 amends APB Opinion No. 29, “Accounting for Non-monetary
      Transactions” to eliminate the exception for non-monetary exchanges of similar
      productive assets and replaces it with a general exception for exchanges of
      non-monetary assets that do not have commercial substance. A non-monetary
      exchange has commercial substance if the future cash flows of the entity are
      expected to change significantly as a result of the exchange. We do not expect
      SFAS No. 153 to affect our financial condition or results of
      operations.





In
      November 2004, the FASB issued SFAS No. 151, “Inventory Costs an amendment of
      ARB 43, Chapter 4.” SFAS No. 151 clarifies that abnormal amounts of idle
      facility expense, freight, handling costs, and wasted materials (spoilage)
      should be recognized as current-period charges and requires the allocation
      of
      fixed production overheads to inventory based on the normal capacity of the
      production facilities. SFAS No. 151 is effective for fiscal years beginning
      after June 15, 2005. We are currently evaluating the financial statement impact
      of the implementation of SFAS No. 151.




**Risk
      Factors**




*An
      investment in our company involves a high degree of risk.  In addition to
      the other information included in this report, you should carefully consider
      the
      following risk factors in evaluating an investment in our company.  You
      should consider these matters in conjunction with the other information included
      or incorporated by reference in this report. Our results of operations or
      financial condition could be seriously harmed, and the trading price of our
      common stock may decline due to any of these or other risks.*




**We
      have a history of net losses. We expect to continue to incur net losses and
      we
      may not achieve or maintain profitability.**




We
      have
      incurred significant operating losses and anticipate continued losses in fiscal
      2006. At September 30, 2005 we had an accumulated deficit of $51,414,200. We
      need to generate additional revenue and reduce operating expenses to be
      profitable in future periods. Failure to achieve profitability, or maintain
      profitability if achieved, may require us to raise additional funding which
      could have a material negative impact on the market value of our common
      stock.







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**We
      may need additional capital for growth.**




Our
      current plans indicate that depending on sales, we may need additional capital
      to support our growth. We may generate a portion of these funds from operations.




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




·
            government
                spending levels impacting the sale of our
                products;


·
            our
                ability to reduce and control
                spending;


·
            introduction
                of new competing technologies;


·
            failure
                of sales from to meet planned projections;


·
            product
                mix and effect on margins; and


·
            acceptance
                of our products in new markets.




Should
      we
      require additional funds, general market conditions or the then-current market
      price of our common stock may not support capital raising transactions. We
      may
      be required to reduce costs, including the scaling back of research and
      development into new products, which could have a negative impact on our ability
      to compete and to innovate. If we raise additional funds by selling additional
      shares of our capital stock or securities convertible into common stock
      (assuming we are able to obtain additional financing), the ownership interest
      of
      our stockholders will be diluted.




**Our
      equity financings impose certain liquidated damages which may impair our
      liquidity and ability to raise capital.**




In
      connection with our July 2005 equity financing, we entered into a registration
      rights agreement with some of the investors, pursuant to which we agreed to
      prepare and file a registration statement covering the resale of the shares
      of
      common stock sold in the financing as well as the shares of common stock
      issuable upon the exercise of the warrants sold in the financing. If the
      registration statement ceases to be effective and available, or for other
      reasons, those selling stockholders are unable to re-sell their shares purchased
      in the financing or acquired upon exercise of their related warrants, we may
      be
      obligated to pay liquidated damages to those selling stockholders in the amount
      of 0.5% of the gross proceeds we received in that financing per month until
      January 14, 2006, and 1% of those gross proceeds per month thereafter. The
      registration statement is currently effective.




**Material
      weaknesses or deficiencies in our internal control over financial reporting
      could harm stockholder and business confidence on our financial reporting,
      our
      ability to obtain financing and other aspects of our
      business.** ****





Maintaining
      an effective system of internal control over financial reporting is necessary
      for us to provide reliable financial reports.





We
      have
      identified material weaknesses in our internal control over financial reporting
      as of September 30, 2005, including the following:




·
              Failure
                  to apply existing controls established for inventory valuation
                  in
                  connection with our financial statement closing
                  process


·
              Insufficient
                  flow of information and
                  communications


·
            Inadequate
                monitoring of controls and
                procedures


·
              Ineffective
                control over our fixed asset accounting
 ·
              Ineffective
                  control over the accounting for accounts
                  receivable


·
            Insufficient
                oversight of financially significant processes and systems, including
                deficiencies relating to monitoring and oversight of the work performed
                by
                our finance and accounting
                personnel


·
            Ineffective
                control over our accounts payable





The
      existence of a material weakness is an indication that there is more than a
      remote likelihood that a material misstatement of our financial statements
      will
      not be prevented or detected.





As
      a
      result of these material weaknesses, management’s assessment as of September 30,
      2005 concluded that the Company’s internal control over financial reporting is
      ineffective. Some of the identified material weaknesses have not been fully
      addressed. It is also possible that additional material weaknesses will be
      identified in the future.  The material weaknesses in our internal
      control over financial reporting related to the lack of controls and procedures
      to ensure that revenues are recognized in accordance with generally accepted
      accounting principles, the lack of adequate manpower and insufficient qualified
      accounting personnel to identify and resolve complex accounting issues, the
      lack
      of controls over accruals and cut-offs, and the lack of controls surrounding
      financial reporting and close procedures.




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Because
      we have concluded that our internal control over financial reporting is not
      effective, and because our independent registered public accountants issued
      an adverse opinion on the effectiveness of our internal controls, and to the
      extent we identify future weaknesses or deficiencies, there could be material
      misstatements in our financial statements and we could fail to meet our
      financial reporting obligations. As a result, our ability to obtain additional
      financing, or obtain additional financing on favorable terms, could be
      materially and adversely affected which, in turn, could materially and
      adversely affect our business, our financial condition and the market value
      of
      our securities. In addition, perceptions of us could also be adversely affected
      among customers, lenders, investors, securities analysts and others. Current
      material weaknesses or any future weaknesses or deficiencies could also hurt
      confidence in our business and consolidated financial statements and our ability
      to do business with these groups.




**One
      customer accounted for approximately 69% of our revenues in fiscal year 2005.
      Two customers and their affiliates accounted for 58% of our revenues in fiscal
      year 2004, one customer accounted for 24% of our revenues in fiscal year 2003,
      and we continue to be dependent on a few large customers.**




ADS,
      Inc., a prime vendor to the U. S. military, accounted for 69% of revenues in
      fiscal year 2005. In fiscal year 2004,ADS accounted for 47% of our revenues,
      and
      a second customer and its affiliates accounted for 11% of our revenues. These
      customers have the right to cease doing business with us at any time. If our
      relationship with ADS or any other material partner or vendor were to cease,
      then our revenues would decline substantially and negatively impact our results
      of operations. Any such decline could result in us incurring net losses,
      increasing our accumulated deficit and causing us to need to raise additional
      capital to fund our operations.




**We
      must expand our customer base in order to grow our
      business.**




To
      grow
      our business, we must fulfill orders from our existing customers, obtain
      additional orders from our existing customers, develop relationships with new
      customers and obtain and fulfill orders from new customers. We cannot guarantee
      that we will be able to increase our customer base. Further, even if we do
      obtain new customers, we cannot guarantee that those customers will purchase
      from us enough quantities of our product or at product prices that will enable
      us to recover our costs in acquiring those customers and fulfilling those
      orders. Whether we will be able to sell more of our products will depend on
      a
      number of factors, including:




·
                our
                    ability to manufacture reliable products that have the features
                    that are
                    required by our customers;
 ·
                our ability to expand relationships with existing
                  customers and to develop relationships with new customers that
                  will lead
                  to additional orders for our
                  products;
 ·
                our ability to develop and expand new markets
                  for
                  directed sound products; and
 ·
                our ability to develop international product
                  distribution
                  directly or through strategic
                  partners.




**The
      growth of our Government & Military Group revenues is materially dependent
      on acceptance of our LRAD products by government, military and developing
      force protection and emergency response agencies, and if these agencies do
      not
      purchase our products, our revenues will be
      adversely affected.**




Although
      our LRAD products are designed for use by both government and commercial
      customers, the products have, to date, been predominantly sold for government
      use. Within the Government & Military Group, our largest customer, ADS, is a
      reseller of our products to end users in various branches of the military such
      as the U.S. Navy, U.S. Marine Corps, U.S. Army and the Department of Homeland
      Security. We have only recently achieved significant sales of LRAD products
      and
      only began offering our smaller LRAD500 in our fiscal fourth quarter 2005,
      and
      neither of the products have been widely accepted in the government market.
      Furthermore, the force protection and emergency response market is itself an
      emerging market which is changing rapidly. If our LRAD products are not widely
      accepted by the government, military and the developing force protection and
      emergency response markets, we may not be able to identify other markets, and
      we
      may fail to achieve our sales projections.




**Perceptions
      that long range hailing devices are unsafe or may be used in an abusive manner
      may hurt sales of our LRAD products which could cause our revenues to
      decline.**




Potential
      customers for our LRAD products, including government, military and force
      protection and emergency response agencies, may be influenced by claims or
      perceptions that long range hailing devices are unsafe or may be used in an
      abusive manner or as a weapon. These claims or perceptions could cause our
      product sales to decline or possibly subject the sale of these products to
      stricter government regulations covering the sale of weapons. In addition,
      if
      governmental agencies determine that our products could be classified as a
      weapon , our sales of these products could be negatively impacted by longer
      sales cycle. These factors could reduce future revenues, adversely affecting
      our
      financial condition and results of operations.




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**We
      may not be successful in obtaining the necessary licenses required for us to
      sell some of our products abroad.**




Licenses
      for the export of certain of our products may be required from government
      agencies in accordance with various statutory authorities, including, for
      example, the Trading with the Enemy Act of 1917, the Arms Export Control Act
      of
      1976, the Export Administration Act of 1979, or the International Emergency
      Economic Powers Act, as well as their implementing regulations and executive
      orders.




In
      the
      case of certain agreements involving equipment or services controlled under
      the
      International Traffic in Arms Regulations (ITAR) and sold at specified dollar
      volumes, the U.S. Department of State must notify Congress at least fifteen
      to
      thirty days, depending on the intended overseas destination, prior to
      authorizing these sales. During that time, Congress may take action to block
      the
      proposed sale. We do not believe our current product lines are subject to the
      congressional notification requirement; however, as our product lines expand,
      this notification requirement could impact our ability to sell certain
      controlled products or services in the international market.




The
      need
      for export licenses and, when required, congressional notification, can
      introduce a period of delay in our ability to consummate international
      transactions. Because issuance of an export license is wholly within the
      discretion of the controlling U.S. government agency, it is possible that,
      in
      some circumstances, we may not be able to obtain the necessary licenses for
      some
      potential transactions.




**We
      are currently introducing new products and technologies. If commercially
      successful products are not produced in a timely manner, we may be unprofitable
      or forced to cease operations.**




Our
      HSS,
      NeoPlanar and LRAD technologies have only recently been introduced to market
      and
      are still being improved. Commercially viable sound technology systems may
      not
      be successfully and timely produced by us due to the inherent risks of
      technology development, new product introduction, limitations on financing,
      manufacturing problems, competition, obsolescence, loss of key technical
      personnel and other factors. Revenues from our sound products have been limited
      to date and we cannot guarantee significant revenues in the future. The
      development and introduction of our current product line took longer than
      anticipated by management and the introduction of future products, if any,
      could
      also be subject to delays. Customers may not accept our current products and
      may
      elect to purchase products from competitors. We experienced quality control
      problems with some of our initial commercial HSS units, and we may not be able
      to resolve future similar problems in a timely and cost effective manner.
      Products employing our sound technology may not achieve market acceptance.
      Our
      various sound projects are high risk in nature, and unanticipated technical
      obstacles can arise at any time and result in lengthy and costly delays or
      result in a determination that further exploitation is unfeasible. If we do
      not
      successfully exploit our technology, our financial condition, results of
      operations and business prospects would be adversely affected.




**Our
      products have never been produced in quantity, and we may incur significant
      and
      unpredictable warranty costs as these products are mass
      produced.**




None
      of
      our products has been produced in sufficient quantities to be considered mass
      produced. Our technologies are substantially different from proven, mass
      produced sound transducer designs. We may incur substantial and unpredictable
      warranty costs from post-production product or component failures. We generally
      warrant our products to be free from defects in materials and workmanship for
      a
      period up to one year from the date of purchase, depending on the
      product.




At
      September 30, 2005, we had a warranty reserve of $248,981. In prior years,
      we
      recorded substantial warranty reserves for early versions of our HSS products
      and have little history to predict future warranty costs. Future warranty costs
      could further adversely affect our financial position, results of operations
      and
      business prospects.




**We
      could incur charges for excess and obsolete inventory.**




Due
      to
      rapidly changing technology, and uneven customer demand, product cycles tend
      to
      be short and the value of our inventory may be adversely affected by changes
      in
      technology that affect our ability to sell the products in our inventory. If
      we
      do not effectively forecast and manage our inventory, we may need to write
      off
      inventory as excess or obsolete, which in turn can adversely affect cost of
      sales and gross profit. In fiscal year 2005, we increased our reserve for excess
      or obsolete and slow moving inventory to $691,206.




While
      we
      will make every attempt to successfully manage product transition, including
      inventory control of older generation products when introducing new products,
      we
      have previously experienced and may, in the future, experience reductions in
      sales of older generation products as customers delay or defer purchases in
      anticipation of new product introductions. We currently have established
      reserves for slow moving or obsolete inventory. The reserves we have established
      for potential losses due to obsolete inventory may, however, prove to be
      inadequate and may give rise to additional charges for obsolete or excess
      inventory.




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**We
      do not have the ability to predict future operating results. Our quarterly
      and
      annual revenues will likely be subject to fluctuations caused by many factors,
      any of which could result in our failure to achieve our revenue
      expectations.**




We
      expect
      our proprietary sound reproduction products and technologies will be the source
      of substantially all of our future revenues. Revenues from our proprietary
      sound
      reproduction products and technologies are expected to vary significantly due
      to
      a number of factors. Many of these factors are beyond our control. Any one
      or
      more of the factors listed below or other factors could cause us to fail to
      achieve our revenue expectations. These factors include:


·
            our
                ability to develop and supply sound reproduction components to customers,
                distributors or OEMs or to license ourtechnologies;


·
            market
                acceptance of and changes in demand for our products or products
                of our
                customers;


·
            gains
                or losses of significant customers, distributors or strategic
                relationships;


·
            unpredictable
                volume and timing of customer
                orders;


·
            the
                availability, pricing and timeliness of delivery of components for
                our
                products and OEM products;


·
            fluctuations
                in the availability of manufacturing capacity or manufacturing yields
                and
                related manufacturing costs;


·
            the
                timing of new technological advances, product announcements or
                introductions by us, by OEMs or licensees and by our
                competitors;


·
            product
                obsolescence and the management of product transitions and
                inventory;


·
            unpredictable
                warranty costs associated with new product
                models;


·
            production
                delays by customers, distributors, OEMs or by us or our
                suppliers;


·
            seasonal
                fluctuations in sales;


·
            the
                conditions of other industries, such as military and commercial
                industries, into which our technologies may be
                licensed;


·
            general
                consumer electronics industry conditions, including changes in demand
                and
                associated effects on inventory and inventory
                practices;


·
            general
                economic conditions that could affect the timing of customer orders
                and
                capital spending and result in order cancellations or rescheduling;
                and


·
            general
                political conditions in this country and in various other parts of
                the
                world that could affect spending for the products that we
                offer.




Some
      or
      all of these factors could adversely affect demand for our products or
      technologies, and therefore adversely affect our future operating
      results.




Most
      of
      our operating expenses are relatively fixed in the short term. We may be unable
      to rapidly adjust spending to compensate for any unexpected sales or license
      revenue shortfalls, which could harm our quarterly operating results. We do
      not
      have the ability to predict future operating results with any
      certainty.




**Our
      expenses may vary from period to period, which could affect quarterly results
      and our stock price.**




If
      we
      incur additional expenses in a quarter in which we do not experience increased
      revenue, our results of operations would be adversely affected and we may incur
      larger losses than anticipated for that quarter. Factors that could cause our
      expenses to fluctuate from period to period include:




·
            the timing and extent of our research and development
              efforts;


·
              investments and costs of maintaining or protecting
                our
                intellectual property;
 ·
                the
                  extent of marketing and sales efforts to promote our products and
                  technologies; and
 ·
                  the
                    timing of personnel and consultant
                    hiring.




**Many
      potential competitors who have greater resources and experience than we do
      may
      develop products and technologies that make ours obsolete.**




Technological
      competition from other and longer established electronic and loudspeaker
      manufacturers is significant and expected to increase. Most of the companies
      with which we expect to compete have substantially greater capital resources,
      research and development staffs, marketing and distribution programs and
      facilities, and many of them have substantially greater experience in the
      production and marketing of products. In addition, one or more of our
      competitors may have developed or may succeed in developing technologies and
      products that are more effective than any of ours, rendering our technology
      and
      products obsolete or noncompetitive.




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**Sound
      reproduction markets are subject to rapid technological change, so our success
      will depend on our ability to develop and introduce new
      technologies.**




Technology
      and standards in the sound reproduction markets evolve rapidly, making timely
      and cost-effective product innovation essential to success in the marketplace.
      The introduction of products with improved technologies or features may render
      our technologies obsolete and unmarketable. If we cannot develop products in
      a
      timely manner in response to industry changes, or if our technologies do not
      perform well, our business and financial condition will be adversely affected.
      The life cycles of our technologies are difficult to estimate, particularly
      those such as HSS and LRAD for which there are no well established markets.
      As a
      result, our technologies, even if successful, may become obsolete before we
      recoup our investment.




**Our
      competitive position will be seriously damaged if we cannot obtain patent
      protection for important differentiating aspects of our products or
      otherwise protect intellectual property rights in our
      technology.**




We
      rely
      on a combination of contracts and trademark, patent and trade secret laws to
      establish and protect our proprietary rights in our technology. However, we
      may
      not be able to prevent misappropriation of our intellectual property, our
      competitors may be able to independently develop and the agreements we enter
      into may not be enforceable.





Our
      success, in part, depends on our ability to obtain and enforce intellectual
      property protection for our technology, particularly our patents. There is
      no
      guarantee any patent will issue on any patent application that we have filed
      or
      may file. Claims allowed from existing or pending patents may not be of
      sufficient scope or strength to protect the economic value of our technologies.
      Further, any patent that we may obtain will expire, and it is possible that
      it
      may be challenged, invalidated or circumvented. If we do not secure and maintain
      patent protection for our technology and products, our competitive position
      will
      be significantly harmed. A competitor may independently develop or patent
      technologies that are substantially equivalent to or superior to our technology.
      For example, patent protection on our LRAD products is limited, and we may
      not
      be able to prevent others from introducing products with similar functionality.
      If this happens, any patent that we may obtain may not provide protection and
      our competitive position could be significantly harmed.




As
      we
      expand our product line or develop new uses for our products, these products
      or
      uses may be outside the protection provided by our current patent applications
      and other intellectual property rights. In addition, if we develop new products
      or enhancements to existing products we cannot assure you that we will be able
      to obtain patents to protect them. Even if we do receive patents for our
      existing or new products, these patents may not provide meaningful protection.
      In some countries outside of the United States where our products can be sold
      or
      licensed, patent protection is not available. Moreover, some countries that
      do
      allow registration of patents do not provide meaningful redress for violations
      of patents. As a result, protecting intellectual property in these countries
      is
      difficult and our competitors may successfully sell products in those countries
      that have functions and features that infringe on our intellectual
      property.




We
      may
      initiate claims or litigation against third parties in the future for
      infringement of our proprietary rights or to determine the scope and validity
      of
      our proprietary rights or the proprietary rights of our competitors. These
      claims could result in costly litigation and divert the efforts of our technical
      and management personnel. As a result, our operating results could suffer and
      our financial condition could be harmed.




**Our
      competitive position will be seriously damaged if our products are found to
      infringe on the intellectual property rights of others.**




Other
      companies and our competitors may currently own or obtain patents or other
      proprietary rights that might prevent, limit or interfere with our ability
      to
      make, use or sell our products. As a result, we may be found to infringe the
      intellectual property rights of others. The electronics industry is
      characterized by vigorous protection and pursuit of intellectual property rights
      or positions, which have resulted in significant and often protracted and
      expensive litigation. In the event of a successful claim of infringement against
      us and our failure or inability to license the infringed technology, our
      business and operating results could be adversely affected. Any litigation
      or
      claims, whether or not valid, could result in substantial costs and diversion
      of
      our resources. An adverse result from intellectual property litigation could
      force us to do one or more of the following:




·
            cease
              selling, incorporating or using products or services that incorporate
              the
              challenged intellectual property;


·
              obtain
                a license from the holder of the infringed intellectual property
                right,
                which license may not be available on reasonable terms, if at all;
                and
 ·
                redesign
                  products or services that incorporate the disputed
                  technology.




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If
      we are
      forced to take any of the foregoing actions, we could face substantial costs
      and
      shipment delays and our business could be seriously harmed. Although we carry
      general liability insurance, our insurance may not cover potential claims of
      this type or be adequate to indemnify us for all liability that may be
      imposed.




In
      addition, it is possible that our customers or end users may seek indemnity
      from
      us in the event that our products are found or alleged to infringe the
      intellectual property rights of others. Any such claim for indemnity could
      result in substantial expenses to us that could harm our operating
      results.





**Our
      HSS technology is subject to government regulation, which could lead to
      unanticipated expense or litigation.**





Our
      HSS
      sound technology emits ultrasonic vibrations, and as such is regulated by the
      Food and Drug Administration. In the event of certain unanticipated defects
      in
      an HSS product, a customer or we may be required to comply with FDA requirements
      to remedy the defect and/or notify consumers of the problem. This could lead
      to
      unanticipated expense, and possible product liability litigation against a
      customer or us. Any regulatory impediment to full commercialization of our
      HSS
      technology, or any of our other technologies, could adversely affect our results
      of operations.




**We
      may face personal injury and other liability claims that harm our reputation
      and
      adversely affect our sales and financial condition.**




Some
      of
      our products are capable of sufficient acoustic output to cause damage to human
      hearing or human health if used improperly, such as when the products are used
      at close ranges or for long periods of exposure. A person injured in connection
      with the use of our products may bring legal action against us to recover
      damages on the basis of theories including personal injury, negligent design,
      dangerous product or inadequate warning. We may also be subject to lawsuits
      involving allegations of misuse of our products. Our product liability insurance
      coverage may be insufficient to pay all such claims. Product liability insurance
      may become too costly for us or may become unavailable for us in the future.
      We
      may not have sufficient resources to satisfy any product liability claims not
      covered by insurance which would materially and adversely affect our financial
      position. Significant litigation could also result in a diversion of
      management’s attention and resources, and negative publicity.




**Our
      operations could be harmed by factors including political instability, natural
      disasters, fluctuations in currency exchange rates and changes in regulations
      that govern international transactions.**




We
      expect
      to sell our products worldwide. The risks inherent in international trade may
      reduce our international sales and harm our business and the businesses of
      our
      customers and our suppliers. These risks include:




·
              changes
                in tariff regulations;
 ·
                political
                  instability, war, terrorism and other political
                  risks;
 ·
                foreign
                  currency exchange rate fluctuations;
 ·
                establishing
                  and maintaining relationships with local distributors and
                  dealers;
 ·
                lengthy
                  shipping times and accounts receivable payment
                  cycles;
 ·
                import
                  and export licensing requirements;
 ·
                compliance
                  with a variety of foreign laws and regulations, including unexpected
                  changes in taxation and regulatory
                  requirements;
 ·
                greater
                  difficulty in safeguarding intellectual property than in the U.S.;
                  and
 ·
                difficulty
                  in staffing and managing geographically diverse
                  operations.





These
      and
      other risks may preclude or curtail international sales or increase the relative
      price of our products compared to those manufactured in other countries,
      reducing the demand for our products.




**Commercialization
      of our proprietary sound technologies depends on collaborations with other
      companies. If we are not able to maintain or find collaborators and strategic
      alliance relationships in the future, we may not be able to develop our
      proprietary sound technologies and products.**




An
      important part of our strategy is to establish business relationships with
      leading participants in various segments of the electronics, government and
      sound reproduction markets to assist us in producing, distributing, marketing
      and selling products that include our proprietary sound
      technologies.




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Our
      success will therefore depend on our ability to maintain or enter into new
      strategic arrangements with partners on commercially reasonable terms. If we
      fail to enter into such strategic arrangements with third parties, our financial
      condition, results of operations, cash flows and business prospects will be
      adversely affected. Any future relationships may require us to share control
      over our development, manufacturing and marketing programs or to relinquish
      rights to certain versions of our sound and other technologies.




**We
      rely on outside manufacturers and suppliers to provide a large number of
      components and sub-assemblies incorporated in our products and may rely on
      third-party turnkey production in the future.**




Our
      products have a large number of components and subassemblies produced by outside
      suppliers. In addition, for certain of these items, we qualify only a single
      source, which can magnify the risk of shortages and decrease our ability to
      negotiate with our suppliers on the basis of price. In particular, we depend
      on
      our HSS piezo-film supplier to provide expertise and materials used in our
      proprietary HSS emitters. If shortages occur, or if we experience quality
      problems with suppliers, then our production schedules could be significantly
      delayed or costs significantly increased, which would have a material adverse
      effect on our business, liquidity, results of operation and financial
      position.




Although
      we have the ability to assemble our products internally, we have from time
      to
      time and in the future may have some or all of our products produced by
      third-party manufacturers either for major subassemblies or on a turnkey basis.
      We may be required to outsource manufacturing if sales of our products increase
      significantly. We have historically used a single third-party contract
      manufacturer to manufacture major subassemblies or products, and we expect
      to
      continue to use a single manufacturer in the future until product volume grows
      substantially. We may not be able to obtain acceptable manufacturing sources
      on
      a timely basis. In addition, from time to time we may change manufacturers
      and
      any new manufacturer engaged by us may not perform as expected. An extended
      interruption in the supply of our products could result in a substantial loss
      of
      sales. In addition, any actual or perceived degradation of product quality
      as a
      result of our reliance on third-party manufacturers may have an adverse effect
      on sales or result in increased warranty costs, product returns and buybacks.
      Failure to maintain quality manufacturing could reduce future revenues,
      adversely affecting financial condition and results of operations.




**Our
      contracts and subcontracts that are funded by the U.S. government or foreign
      governments are subject to government regulations and audits and other
      requirements.**




Government
      contracts require compliance with various contract provisions and procurement
      regulations. The adoption of new or modified procurement regulations could
      have
      a material adverse effect on our business, financial condition or results of
      operations or increase the costs of competing for or performing government
      contracts. If we violate any of these regulations, then we may be subject to
      termination of these contracts, imposition of fines or exclusion from government
      contracting and government-approved subcontracting for some specific time
      period. In addition, our contract and subcontract costs and revenues may be
      subject to adjustment as a result of audits by government auditors.





**We
      derive revenue from government contracts and subcontracts, which are often
      non-standard, may involve competitive bidding, may be subject to cancellation
      with or without penalty and may produce volatility in earnings and
      revenue.**




Our
      Government Group business has involved and is expected in the future to involve
      providing products and services under contracts or subcontracts with U.S.
      federal, state, local and foreign government agencies. Obtaining contracts
      and
      subcontracts from government agencies is challenging, and contracts often
      include provisions that are not standard in private commercial transactions.
      For
      example, government contracts may:




·
            include
              provisions that allow the government agency to terminate the contract
              without penalty under some circumstances;


·
              be
                subject to purchasing decisions of agencies that are subject to political
                influence;
 ·
                contain
                  onerous procurement procedures; and
 ·
                  be
                    subject to cancellation if government funding becomes
                    unavailable.


Securing
      government contracts can be a protracted process involving competitive bidding.
      In many cases, unsuccessful bidders may challenge contract awards, which can
      lead to increased costs, delays and possible loss of the contract for the
      winning bidder.




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**Our
      success is dependent on the performance and integration of our new executive
      team, and the cooperation, performance and retention of our executive officers
      and key employees.**




John
      R.
      Zavoli joined as our President and Chief Operating Officer in November 2005.
      He
      assumed the role of Interim Chief Financial Officer in December 2005. Also
      in
      November 2005, Rose Tomich-Litz was appointed Vice President, Operations, and
      in
      December 2005, Karen Jordan, our Director of Finance, was promoted to Chief
      Accounting Officer. Two other existing employees were promoted to executive
      officers during 2005. We are presently seeking a permanent chief financial
      officer, and as of September 30, 2005, our management identified a material
      weakness concerning oversight of accounting processes and personnel, which
      was
      primarily due to a lack of human resources and insufficiently skilled personnel
      within our operations and accounting reporting functions.




Our
      business and operations are substantially dependent on the performance and
      integration of our new President and Chief Operating Officer, the newly rebuilt
      finance department and the other new executives. Our performance is also
      substantially dependent on Elwood G. Norris, our Chairman. Our senior executives
      have worked together for only a short period of time. We do not maintain “key
      person” life insurance on any of our executive officers. The loss of one or
      several key employees could seriously harm our business.




We
      are
      also dependent on our ability to retain and motivate high quality personnel,
      especially sales and marketing executives and skilled technical personnel.
      Competition for such personnel is intense, and we may not be able to attract,
      assimilate or retain other highly qualified managerial, sales and technical
      personnel in the future. The inability to attract and retain the necessary
      managerial, sales and technical personnel could cause our business, operating
      results or financial condition to suffer.




**We
      may not address successfully the problems encountered in connection with any
      potential future acquisitions.**




We
      expect
      to continue to consider opportunities to acquire or make investments in other
      technologies, products and businesses that could enhance our capabilities,
      complement our current products or expand the breadth of our markets or customer
      base. We have limited experience in acquiring other businesses and technologies.
      Potential and completed acquisitions and strategic investments involve numerous
      risks, including:




·
            problems
              assimilating the purchased technologies, products or business
              operations;


·
              problems
                maintaining uniform standards, procedures, controls and
                policies;
 ·
              unanticipated
                costs associated with the acquisition;
 ·
              diversion
                of management’s attention from our core
                business;
 ·
              adverse
                effects on existing business relationships with suppliers and
                customers;
 ·
              risks
                associated with entering new markets in which we have no or limited
                prior
                experience;
 ·
              potential
                loss of key employees of acquired businesses;
                and
 ·
              increased
                legal and accounting costs as a result of the newly adopted rules
                and
                regulations related to the Sarbanes-Oxley Act of
                2002.


If
      we
      fail to properly evaluate and execute acquisitions and strategic investments,
      our management team may be distracted from our day-to-day operations, our
      business may be disrupted and our operating results may suffer. In addition,
      if
      we finance acquisitions by issuing equity or convertible debt securities, our
      stockholders would be diluted.





**Evolving
      regulation of corporate governance and public disclosure may result in
      additional expenses and continuing uncertainty.**




During
      fiscal 2005 we incurred substantial costs in complying with Section 404 of
      the
      Sarbanes-Oxley Act of 2002 relating to the evaluation of our internal control
      over financial reporting and having our independent auditor attest to that
      evaluation. Compliance with these requirements has been and is expected to
      continue to be expensive and time consuming.




Changing
      laws, regulations and standards relating to corporate governance and public
      disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
      NASDAQ Capital Market rules are creating uncertainty for public companies.
      We
      continually evaluate and monitor developments with respect to new and proposed
      rules and cannot predict or estimate the amount of the additional costs we
      may
      incur or the timing of such costs. These new or changed laws, regulations and
      standards are subject to varying interpretations, in many cases due to their
      lack of specificity, and as a result, their application in practice may evolve
      over time as new guidance is provided by regulatory and governing bodies. This
      could result in continuing uncertainty regarding compliance matters and higher
      costs necessitated by ongoing revisions to disclosure and governance
      practices.




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We
      are
      committed to maintaining high standards of corporate governance and public
      disclosure. If our efforts to comply with new or changed laws, regulations
      and
      standards differ from the activities intended by regulatory or governing bodies
      due to ambiguities related to practice, regulatory authorities may initiate
      legal proceedings against us and we may be harmed.





**If
      we are not current in our filings with the SEC, we will face several adverse
      consequences.**





If
      we are
      unable to remain current in our financial filings, we will not be able to have
      a
      registration statement under the Securities Act of 1933, covering a public
      offering of securities, declared effective by the SEC, and we will not be able
      to make offerings pursuant to existing registration statements or pursuant
      to
      certain “private placement” rules of the SEC under Regulation D, to any
      purchasers not qualifying as “accredited investors.” Finally, we will not be
      eligible to use a “short form” registration statement on Form S-3 for a period
      of 12 months after the delinquency occurs. In addition to the liquidated damages
      discussed above with respect to existing placements, these restrictions may
      impair our ability to raise funds, should we desire to do so, and to attract
      and
      retain key employees.





If
      we
      fail to keep our filings current with the SEC our common stock may be delisted
      from the NASDAQ Capital Market and subsequently would trade on the Pink Sheets.
      The trading of our common stock on the Pink Sheets may reduce the price of
      our
      common stock and the levels of liquidity available to our stockholders. In
      addition, the trading of our common stock on the Pink Sheets will materially
      adversely affect our access to the capital markets, and the limited liquidity
      and reduced price of our common stock could materially adversely affect our
      ability to raise capital through alternative financing sources on terms
      acceptable to us or at all. Stocks that trade on the Pink Sheets are no longer
      eligible for margin loans.,





**When
      we adopt SFAS 123R related to the accounting for employee stock option and
      employee stock purchase plans using a fair-value method, our results from
      operations and earnings per share will be reduced
      significantly.**





The
      Financial Accounting Standards Board issued SFAS No. 123R “Share-Based Payment”
in December 2004. SFAS 123R requires companies to measure all stock-based
      compensation awards using a fair-value method and record such expense in their
      financial statements. SFAS 123R is effective beginning our first quarter of
      fiscal 2006. We are assessing the impact of SFAS 123R on our stock-based
      compensation programs; however, we expect to record significant stock-based
      compensation expense that will increase our net loss and loss per share.





Technology
      companies in general and our company in particular have a history of depending
      upon and using broad-based employee stock option programs to hire, incentivize
      and retain employees in a competitive marketplace. This change in accounting
      rules could impact our ability to utilize broad-based employee stock plans
      to
      reward employees and could result in a competitive disadvantage to us in the
      employee marketplace.




**There
      are a large number of shares that we sold in our July 2005 financing that have
      recently been registered in a registration statement, and the sale of these
      shares may depress the price of our common stock and encourage short sales
      by
      third parties.**




To
      the
      extent that the investors in our 2005 financing sell shares of our common stock
      under the currently effective registration statement, our stock price may
      decrease due to the additional selling pressure in the market. The perceived
      risk of additional shares available for sale in the market may cause holders
      of
      our common stock to sell their shares, which could continue to depress or
      contribute to a decline in our stock price.




The
      sale
      of material amounts of common stock by selling stockholders under the
      registration statement for the July 2005 financing could also encourage short
      sales by third parties. In a short sale, a prospective seller borrows stock
      from
      a stockholder or broker and sells the borrowed stock. The prospective seller
      hopes that the stock price will decline, at which time the seller can purchase
      shares at a lower price to repay the lender. The seller profits when the stock
      price declines because the seller can purchase the shares at a price which
      is
      lower than the price at which the seller sold the borrowed stock. Short sales
      could place downward pressure on the price of our common stock by increasing
      the
      number of shares being sold, which could contribute to the future decline of
      our
      stock price.




**We
      may issue additional common stock in the future and this stock may reduce the
      value of your common stock.**




We
      may
      issue additional shares of common stock without further action by our
      stockholders. Moreover, the economic and voting interests of each stockholder
      will be diluted as a result of such issuances. Although the number of shares
      of
      common stock that stockholders presently own will not decrease, such shares
      will
      represent a smaller percentage of our total shares that will be outstanding
      after such events.




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**Sales
      of common stock issuable on the exercise of outstanding options and warrants,
      may depress the price of our common stock.**




As
      of
      September 30, 2005, we had outstanding options granted to our employees,
      directors and consultants to purchase 2,070,810 shares of our common stock,
      and
      had outstanding warrants issued to investors and others to purchase 3,577,653
      shares of our common stock. The exercise prices for the options and warrants
      range from $2.00 to $10.10 per share. In the future we may issue additional
      convertible securities, options and warrants. The issuance of shares of common
      stock issuable upon the exercise of convertible securities, options or warrants
      could cause substantial dilution to holders of common stock, and the sale of
      those shares in the market could cause the market price of our common stock
      to
      decline. The potential dilution from these shares could negatively affect the
      terms on which we could obtain equity financing.




**We
      may issue preferred stock in the future, and the terms of the preferred stock
      may reduce the value of your common stock.**




We
      are
      authorized to issue up to 5,000,000 shares of preferred stock in one or more
      series. Our board of directors may determine the terms of future preferred
      stock
      offerings without further action by our stockholders. If we issue additional
      preferred stock, it could affect your rights or reduce the value of your common
      stock. In particular, specific rights granted to future holders of preferred
      stock could be used to restrict our ability to merge with or sell our assets
      to
      a third party. These terms may include voting rights, preferences as to
      dividends and liquidation, conversion and redemption rights, and sinking fund
      provisions.




**Our
      stock price is volatile and may continue to be volatile in the
      future.**




Our
      common stock trades on the NASDAQ Capital Market. The market price of our common
      stock has fluctuated significantly to date. In the future, the market price
      of
      our common stock could be subject to significant fluctuations due to general
      market conditions and in response to quarter-to-quarter variations
      in:




·
            our
              anticipated or actual operating results;


·
            developments
              concerning our sound reproduction
              technologies;


·
            technological
              innovations or setbacks by us or our
              competitors;


·
            conditions
              in the consumer electronics market;


·
            announcements
              of merger or acquisition transactions;


·
            changes
              in personnel within our company; and


·
            other
              events or factors and general economic and market
              conditions.




The
      stock
      market in recent years has experienced extreme price and volume fluctuations
      that have affected the market price of many technology companies, and that
      have
      often been unrelated or disproportionate to the operating performance of
      companies.




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**Item
      7A.  Quantitative and Qualitative Disclosures About Market
      Risk.**




Market
      risk represents the risk of loss that may impact our financial position, results
      of operations or cash flows due to adverse changes in market prices, including
      interest rate risk and other relevant market rate or price risks. We do not
      use
      derivative financial instruments in our investment portfolio.




We
      are
      currently exposed to some market risk through interest rates, related to our
      investment of current cash and cash equivalents. Based on our balance of cash
      and cash equivalents of $10.3 million at September 30, 2005, a change of one
      percent in interest rate would cause a change in interest income of
      approximately $103,000. The risk is not considered material and we manage such
      risk by continuing to evaluate the best investment rates available for
      short-term high quality investments.




**Item
      8.  Financial Statements and Supplementary
      Data.**





The
      financial statements required by this item begin on page F-1 with the index
      to
      financial statements followed by the financial statements.





**Item
      9.  Changes in and Disagreements with Accountants on
      Accounting and Financial Disclosure.**





On
      June
      29, 2005, BDO Seidman, LLP, the independent registered public accounting firm
      previously engaged as the principal accountant to audit our financial
      statements, whom we will hereinafter refer to as BDO, informed us of its
      resignation as our independent registered public accounting firm.




BDO’s
      reports on our financial statements for each of the fiscal years ended September
      30, 2004 and 2003 did not contain an adverse opinion or disclaimer of opinion,
      nor were such reports qualified or modified as to uncertainty, audit scope
      or
      accounting principles.




In
      connection with its audit for each of the fiscal years ended September 30,
      2004
      and 2003, and through the interim period from October 1, 2004 through June
      29,
      2005, there has been no disagreement between us and BDO on any matters of
      accounting principles or practices, financial statement disclosure or auditing
      scope or procedure, which disagreement(s), if not resolved to the satisfaction
      of BDO, would have caused BDO to make reference to the subject matter of the
      disagreement(s) in connection with its reports on our financial
      statements.





On
      July
      6, 2005, our audit committee engaged Swenson Advisors, LLP as our principal
      independent registered public accounting firm, which firm audited our
      financial statements for the fiscal year ended September 30, 2005. We did not,
      nor did anyone on our behalf, consult Swenson Advisors during our two most
      recent fiscal years or during the subsequent interim period prior to our
      engagement of Swenson Advisors regarding the application of accounting
      principles to a specified transaction (completed or proposed) or the type of
      audit opinion that might be rendered on our financial statements, or regarding
      any matter that was the subject of a disagreement described in Item
      304(a)(1)(iv) of Regulation S-K or a reportable event described in Item
      304(a)(1)(v) of Regulation S-K.





**Item
      9A.  Controls and Procedures.**




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




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**Conclusion
      Regarding the Effectiveness of Disclosure Controls and
      Procedures**




Under
      the
      supervision and with the participation of our management, including our
      co-principal executive officers and principal financial officer, we conducted
      an
      evaluation of our disclosure controls and procedures, as such term is defined
      under Rules 13a-15(e) and 15d-15(e) promulgated under the
      Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based on
      this
      evaluation, our co-principal executive officers and our principal financial
      officer concluded that our disclosure controls and procedures were not effective
      as of September 30, 2005 due to the material weaknesses in internal control
      over
      financial reporting described below under "Management's Report on Internal
      Control Over Financial Reporting."





**Management’s
      Report on Internal Control Over Financial Reporting**





Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting, as such term is defined in Exchange Act
      Rules 13a-15(f) and 15d-15(f). Under the supervision and with the
      participation of our management, including our co-principal executive officers
      and principal financial officer, we conducted an evaluation of the effectiveness
      of our internal control over financial reporting based on the framework in *Internal
      Control - Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission (COSO
      Framework). Based on our evaluation under the framework in *Internal
      Control - Integrated Framework* ,
      our
      management identified a number of material weaknesses in internal control over
      financial reporting. A material weakness is defined in Public Company Accounting
      Oversight Board Standard No. 2 as a significant deficiency, or combination
      of
      significant deficiencies, that results in there being more than a remote
      likelihood that a material misstatement of the annual or interim financial
      statements will not be prevented or detected.





In
      December 2005, in connection with the audit of our financial statements for
      the
      year ended September 30, 2005 and management’s assessment of the effectiveness
      of our internal control over financial reporting, we identified the following
      material weaknesses in our internal control over financial reporting as of
      September 30, 2005 any of which could result in the misstatement of our interim
      or annual financial statements which would not be prevented or
      detected.





·
            Oversight
                of Accounting Processes and
                Personnel





We
                did not maintain sufficient oversight and supervision of financially
                significant processes and systems, and we noted deficiencies relating
                to
                monitoring and oversight of the work performed by our operations
                and
                accounting personnel*.*This material weakness was due primarily to a lack of adequate finance
                department supervision over finance and accounting personnel, and
                a lack
                of human resources and insufficiently skilled personnel within our
                operations and accounting reporting functions. This material weakness
                resulted in errors in the preparation and review of financial statements,
                disclosures, schedules and reconciliations supporting certain general
                ledger account balances, errors not detected in certain accrued liability
                accounts and accounts payable, proper valuation and costing of inventory,
                proper tracking and accounting for fixed assets, and accurate valuation
                of
                accounts receivables, thereby resulting in audit adjustments to our
                fiscal
                year 2005 annual financial statements.




·
              Information
                    and Communications
  We
          did
          not maintain adequate processes for gathering key financial information
          to
          support the achievement of financial reporting objectives. As a result,
          management's ability to monitor both internal and external events was
          compromised. This material weakness resulted from a lack of skilled personnel
          and adequate supervisory management, primarily in our finance and operations
          organizations. This material weakness resulted in the unavailability of
          reliable
          information concerning inventory, fixed assets, accounts receivable and
          accounts
          payable, which in turn contributed to audit adjustments to our fiscal year
          2005
          annual financial statements.
  ·
                  Monitoring
 
 We
                          did not maintain adequate processes to determine whether
                          internal control
                          over financial reporting was operating effectively and
                          whether financial
                          reports were reliably and accurately prepared. In particular,
                          we lacked an
                          ongoing monitoring process that would have enabled management
                          to determine
                          whether internal control over financial reporting was present
                          and
                          functioning. This material weakness resulted from a lack
                          of skilled
                          personnel and adequate supervisory management, primarily
                          in our finance
                          and operations organizations. This material weakness resulted
                          in various
                          deficiencies in our financial reporting process relating
                          to our inventory
                          valuation, fixed asset accounting, accounts receivable
                          and accounts
                          payable, and resulted in audit adjustments for our fiscal
                          year 2005 annual
                          financial statements.


·
            Inventory
                Valuation





Controls
                that we have established for inventory valuation were not properly
                applied
                in connection with our financial statement closing process for the
                year
                ended September 30, 2005. This failure to apply existing controls
                relative
                to inventory valuation resulted both from lack of experienced accounting
                and operations personnel , the lack of proper supervision of such
                personnel, and the unexpected departure of personnel responsible
                for the
                application of such controls. This material weakness resulted in
                incorrect
                valuation and proper pricing of our inventory at our fiscal year
                ended
                September 30, 2005, thereby resulting in an audit adjustment to our
                fiscal
                year 2005 annual financial
                statements.




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  ·
                Fixed
                    Asset Accounting
  We
                      did not maintain effective control over the accounting for
                      fixed assets.
                      We lacked an appropriate policy for reconciling certain recorded
                      assets
                      for which there was incomplete identifying information with
                      assets on
                      hand, and also lacked experienced accounting personnel responsible
                      for
                      maintaining fixed assets. This material weakness resulted in
                      an adjustment
                      of the value of the company’s fully depreciated fixed assets for which
                      there was no impact to the company’s reported fixed assets net of
                      depreciation, as well as an adjustment to the valuation of
                      net fixed
                      assets at September 30, 2005.


·
            Accounts
                Receivable





We
                  did not maintain effective control over the accounting for accounts
                  receivable. This failure to apply existing controls relative to
                  accounting
                  for accounts receivables resulted from a lack of experienced accounting
                  personnel and inadequate supervision of the personnel responsible
                  for
                  timely accounts receivables reconciliations. We discovered several
                  discrepancies between our accounting records and those of our customers
                  concerning the value of accounts receivable outstanding at September
                  30,
                  2005. This material weakness resulted in audit adjustments to our
                  fiscal
                  2005 annual financial
                  statements.





·
            Accounts
                Payable




We
                    did not maintain effective controls over the accuracy of our
                    accounts
                    payable and recorded liabilities at September 30, 2005. Specifically,
                    we
                    did not account for all invoices that had been issued to us by
                    various
                    vendors for the period ended September 30, 2005. This material
                    weakness
                    resulted in audit adjustments to our fiscal year 2005 annual
                    financial
                    statements.


Our
      management’s assessment of the effectiveness of our internal control over
      financial reporting as of September 30, 2005 has been audited by Swenson
      Advisors, LLP, the independent registered public accounting firm that also
      audited our consolidated financial statements included in this annual report,
      as
      stated in their report which is included herein.





Our
      management has discussed the material weaknesses described above with our audit
      committee. In an effort to remediate the identified material weaknesses and
      other control deficiencies, we have implemented and/or plan to implement the
      measures described below. Although we believe these actions will remediate
      the
      material weaknesses described above, management will need to complete further
      testing to verify that these remediation efforts have been executed in a manner
      sufficient to remedy such material weaknesses.




Because
      of these material weaknesses, management has concluded that our company did
      not
      maintain effective internal control over financial reporting as of September
      30,
      2005, based on the COSO Framework .




Our
      independent registered public accounting firm, Swenson Advisors LLP, has audited
      management’s assessment of the effectiveness of the company’s internal control
      over financial reporting as stated in its report which appears on page F-2
      of this Annual Report on Form 10-K.




**Remediation
      of Material Weaknesses**




As
      of the
      filing date of this report, we have not fully remediated the material weaknesses
      in our internal control over financial reporting identified as of
      September 30, 2005.  However, beginning in November 2005, management has
      taken a number of steps that it believes will improve the effectiveness of
      our
      internal control over financial reporting including the following:




·
            Oversight
                of Accounting Processes and
                Personnel




As
                  discussed above, in November and December 2005,
                  we hired new accounting department personnel who we believe have
                  the
                  expertise and experience required to perform the functions to timely
                  and correctly report financial results. In December 2005, we promoted
                  Karen Jordan, who joined us in November 2005 as Director of Finance,
                  to
                  Chief Accounting Officer. In December 2005, our Chief Financial
                  Officer
                  resigned from his employment, and Mr. John R. Zavoli, our President
                  and
                  Chief Operating Officer, was appointed Interim Chief Financial
                  Officer.
                  Mr. Zavoli has significant financial oversight experience. See
                  "Description of Business - Executive Officers" above for more information
                  on the backgrounds of Mr. Zavoli and Ms. Jordan. We are actively
                  seeking a
                  new permanent chief financial officer who will provide close supervision
                  of accounting personnel to ensure compliance with our controls
                  and
                  procedures. In part due to our ongoing search for a permanent chief
                  financial officer, we cannot be certain at this time that these
                  steps have
                  corrected the associated material
                  weakness.
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 ·
                Information
                      and Communications
  We
                      have hired new accounting and operations personnel in November
                      and
                      December 2005, including new management personnel. In December
                      2005, we
                      designed a procedure for our accounting department to disseminate
                      key
                      information and metrics to senior management beginning in our
                      second
                      quarter of fiscal 2006 in order to support the achievement
                      of financial
                      reporting objectives. We believe that these steps will correct
                      the
                      associated material weakness discussed
                      above.
 ·
                      Monitoring
  We
                            have hired new accounting personnel in November and December
                            2005,
                            including new management personnel. In December 2005,
                            these personnel were
                            directed to review our monitoring controls, and to the
                            extent necessary,
                            improve monitoring processes to be consistent with the
                            criteria based on
                            the COSO Framework.


·
            Inventory
                Valuation




We
                  have hired new accounting personnel in November
                  and December 2005, and have documented closing procedures that
                  these
                  personnel will follow in properly computing the cost of inventory
                  on a net
                  realizable basis. We believe these steps will remediate the associated
                  material weakness discussed above.


·
            Fixed
                Asset Accounting




In
                  December 2005, we implemented a control for
                  accounting personnel to conduct an annual inventory of our fixed
                  assets.
                  The control also calls for purchases of new assets to be properly
                  entered
                  into our accounting system by asset description and type, and all
                  current
                  and future assets to be tagged with an asset number for tracking
                  in our
                  accounting system. We believe this step will correct the associated
                  material weakness discussed above.


·
            Accounts
                Receivable




Accounting
                  personnel will follow control
                  procedures managing accounts receivable and periodic reconciliation
                  of
                  accounts receivable with customers consistent with our closing
                  processes.
                  We believe this step will correct the associated material weakness
                  discussed above.


·
            Accounts
                Payable




In
                November 2005, we implemented a policy for
                all company personnel to follow our controls and procedures related
                to
                incurring liabilities, including purchasing procedures and properly
                identifying and recording accounts payable. We believe these steps
                will
                correct the associated material weakness discussed
                above.




**Changes
      in Internal Controls**




Except
      as
      discussed above, there were no changes in our internal control over financial
      reporting during our fiscal quarter ended September 30, 2005 that have
      materially affected, or are reasonably likely to materially affect, our internal
      control over financial reporting.





**Item
      9B.  Other Information.**





On
      December 23, 2005, we entered into a separation agreement with Michael A.
      Russell. Mr. Russell was formerly our Chief Financial Officer and Secretary
      and
      resigned from his employment on December 16, 2005. The agreement provides that
      Mr. Russell will remain an employee of our company through January 3, 2006.
      The
      agreement provides for our payment of $46,250 as severance, to be paid at Mr.
      Russell's former base rate of pay following termination in accordance with
      our
      regular payroll practices, with all then unpaid amounts paid by March 31, 2006,
      and our payment of health benefit premiums on Mr. Russell's behalf for a period
      not to extend beyond March 31, 2006. In addition, the agreement requires Mr.
      Russell to execute a general release of all claims against the
      company.





The
      foregoing disclosure is made in lieu of disclosure under Item 1.01 on Form
      8-K.




39
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**PART
        III******
  Certain
        information required by this Part III is omitted from this report and is
        incorporated by reference to our Definitive Proxy Statement to be filed with
        the
        Securities and Exchange Commission in connection with the Annual Meeting
        of
        Stockholders to be held in 2006 (the Proxy Statement).
  **Item
        10. Directors and Executive Officers of the
        Registrant.**
  (a)
              Executive
                  Officers—See “Executive Officers” in Part I, Item 1
                  hereof.
  (b)
              Directors---The
                  information required by this Item is incorporated herein by reference
                  to
                  our Proxy Statement.


(c)
            Audit
                Committee Financial Expert—The board of directors has determined that
                Daniel Hunter is an “audit committee financial expert” and “independent”
                as defined under applicable SEC and NASDAQ rules.  The board’s
                affirmative determination was based, among other things, upon his
                over 25
                years as a certified public
                accountant.




(d)
            We
                have adopted a “Code of Business Conduct and Ethics,” a code of ethics
                that applies to all employees, including our executive officers.
                A copy of
                the Code of Business Conduct and Ethics is posted on our Internet
                website
                at www.atcsd.com.  In the event we make any amendments to, or
                grant any waivers of, a provision of the Code of Business Conduct
                and
                Ethics that applies to the principal executive officer, principal
                financial officer, or principal accounting officer that requires
                disclosure under applicable SEC rules, we intend to disclose such
                amendment or waiver and the reasons therefore on a Form 8-K or on
                our next
                periodic report.




**Item
      11.  Executive Compensation.**




The
      information required by this item is incorporated by reference to the Proxy
      Statement under the heading "Executive Compensation."




**Item
      12.  Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters.**




The
      information required by this item is incorporated by reference to the Proxy
      Statement under the heading "Security Ownership of Certain Beneficial Owners
      and
      Management and Related Stockholder Matters."




**Item
      13.  Certain Relationships and Related
      Transactions.**




The
      information required by this item is incorporated by reference to the Proxy
      Statement under the heading "Certain Relationships and Related
      Transactions."




**Item
      14.  Principal Accounting Fees and
      Services.**




The
      information required by this item is incorporated by reference to the Proxy
      Statement under the heading "Principal Accounting Fees and
      Services."




40
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**PART
      IV******




**Item
      15.  Exhibits, Financial Statement Schedules and Reports
      on Form 8-K.**





The
      following financial statements are filed as part of this report under “Part II,
      Item 8 - Financial Statements and Supplementary Date”:




**Financial
                  Statements and Schedules:**Management’s
                  Report on Internal Control over Financial ReportingReports
                  of Independent Registered Public Accounting FirmsBalance
                  Sheets as of September 30, 2005 and 2004Statements
                  of Operations for the Years Ended September 30, 2005,  2004 and
                  2003Statements
                  of Stockholders’ Equity (Deficit) for the Years Ended September 30, 2005,
                  2004 and 2003Statements
                  of Cash Flows for the Years Ended September 30, 2005, 2004 and
                  2003Summary
                  of Accounting Policies and Notes to Financial
                  StatementsSchedule
                  II - Valuation and Qualifying Accounts(Schedules
                  I, III, IV and V are not applicable and have therefore been
                  omitted.)
  **Exhibits:**




**3.  Articles
                of Incorporation and Bylaws**3.1
            
            Certificate
                of Incorporation of American Technology Corporation (Delaware) dated
                March
                1, 1992. Filed as Exhibit 2.1 on Form 10-SB effective August 1,
                1994.3.1.1
            
            Amendment
                to Certificate of Incorporation of American Technology Corporation
                dated
                March 24, 1997 and filed with Delaware on April 22, 1997. Filed as
                Exhibit
                3.1.1 on Form 10-QSB for the quarter ended March 31, 1997, dated May
                13, 1997.3.1.2
            
            Corrected
                Certificate of Designations of Series A Convertible Preferred Stock
                dated
                and filed with Delaware on August 25, 1997. Filed as Exhibit 3.1.3
                on Form
                8-K dated August 29, 1997.3.1.3
            
            Corrected
                Certificate of Designations of Series B Convertible Preferred Stock
                filed
                with Delaware on December 23, 1998. Filed as Exhibit 3.1.4 on Form
                10-KSB
                for the year ended September 30, 1998, dated December 29,
                1998.3.1.4
            
            Corrected
                Certificate of Designation of Series C Preferred Stock filed with
                Delaware
                on April 19, 2000. Filed as Exhibit 3.1.5 on Form 8-K dated April
                19,
                2000.3.1.5
            
            Certificate
                of Designation of Series D Preferred Stock filed with Delaware on
                May 3,
                2002. Filed as Exhibit 3.1 on Form 10-Q for the quarter ended March
                31,
                2002, dated May 15, 2002.3.1.6
            
            Certificate
                of Amendment to Certificate of Incorporation filed with Delaware
                on
                September 26, 2002. Filed as Exhibit 3.1.6 on Form 10-K for the year
                ended
                September 30, 2002, dated December 23, 2002.3.1.7
            
            Certificate
                of Designation of Series E Preferred Stock filed with Delaware on
                February
                28, 2003. Filed as Exhibit 4.2 on Form 8-K dated March 6,
                2003.




3.2
            
            Amended
                and Restated Bylaws of American Technology Corporation. Filed as
                Exhibit
                3.1 on Form 10-Q for the quarter ended March 31, 2004, dated May
                5,
                2004.3.3
            
            Restated
                Bylaws of American Technology Corporation. Filed as Exhibit 3.1 on
                Form
                10-Q for the quarter ended December 31, 2004, dated February 11,
                2005.





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**10.  Material
                Contracts**10.1
            
            Royalty
                Agreement between ATC and Elwood G. Norris dated September 3,
                1985.  Filed as Exhibit 6.2 on Form 10-SB effective August 1,
                1994.+10.2
            
            Assignment
                of Technology Agreement between ATC and Elwood G. Norris dated March
                2,
                1992. Filed as Exhibit 6.3 on Form 10-SB effective August 1,
                1994.+10.2.1
            
            Addendum
                Agreement to Assignment of Technology Agreement between ATC and Elwood
                G.
                Norris dated December 2, 1996. Filed as Exhibit 10.3.1 on Form 10-KSB
                for
                year ended September 30, 1996, dated December 13,
                1996.+10.3
            
            Amended
                and Restated Sublease Agreement between ATC and Smiths Industries
                Aerospace & Defense Systems, Inc. as amended, dated September 1,
                2000.  Filed as Exhibit 10.6.1 on Form 10-K for the year ended
                September 30, 2000, dated October 29, 2000.10.3.1
            
            First
                Amendment to Amended and Restated Sublease Agreement, dated January
                1,
                2004.  Filed as Exhibit 10.1 on Form 10-Q for the quarter ended
                March 31, 2004, dated May 5, 2004.10.3.2
            
            Attornment
                Agreement between ATC and LBA Realty Fund-Holding Co. I, LLC dated
                August
                1, 2005.*10.3.3
            
            First
                Amendment to Attornment Agreement between ATC and LBA Realty Fund-Holding
                Co. I, LLC dated November 15, 2005.*10.4
            
            Employment
                Agreement dated as of September 1, 1997 between ATC and Elwood G.
                Norris
                filed as Exhibit 10.16 on Form 10-KSB for year ended September 30,
                1997,
                dated December 1, 1997.+10.5
            
            1997
                Stock Option Plan as adopted on January 23, 1998 filed as Exhibit
                10.1 on
                Form S-8 dated July 27, 1998.+10.5.1
            
            Form
                of Incentive Stock Option Agreement under 1997 Stock Option Plan.
                Filed as
                Exhibit 10.5.1 on Form 10-K for the year ended September 30, 2004,
                dated
                December 28, 2004.+10.5.2
            
            Form
                of Non-Statutory Stock Option Agreement under 1997 Stock Option Plan.
                Filed as Exhibit 10.5.2 on Form 10-K for the year ended September
                30,
                2004, dated December 28, 2004.+10.6
            
            2002
                Stock Option Plan.  Filed as Exhibit 99.1 on Form S-8 dated
                November 18, 2002.+10.6.1
            
            Form
                of Stock Option Grant Notice and Stock Option Agreement under 2002
                Stock
                Option Plan. Filed as Exhibit 10.6.1 on Form 10-K for the year ended
                September 30, 2004, dated December 28, 2004.+10.7
            
            Form
                of Stock Purchase Warrant exercisable until September 30, 2006 granted
                to
                accredited investors for an aggregate of 1,012,500 common shares
                (individual warrants differ as to holder, number of shares and issuance
                date).  Filed as Exhibit 4.12 on Form 8-K dated October 12,
                2001.10.8
            
            Form
                of Stock Purchase Warrant exercisable until March 31, 2007 granted
                to
                investors for an aggregate of 517,880 common shares (individual warrants
                differ as to holder, number of shares and issuance date). Filed as
                Exhibit
                10.2 on Form 10-Q for the quarter ended March 31, 2002, dated May
                15,
                2002.10.9
            
            Form
              of Stock Purchase Warrant exercisable until December 31, 2007 granted
              to
              accredited investors for an aggregate of 514,875 common shares (individual
              warrants differ as to holder, number of shares and issuance
              date).  Filed as Exhibit 4.3 on Form 8-K dated March 6,
              2003.10.10
            
            Securities
              Purchase
              Agreement dated July 11, 2003. Filed as Exhibit 4.1 on Form 8-K dated
              July
              17, 2003.





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10.11
            
            Registration
                Rights Agreement dated July 11, 2003. Filed as Exhibit 4.2 on Form
                8-K
                dated July 17, 2003.10.12
            
            Form
                of Common Stock Warrant exercisable until July 10, 2007 granted to
                accredited investors for an aggregate of 454,547 common shares (individual
                warrants differ as to holder, number of shares and issuance date).
                Filed
                as Exhibit 4.3 on Form 8-K dated July 17, 2003.10.13
            
            Employment
                Agreement of Kalani Jones dated August 28, 2003, as amended. Filed
                as
                Exhibit 10.29 on Form 10-K for the year ended September 30, 2003,
                dated
                December 29, 2003.+10.13.1
            
            Separation
                and Release Agreement with Kalani Jones dated October 20,
                2005.+*10.14
            
            Employment
                Agreement of Carl Gruenler, as amended. Filed as Exhibit 10.30 on
                Form
                10-K for the year ended September 30, 2003, dated December 29,
                2003.+10.14.1
            
            Separation
                and Release Agreement with Carl Gruenler dated June 15, 2005. Filed
                as
                Exhibit 99.1 on Form 8-K filed June 17, 2005.+10.14.2
            
            Consulting
                Agreement with Carl Gruenler dated June 15, 2005. Filed as Exhibit
                99.2 on
                Form 8-K filed June 17, 2005.+10.15
            
            Form
                of Inducement Grant Notice and Inducement Stock Option Agreement.
                Filed as
                Exhibit 4.1 on Form 8-K dated September 28, 2004.+10.16
            
            Table
                of Inducement Grants.+*10.17
            
            Form
                of Special Stock Option.  Filed as Exhibit 99.2 on Form S-8
                dated November 18, 2002.+10.18
            
            Employment
                Agreement of Michael Russell. Filed as Exhibit 10.1 on Form 10-Q
                for the
                quarter ended June 30, 2004, dated August 4, 2004.+10.19
            
            Inducement
                Grant Notice and Inducement Stock Option Agreement of Michael Russell.
                Filed as Exhibit 10.28 on Form 10-K for the year ended September
                30, 2004,
                dated December 28, 2004.+10.20
            
            Employment
                Agreement of Joseph A. Zerucha.  Filed as Exhibit 10.2 on Form
                10-Q for the quarter ended December 31, 2003, dated February 12,
                2004.+10.21
            
            Separation
                Agreement of Joseph A. Zerucha.  Filed as Exhibit 10.2 on Form
                10-Q for the Form 10-Q for the quarter ended June 30, 2004, dated
                August
                4, 2004.+10.22
            
            Employment
                Agreement of Bruce Ehlers.  Filed as Exhibit 10.1 on Form 10-Q
                for the quarter ended December 31, 2003, dated February 12,
                2004.+10.23
            
            Release
                Agreement of Bruce Ehlers. Filed as Exhibit 10.32 on Form 10-K for
                the
                year ended September 30, 2004, dated December 28,
                2004.+10.24
            
            Common
                Stock Purchase Agreement dated December 14, 2004 with Kingsbridge
                Capital
                Limited. Filed as Exhibit 10.1 on Form 8-K filed December 17,
                2004.10.25
            
            Registration
                Rights Agreement dated December 14, 2004 with Kingsbridge Capital
                Limited.
                Filed as Exhibit 10.2 on Form 8-K filed December 17, 2004.10.26
            
            Warrant
                dated December 14, 2004 in favor of Kingsbridge Capital Limited.
                Filed as
                Exhibit 4.1 to Form 8-K filed December 17, 2004.





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10.27
            
            Termination,
                Settlement and Release Agreement with Kingsbridge Capital Limited
                dated
                July 8, 2005. Filed as Exhibit 10.3 on Form 10-Q for the quarter
                ended
                June 30, 2005, dated August 9, 2005.10.28
            
            Promissory
                Note and Warrant Purchase Agreement dated December 23, 2004 with
                the
                purchasers described therein. Filed as Exhibit 10.39 on Form 10-K
                for the
                year ended September 30, 2004, dated December 28,
                2004.+10.29
            
            Form
                of Unsecured Subordinated Promissory Note. Filed as Exhibit 10.40
                on Form
                10-K for the year ended September 30, 2004, dated December 28,
                2004.+10.30
            
            Form
                of Warrant. Filed as Exhibit 10.41 on Form 10-K for the year ended
                September 30, 2004, dated December 28, 2004.+10.31
            
            Summary
                Sheet of Director and Executive Officer Compensation.*10.32
            
            Employment
                offer letter for Bruce Gray effective March 21, 2005. Filed as Exhibit
                10.2 on Form 10-Q for the quarter ended March 31, 2005, dated May
                10,
                2005.+10.33
            
            Inducement
                Stock Option Grant Notice and Inducement Stock Option Agreement for
                Bruce
                Gray dated March 22, 2005. Filed as Exhibit 10.3 on Form 10-Q for
                the
                quarter ended March 31, 2005, dated May 10, 2005.+10.34
            
            Commission
                Plan for Bruce Gray pursuant to Employment letter dated March 21,
                2005,
                approved by the board of directors on September 28,
                2005.+*^10.35
            
            Securities
                Purchase Agreement dated July 14, 2005. Filed as Exhibit 99.1 on
                Form 8-K
                filed July 19, 2005.10.36
            
            Registration
                Rights Agreement dated July 14, 2005. Filed as Exhibit 99.2 on Form
                8-K
                filed July 19, 2005.10.37
            
            Form
                of Warrant-A issued July 18, 2005. Filed as Exhibit 99.3 on Form
                8-K filed
                July 19, 2005.10.38
            
            Form
                of Warrant-B issued July 18, 2005. Filed as Exhibit 99.4 on Form
                8-K filed
                July 19, 2005.10.39
            
            Engagement
                letter with Olympus Securities, LLC dated July 15, 2005. Filed as
                Exhibit
                99.5 on Form 8-K filed July 19, 2005.10.40
            
            2005
                Equity Incentive Plan as amended August 5, 2005. Filed as Exhibit
                10.9 on
                Form 10-Q for the quarter ended June 30, 2005 dated August 9,
                2005.+10.41
            
            Form
                of Stock Option Agreement under the 2005 Equity Incentive Plan for
                grants
                prior to August 5, 2005. Filed as Exhibit 99.2 to Form S-8 filed
                June 2,
                2005.+10.42
            
            Form
                of Stock Option Agreement under the 2005 Equity Incentive Plan for
                grants
                on or after August 5, 2005. Filed as Exhibit 10.11 on Form 10-Q for
                the
                quarter ended June 30, 2005 dated August 9, 2005.+10.43
            
            Form
                of Stock Award Agreement under the 2005 Equity Incentive Plan. Filed
                as
                Exhibit 10.12 on Form 10-Q for the quarter ended June 30, 2005 dated
                August 9, 2005.+10.44
            
            Settlement
                Agreement and Mutual Release with eSoundIdeas, Inc., SoundIdeas,
                Greg O.
                Endsley, Douglas J. Paschall and Gordon & Holmes LLP dated April 27,
                2005. Filed as Exhibit 10.14 on Form 10-Q for the quarter ended June
                30,
                2005 dated August 9, 2005.





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10.45
            
            Registration
                Rights Agreement with Greg O. Endsley, Douglas J. Paschall and Gordon
                & Holmes LLP dated April 27, 2005. Filed as Exhibit 10.15 on Form 10-Q
                for the quarter ended June 30, 2005 dated August 9,
                2005.10.46
            
            Employment
                Agreement with James Croft III dated February 28,
                2000.+*10.47
            
            Employment
                Letter Agreement with John R. Zavoli dated October 17,
                2005.+*10.48
            
            Employment
                letter of Alan J. Ballard dated November 21, 2003.+*10.49
            
            Employment
                letter of Rose Tomich-Litz dated November 29, 2005.+*10.50
            
            Employment
                letter of Karen Jordan dated October 26, 2005, 2005.+*10.51
            
            Sublease
                between ATC and Anacomp, Inc. dated December 13, 2005.*10.52
            
            Separation
                Agreement between ATC and Michael A. Russell dated December 23,
                2005.***23.  Consents
                of Experts and Counsel**23.1
            
            Consent
                of BDO Seidman, LLP.*23.2
            
            Consent
                of Swenson Advisors, LLP.***24.  Power
                of Attorney**24.1
            
            Power
                of Attorney. Included on signature
                page.




**31.
                  Certifications**31.1
              
              Certification
                  of Elwood G. Norris, Co-Principal Executive Officer, pursuant to
                  Rule
                  13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934,
                  as
                  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002.*31.2
              
              Certification
                  of John R. Zavoli, Co-Principal Executive Officer and Principal
                  Financial
                  Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities
                  and
                  Exchange Act of 1934, as adopted pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002.*32.1
              
              Certification
                  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                  Section 906 of the Sarbanes-Oxley Act of 2002, executed by Elwood G.
                  Norris, Co-Principal Executive Officer, John R. Zavoli, Co-Principal
                  Executive Officer and Principal Financial
                  Officer.*
  *  Filed
                  concurrently herewith+  Management
                  contract or compensatory plan or arrangement. Exhibits 10.28, 10.29
                  and
                  10.30 are included as a management contract given that a trust
                  affiliated
                  with an officer, director and significant stockholder purchased
                  a note and
                  received a warrant in connection with that financing and is a party
                  to
                  those exhibits.^ 
                Confidential treatment has been requested with respect to certain
                portions
                of this exhibit. Omitted portions have been filed separately with the
                Securities and Exchange Commission.


45
 Table
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**American
      Technology Corporation**


**Index
      to Financial Statements**





Report
                  of Independent Registered Public Accounting Firm
              F-2Report
                  of Independent Registered Public Accounting Firm
              F-5Balance
                  Sheets as of September 30, 2005 and 2004
              F-6Statements
                    of Operations for the Years EndedSeptember
                    30, 2005, 2004 and 2003
              F-7Statements
                    of Stockholders’ Equity (Deficit) for the Years Ended September 30, 2005,
                    2004 and 2003
              F-8
                  - F-9Statements
                    of Cash Flows for the Years EndedSeptember
                    30, 2005, 2004 and 2003
              F-10Summary
                  of Accounting Policies and Notes to Financial Statements
              F-11
                  - F-32Schedule
                  II - Valuation and Qualifying Accounts
              F-33




F-1
 Table
            of Contents


**Report
      of Independent Registered Public Accounting Firm**


REPORT
          OF
          INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
  To
          the
          Board of Directors and Stockholders of
 American
          Technology Corporation:
 
 We
          have
          completed an integrated audit of American Technology Corporation’s 2005
          financial statements and of its internal control over financial reporting
          as of
          September 30, 2005 in accordance with the standards of the Public Company
          Accounting Oversight Board (United States). Our opinion, based on our audit,
          is
          presented below.
 
 Financial
          Statements and financial statement schedule
 
 In
          our
          opinion, the financial statements listed in the index appearing under Item
          15
          (a)(1) present fairly in all material respects, the financial position
          of
          American Technology Corporation as of September 30, 2005 and the results
          of
          their operations and their cash flows for the year then ended in conformity
          with
          accounting principles generally accepted in the United States of America.
          In
          addition, in our opinion, the financial statement schedule listed in the
          index
          appearing under Item 15(a)(2) presents fairly, in all material respects,
          the
          information set forth therein when read in conjunction with the related
          financial statements. These financial statements and financial statement
          schedule are the responsibility of the Company’s management. Our responsibility
          is to express an opinion on these financial statements and financial statement
          schedule based on our audit. We conducted our audit of these statements
          in
          accordance with the standards of the Public Company Accounting Oversight
          Board
          (United States). Those standards require that we plan and perform the audit
          to
          obtain reasonable assurance about whether the financial statements are
          free of
          material misstatement. An audit of financial statements includes examining,
          on a
          test basis, evidence supporting the amounts and disclosures in the financial
          statements, assessing the accounting principles used and significant estimates
          made by management, and evaluating the overall financial statement presentation.
          We believe that our audit provides a reasonable basis for our
          opinion.
 
 Internal
          control over financial reporting
 
 Also,
          we
          have audited management’s assessment, included in Management’s Report on
          Internal Control Over Financial Reporting appearing under item 9A, that
          American
          Technology Corporation did not maintain effective control over financial
          reporting as of September 30, 2005 because the Company did not maintain
          sufficient oversight and supervision of financially significant process
          systems
          to include the preparation of the financial statements, schedules and related
          disclosures, did not maintain adequate processes for gathering key financial
          information to support the achievement of financial reporting objectives,
          did
          not maintain adequate processes to determine whether internal control over
          financial reporting was operating effectively and whether financial reports
          were
          reliably and accurately prepared, did not properly and completely maintain
          inventory costs in accordance with generally accepted accounting principles
          as
          of September 30, 2005, did not maintain accurate fixed asset records, did
          not
          properly maintain effective control over the accounting for accounts receivable,
          and did not maintain effective controls over accounts payable to properly
          record
          all invoices issued to the Company for the period ended September 30, 2005.
          The
          Company’s management is responsible for maintaining effective control over
          financial reporting and for its assessment of the effectiveness of internal
          control over financial reporting. Our responsibility is to express an opinion
          on
          management’s assessment and on the effectiveness of the Company’s internal
          control over financial reporting based on our audit.
   F-2
 
 We
          conducted our audit of internal control over financial reporting in accordance
          with the standards of the Public Company Accounting Oversight Board (United
          States). Those standards require that we plan and perform the audit to
          obtain
          reasonable assurance about whether effective control over financial reporting
          was maintained in all material respects. An audit of internal control over
          financial reporting includes obtaining an understanding of internal control
          over
          financial reporting, evaluating management’s assessment, testing and evaluating
          the design and operating effectiveness of internal control, and performing
          such
          other procedures as we consider necessary in the circumstances. We believe
          that
          our audit provides a reasonable basis for our opinion.
 
 A
          company’s internal control over financial reporting is a process designed to
          provide reasonable assurance regarding the reliability of financial reporting
          and the preparation of financial statements for external purposes in accordance
          with generally accepted accounting principles. A company’s internal control over
          financial reporting includes those policies and procedures that (i) pertain
          to
          the maintenance of records that, in reasonable detail, accurately and fairly
          reflect the transaction and dispositions of the assets of the company;
          (ii)
          provide reasonable assurance that transactions are recorded as necessary
          to
          permit preparation of financial statements in accordance with generally
          accepted
          accounting principles, and that receipts and expenditures of the company
          are
          being made only in accordance with authorizations of management and directors
          of
          the company; and (iii) provide reasonable assurance regarding prevention
          or
          timely detection of unauthorized acquisition, use, or disposition of the
          company’s assets that could have a material effect on the financial statements.
 
 Because
          of its inherent limitations, internal control over financial reporting
          may not
          prevent or detect misstatements. Also, projections of any evaluation of
          effectiveness to future periods are subject to the risk that controls may
          become
          inadequate because of changes in conditions, or that the degree of compliance
          with the policies or procedures may deteriorate.
 
 A
          material weakness is a control deficiency, or combination of control
          deficiencies, that results in more than a remote likelihood that a material
          misstatement of the annual financial statements will not be prevented or
          detected. The following material weaknesses have been identified and included
          in
          management’s assessment:
 
  F-3
 
 ·
                      Oversight
                          of Accounting Processes and
                          Personnel
 
 The
            Company did not maintain sufficient oversight and supervision of financially
            significant processes and systems, and did not monitor and oversee the
            work
            performed by their operations and accounting personnel. This material
            weakness
            was due primarily to a lack of adequate finance department supervision
            over
            finance and accounting personnel, and a lack of human resources and
            insufficiently skilled personnel within the operations and accounting
            reporting
            functions. This material weakness resulted in errors in the preparation
            and
            review of financial statements, disclosures, schedules and reconciliations
            supporting certain general ledger account balances, errors not detected
            in
            certain accrued liability accounts and accounts payable, proper valuation
            and
            costing of inventory, proper tracking and accounting for fixed assets,
            and
            accurate valuation of accounts receivables.
 
 ·
                  Information
                      and Communication
 
 The
            Company did not maintain adequate processes for gathering key financial
            information to support achievement of financial reporting objectives.
            As a
 result,
            management’s ability to monitor internal and external events was compromised.
            This material weakness resulted from a lack of personnel and adequate
            supervisory management, primarily in the finance and operations organizations.
            This material weakness resulted in the unavailability of reliable information
            concerning inventory, fixed assets, accounts receivable, and accounts
            payable.
 
 ·
                  Monitoring
 
 The
            Company did not maintain adequate processes to determine whether internal
            control over financial reporting was operating effectively and whether
            financial
            reports were reliably and accurately prepared. In particular, the Company
            lacked
            an ongoing monitoring process that would have enabled management to determine
            whether internal control over financial reporting was present and functioning.
            This material weakness resulted from a lack of skilled personnel and
            adequate
            supervisory management, primarily in the finance and operations organizations.
            This material weakness resulted in various deficiencies relating to inventory
            valuation, fixed asset accounting, accounts receivable, and accounts
            payable.
 
 ·
                      Inventory
                          Valuation
 
 Controls
            that the Company established for inventory valuation were not properly
            applied
            in connection with the financial statement closing process for the year
            ended
            September 30, 2005. This failure to apply existing controls relative
            to
            inventory valuation resulted both from lack of experienced accounting
            and
            operations personnel , the lack of proper supervision of such personnel,
            and the
            unexpected departure of personnel responsible for the application of
            such
            controls. This material weakness resulted in incorrect valuation and
            improper
            pricing of our inventory at the fiscal year ended September 30,
            2005.
 
 ·
                  Fixed
                      Asset Accounting
 
 The
            Company did not maintain effective control over the accounting for fixed
            assets.
            The Company lacked an appropriate policy for reconciling certain recorded
            assets
            for which there was incomplete identifying information with assets on
            hand, and
            also lacked experienced
            accounting personnel responsible for maintaining fixed assets. This material
            weakness resulted in an adjustment to the value of the Company’s fully
            depreciated fixed assets as well as an adjustment to the valuation of
            net fixed
            assets at September 30, 2005.
 
 ·
                  Accounts
                      Receivable
 
 The
            Company did not maintain effective control over the accounting for accounts
            receivable. This failure to apply existing controls relative to accounting
            for
            accounts receivables resulted from a lack of experienced accounting personnel
            and inadequate supervision of the
            personnel responsible for timely accounts receivables reconciliations.
            The
            Company discovered several discrepancies between their accounting records
            and
            those of their customers concerning the value of accounts receivable
            outstanding
            at September 30, 2005.
 
 ·
                  Accounts
                      Payable
 
 The
            Company did not maintain effective controls over the accuracy of their
            accounts
            payable and recorded liabilities at September 30, 2005. Specifically,
            the
            Company did not account for all invoices that had been issued to them
            by various
            vendors for the period ended September 30, 2005.
 
 These
            material weaknesses were considered in determining the nature, timing,
            and
            extent of audit tests applied in our audit of the 2005 financial statements
            and
            our opinion regarding the effectiveness of the Company’s internal control does
            not affect our opinion on those financial statements.
 
 In
            our
            opinion, management’s assessment that American Technology Corporation did not
            maintain effective internal control over financial reporting as of September
            30,
            2005 is fairly stated, in all material respects, based on criteria established
            in *Internal
            Control - Integrated Framework* issued
            by COSO. Also, in our opinion, because of the effects of the material
            weakness
            described above on the achievement of the objectives of the control criteria,
            American Technology Corporation has not maintained effective internal
            control
            over financial reporting as of September 30, 2005, based on criteria
            established
            in Internal Control - Integrated Framework issued by COSO.
 
 The
            financial statements of American Technology Corporation as of September
            30, 2004
            and 2003 were audited by other auditors whose report dated November 10,
            2004
            except for Note 14 as to which the date is December 23, 2004, and included
            in
            this Form 10K, stated the financial statements presented fairly, in all
            material
            respects the financial position of American Technology Corporation as
            of
            September 30, 2004 and 2003 and for the years then ended.
 /s/
            Swenson Advisors LLP
 Swenson
            Advisors LLP
 San
            Diego, California
 December
            27, 2005
 
 F-4
 Table
                  of Contents
 
 **Report
        of Independent Registered Public Accounting Firm**
 
 To
          the
          Stockholders and Board of Directors
 American
          Technology Corporation
 San
          Diego, California
  We
          have
          audited the accompanying balance sheet of American Technology Corporation
          as of
          September 30, 2004, and the related statements of operations, stockholders’
equity (deficit) and cash flows for each of the two years in the period
          ended
          September 30, 2004. We have also audited the related fiscal 2004 and 2003
          financial statement schedules listed as Schedule II in Item 15. These financial
          statements and schedules are the responsibility of the Company’s management. Our
          responsibility is to express an opinion on these financial statements based
          on
          our audits.
  We
          conducted our audits in accordance with the standards of the Public Company
          Accounting Oversight Board (United States). Those standards require that
          we plan
          and perform the audit to obtain reasonable assurance about whether the
          financial
          statements are free of material misstatement. An audit includes consideration
          of
          internal control over financial reporting as a basis for designing audit
          procedures that are appropriate in the circumstances, but not for the purpose
          of
          expressing an opinion on the effectiveness of the Company’s internal control
          over financial reporting. Accordingly, we express no such opinion. An audit
          also
          includes examining, on a test basis, evidence supporting the amounts and
          disclosures in the financial statements. An audit also includes assessing
          the
          accounting principles used and significant estimates made by management,
          as well
          as evaluating the overall financial statement presentation. We believe
          that our
          audits provide a reasonable basis for our opinion.
  In
          our
          opinion, the financial statements referred to above present fairly, in
          all
          material respects, the financial position of American Technology Corporation
          at
          September 30, 2004, and the results of its operations and its cash flows
          for
          each of the two years in the period ended September 30, 2004 in conformity
          with
          accounting principles generally accepted in the United States of America.
  Also,
          in
          our opinion, the related fiscal 2004 and 2003 financial statement schedules
          present fairly, in all material respects, the information set forth therein.
  /s/
        BDO SEIDMAN, LLP
 
 
 Costa
        Mesa, California
 November
        10, 2004
  F-5
 Table
            of Contents
  **PART
          I. FINANCIAL INFORMATION**
 **Item
          1. Financial Statements.**
 **American
          Technology Corporation**
 BALANCE
          SHEETS
 
 September
                    30,
                
                2005
                
                2004**ASSETS****Current
                    Assets:**Cash
                
                $
                10,347,779
                
                $
                4,178,968Trade
                    accounts receivable, less allowance of$125,000
                    and $25,000 for doubtful accounts, respectively
                
                
                880,276
                
                
                926,747Inventories,
                    net of $691,206 and $110,000 reserve for obsolescence
                
                
                1,799,447
                
                
                651,095Prepaid
                    expenses and other
                
                
                201,339
                
                
                156,419**Total
                    current assets**
                
                
                13,228,841
                
                
                5,913,229**Equipment**,
                    net
                
                
                606,871
                
                
                453,355**Patents**,
                    net
                
                
                1,373,158
                
                
                1,278,707**Total
                    assets**
                
                $
                15,208,870
                
                $
                7,645,291**LIABILITIES
                    AND STOCKHOLDERS' EQUITY****Current
                    Liabilities:**Accounts
                    payable
                
                $
                1,985,353
                
                $
                1,300,075Accrued
                    liabilities:Payroll
                    and related
                
                
                476,331
                
                
                302,706Deferred
                    revenue
                
                
                395,833
                
                
                322,344Warranty
                    reserve
                
                
                248,981
                
                
                331,917Legal
                    settlements
                
                
                71,900
                
                
                150,000Other
                
                
                30,003
                
                
                22,236Derivative
                    warrant instrument
                
                
                282,000
                
                
                -Capital
                    lease short-term portion
                
                
                12,131
                
                
                10,967**Total
                    current liabilities**
                
                
                3,502,532
                
                
                2,440,245**Long-Term
                    Liabilities:**Derivative
                    warrant instrument
                
                
                1,564,000
                
                
                -Capital
                    lease long-term portion
                
                
                -
                
                
                12,131**Total
                    liabilities**
                
                
                5,066,532
                
                
                2,452,376**Commitments
                    and contingencies****Stockholders'
                    equity****Preferred
                    stock**, $0.00001 par value; 5,000,000 shares
                    authorized:Series
                    D Preferred stock 250,000 shares designated: 0 and 50,000issued
                    and outstanding, respectively. Liquidationpreference
                    of $0 and $572,500, respectively.
                
                
                -
                
                
                -Series
                    E Preferred stock 350,000 shares designated: 0 and 233,250issued
                    and outstanding, respectively. Liquidation preferenceof
                    $0 and $2,556,000, respectively.
                
                
                -
                
                
                3**Common
                    stock**, $0.00001 par value; 50,000,000 shares
                    authorized;24,290,840
                    and 19,808,819 shares issued and outstanding respectively.
                
                
                243
                
                
                198**Additional
                    paid-in capital**
                
                
                61,556,295
                
                
                47,520,207**Accumulated
                    deficit**
                
                
                (51,414,200
                )
                
                (42,327,493
                )**Total
                    stockholders' equity**
                
                
                10,142,338
                
                
                5,192,915**Total
                    liabilities and stockholders' equity**
                
                $
                15,208,870
                
                $
                7,645,291See
                    accompanying notes to financial statements
 F-6
 Table
              of Contents
 
 **American
        Technology Corporation**
 STATEMENTS
        OF OPERATIONS
 
 Years
                  Ended September 30,
              
              2005
              
              2004
              
              2003**Revenues:**Product
                  sales
              
              $
              10,013,215
              
              $
              5,581,936
              
              $
              1,070,645Contract
                  and license
              
              
              182,331
              
              
              170,613
              
              
              244,781Total
                  revenues
              
              
              10,195,546
              
              
              5,752,549
              
              
              1,315,426Cost
                  of revenues
              
              
              5,624,361
              
              
              3,469,821
              
              
              1,544,077**Gross
                  profit**
              
              
              4,571,185
              
              
              2,282,728
              
              
              (228,651
              )**Operating
                  expenses:**Selling,
                  general and administrative
              
              
              9,333,436
              
              
              5,309,547
              
              
              4,839,198Research
                  and development
              
              
              4,621,532
              
              
              2,988,784
              
              
              2,493,351Total
                  operating expenses
              
              
              13,954,968
              
              
              8,298,331
              
              
              7,332,549Loss
                  from operations
              
              
              (9,383,783
              )
              
              (6,015,603
              )
              
              (7,561,200
              )**Other
                  income (expense):**Interest
                  income
              
              
              84,510
              
              
              58,056
              
              
              23,293Interest
                  expense
              
              
              (837,434
              )
              
              (2,889
              )
              
              (686,639
              )Unrealized
                  gain on derivative revaluation
              
              
              1,233,259
              
              
              -
              
              
              -Warrant
                  impairment expense
              
              
              (183,259
              )
              
              -
              
              
              -Other
              
              
              -
              
              
              -
              
              
              (2,467
              )Total
                  other income (expense)
              
              
              297,076
              
              
              55,167
              
              
              (665,813
              )**Net
                  loss**
              
              
              (9,086,707
              )
              
              (5,960,436
              )
              
              (8,227,013
              )Dividend
                  requirements on convertible preferred stock
              
              
              1,796,426
              
              
              1,365,349
              
              
              2,409,228**Net
                  loss available to common stockholders**
              
              $
              (10,883,133
              )
              $
              (7,325,785
              )
              $
              (10,636,241
              )**Net
                  loss per share of common stock - basic and
                  diluted**
              
              $
              (0.50
              )
              $
              (0.37
              )
              $
              (0.67
              )**Average
                  weighted number of common shares outstanding**
              
              
              21,570,002
              
              
              19,603,265
              
              
              15,857,569See
                  accompanying notes to financial statements
  F-7
 Table
            of Contents
 **American
          Technology Corporation**
 STATEMENTS
          OF STOCKHOLDERS' EQUITY (DEFICIT)
 Years
                    Ended September 30, 2005, 2004 and 2003Convertible
                    Preferred StockSeries
                    B
                
                Series
                    C
                
                Series
                    D
                
                Series
                    EShares
                
                Amount
                
                Shares
                
                Amount
                
                Shares
                
                Amount
                
                Shares
                
                Amount**Balance,
                    September 30, 2002**
                
                
                -
                
                $
                -
                
                
                10,000
                
                $
                -
                
                
                235,400
                
                $
                2
                
                
                -
                
                $
                -Issuance
                    of Series E preferred stock, net of
                  offering
                    costs of $176,225
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                343,250
                
                
                3Issuance
                    of common stock:Upon
                    exercise of stock options
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -For
                    compensation and services
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -For
                    cash at $5.50 per share, net of offering
                  costs
                    of $545,000
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Conversion
                    of Series C preferred stock
                
                
                -
                
                
                -
                
                
                (10,000
                )
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Conversion
                    of Series D preferred stock
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (185,400
                )
                
                (2
                )
                
                -
                
                
                -Conversion
                    of Series E preferred stock
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (80,000
                )
                
                -Exercise
                    of warrants
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Legal
                    settlement at $5.85 per share
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Conversion
                    of 12% convertible subordinated notes
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Issuance
                    of stock options and warrants for
                  services
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Deemed
                    dividends and accretion on
                  convertible
                    preferred stock of $2,409,228
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Net
                    loss for the year
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -**Balance,
                    September 30, 2003**
                
                
                -
                
                $
                -
                
                
                -
                
                $
                -
                
                
                50,000
                
                $
                -
                
                
                263,250
                
                $
                3Issuance
                    of common stock:Upon
                    exercise of stock options
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Legal
                    settlement and royalty buyout at
                  $4.96
                    per share
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Conversion
                    of Series E preferred stock
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (30,000
                )
                
                -Exercise
                    of warrants
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Value
                    assigned to 28,438 options issued
                  on
                    termination
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Deemed
                    dividends and accretion on
                  convertible
                    preferred stock of $1,365,349
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Net
                    loss for the year
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -**Balance,
                    September 30, 2004**
                
                
                -
                
                $
                -
                
                
                -
                
                $
                -
                
                
                50,000
                
                $
                -
                
                
                233,250
                
                $
                3Issuance
                    of common stock:Upon
                    exercise of stock options
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -For
                    cash at $4.88 per share, net of
                  offering
                    costs of $828,176
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Value
                    assigned to warrants
                
                
                
                
                
                
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Conversion
                    of Series D preferred stock
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (50,000
                )
                
                -
                
                
                -
                
                
                (1
                )Conversion
                    of Series E preferred stock
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (233,250
                )
                
                (2
                )Exercise
                    of warrants
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Cashless
                    exercise of 25,000 warrants
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Legal
                    settlement at $8.01 per share
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Value
                    assigned to extension of time to
                  exercise 92,675 options
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Debt
                    discount for 150,000 warrants granted on 8%
                  unsecured
                    subordinated promissory notes
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Issuance
                    of stock options and warrants for
                  services
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Deemed
                    dividends and accretion on
                  convertible preferred stock of $1,796,426
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Net
                    loss for the year
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -**Balance,
                    September 30, 2005**
                
                
                -
                
                $
                -
                
                
                -
                
                $
                -
                
                
                -
                
                $
                -
                
                
                -
                
                $
                -
 See
          accompanying notes to financial statements.
 F-8
 Table
            of Contents
 **American
          Technology Corporation**
 STATEMENTS
            OF STOCKHOLDERS' EQUITY (DEFICIT)
 Years
                      Ended September 30, 2005, 2004 and 2003Common
                      StockShares
                  
                  Amount
                  
                  Additional
                      Paid-in Capital
                  
                  Accumulated
                      Deficit
                  
                  Total
                      Stockholders' Equity (Deficit)**Balance,
                      September 30, 2002**
                  
                  
                  14,351,476
                  
                  $
                  144
                  
                  $
                  27,255,016
                  
                  $
                  (28,140,044
                  )
                  $
                  (884,882
                  )Issuance
                      of Series E preferred stock, net of offering costs of $176,225
                  
                  
                  -
                  
                  
                  -
                  
                  
                  3,256,272
                  
                  
                  -
                  
                  
                  3,256,275Issuance
                      of common stock:Upon
                      exercise of stock options
                  
                  
                  408,951
                  
                  
                  4
                  
                  
                  1,614,223
                  
                  
                  -
                  
                  
                  1,614,227For
                      compensation and services
                  
                  
                  109,844
                  
                  
                  1
                  
                  
                  410,815
                  
                  
                  -
                  
                  
                  410,816For
                      cash at $5.50 per share, net of offering costs of $545,000
                  
                  
                  1,818,180
                  
                  
                  18
                  
                  
                  9,454,982
                  
                  
                  -
                  
                  
                  9,455,000Conversion
                      of Series C preferred stock
                  
                  
                  41,130
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Conversion
                      of Series D preferred stock
                  
                  
                  695,266
                  
                  
                  7
                  
                  
                  (5
                  )
                  
                  -
                  
                  
                  -Conversion
                      of Series E preferred stock
                  
                  
                  253,294
                  
                  
                  3
                  
                  
                  (3
                  )
                  
                  -
                  
                  
                  -Exercise
                      of warrants
                  
                  
                  347,000
                  
                  
                  3
                  
                  
                  903,718
                  
                  
                  -
                  
                  
                  903,721Legal
                      settlement at $5.85 per share
                  
                  
                  100,000
                  
                  
                  1
                  
                  
                  584,999
                  
                  
                  -
                  
                  
                  585,000Conversion
                      of 12% convertible subordinated notes
                  
                  
                  1,217,516
                  
                  
                  12
                  
                  
                  2,435,020
                  
                  
                  -
                  
                  
                  2,435,032Issuance
                      of stock options and warrants for services
                  
                  
                  -
                  
                  
                  -
                  
                  
                  179,995
                  
                  
                  -
                  
                  
                  179,995Deemed
                      dividends and accretion on convertible    preferred stock of
                      $2,409,228
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Net
                      loss for the year
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (8,227,013
                  )
                  
                  (8,227,013
                  )**Balance,
                      September 30, 2003**
                  
                  
                  19,342,657
                  
                  $
                  193
                  
                  $
                  46,095,032
                  
                  $
                  (36,367,057
                  )
                  $
                  9,728,171Issuance
                      of common stock:Upon
                      exercise of stock options
                  
                  
                  292,573
                  
                  
                  3
                  
                  
                  1,061,314
                  
                  
                  -
                  
                  
                  1,061,317Legal
                      settlement and royalty buyout at $4.96 per share
                  
                  
                  50,000
                  
                  
                  1
                  
                  
                  247,999
                  
                  
                  -
                  
                  
                  248,000Conversion
                      of Series E preferred stock
                  
                  
                  98,589
                  
                  
                  1
                  
                  
                  (1
                  )
                  
                  -
                  
                  
                  -Exercise
                      of warrants
                  
                  
                  25,000
                  
                  
                  -
                  
                  
                  50,000
                  
                  
                  -
                  
                  
                  50,000Value
                      assigned to 28,438 options issued on termination
                  
                  
                  -
                  
                  
                  -
                  
                  
                  65,863
                  
                  
                  -
                  
                  
                  65,863Deemed
                      dividends and accretion on convertible    preferred stock of
                      $1,365,349
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Net
                      loss for the year
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (5,960,436
                  )
                  
                  (5,960,436
                  )**Balance,
                      September 30, 2004**
                  
                  
                  19,808,819
                  
                  $
                  198
                  
                  $
                  47,520,207
                  
                  $
                  (42,327,493
                  )
                  $
                  5,192,915Issuance
                      of common stock:Upon
                      exercise of stock options
                  
                  
                  237,612
                  
                  
                  3
                  
                  
                  830,111
                  
                  
                  -
                  
                  
                  830,114For
                      cash at $4.88 per share, net of offering costs of $828,176
                  
                  
                  2,868,851
                  
                  
                  29
                  
                  
                  13,171,795
                  
                  
                  -
                  
                  
                  13,171,824Value
                      assigned to warrants
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (2,896,000
                  )
                  
                  -
                  
                  
                  (2,896,000
                  )Conversion
                      of Series D preferred stock
                  
                  
                  129,259
                  
                  
                  1
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Conversion
                      of Series E preferred stock
                  
                  
                  801,306
                  
                  
                  8
                  
                  
                  (6
                  )
                  
                  -
                  
                  
                  -Exercise
                      of warrants
                  
                  
                  407,068
                  
                  
                  4
                  
                  
                  1,736,271
                  
                  
                  -
                  
                  
                  1,736,275Cashless
                      exercise of 25,000 warrants
                  
                  
                  20,425
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Legal
                      settlement at $8.01 per share
                  
                  
                  17,500
                  
                  
                  -
                  
                  
                  140,175
                  
                  
                  -
                  
                  
                  140,175Value
                      assigned to extension of time to exercise 92,675 options
                  
                  
                  -
                  
                  
                  -
                  
                  
                  266,963
                  
                  
                  -
                  
                  
                  266,963Debt
                      discount for 150,000 warrants granted on 8% unsecured
                    subordinated
                      promissory notes
                  
                  
                  -
                  
                  
                  -
                  
                  
                  723,000
                  
                  
                  -
                  
                  
                  723,000Issuance
                      of stock options and warrants for services
                  
                  
                  -
                  
                  
                  -
                  
                  
                  63,779
                  
                  
                  -
                  
                  
                  63,779Deemed
                      dividends and accretion on convertible
                    preferred stock of $1,796,426
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Net
                      loss for the year
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (9,086,707
                  )
                  
                  (9,086,707
                  )**Balance,
                      September 30, 2005**
                  
                  
                  24,290,840
                  
                  $
                  243
                  
                  $
                  61,556,295
                  
                  $
                  (51,414,200
                  )
                  $
                  10,142,338
 See
        accompanying notes to financial
        statements.
 F-9
 Table
            of Contents
  **American
          Technology Corporation**
 STATEMENTS
          OF CASH FLOWS
  Years
                      ended September 30,
                  
                  2005
                  
                  2004
                  
                  2003**Increase
                      (Decrease) in Cash****Operating
                      Activities:**Net
                      loss
                  
                  $
                  (9,086,707
                  )
                  $
                  (5,960,436
                  )
                  $
                  (8,227,013
                  )Adjustments
                      to reconcile net loss to net cash used
                      in operations:Depreciation
                      and amortization
                  
                  
                  444,566
                  
                  
                  239,948
                  
                  
                  549,612Allowance
                      for doubtful accounts
                  
                  
                  102,492
                  
                  
                  -
                  
                  
                  4,809Warranty
                      provision
                  
                  
                  71,731
                  
                  
                  101,671
                  
                  
                  313,187Provision
                      for obsolete inventory
                  
                  
                  784,150
                  
                  
                  90,000
                  
                  
                  -Loss
                      on disposition of asset
                  
                  
                  23,064
                  
                  
                  -
                  
                  
                  -Common
                      stock issued for services and compensation
                  
                  
                  -
                  
                  
                  -
                  
                  
                  410,816Options
                      and warrants granted for services
                  
                  
                  6,160
                  
                  
                  -
                  
                  
                  179,995Options
                      granted for compensation
                  
                  
                  324,582
                  
                  
                  65,863
                  
                  
                  -Common
                      stock issued for legal settlement
                  
                  
                  -
                  
                  
                  -
                  
                  
                  585,000Write-off
                      of abandoned patents
                  
                  
                  40,916
                  
                  
                  37,798
                  
                  
                  -Amortization
                      of debt discount
                  
                  
                  723,000
                  
                  
                  -
                  
                  
                  405,000Unrealized
                      gain on derivative revaluation
                  
                  
                  (1,233,259
                  )
                  
                  -
                  
                  
                  -Warrant
                      impairment expense
                  
                  
                  183,259
                  
                  
                  -
                  
                  
                  -Changes
                      in assets and liabilities:Trade
                      accounts receivable
                  
                  
                  (56,021
                  )
                  
                  (742,585
                  )
                  
                  (77,485
                  )Inventories
                  
                  
                  (1,932,502
                  )
                  
                  (332,151
                  )
                  
                  (272,063
                  )Prepaid
                      expenses and other
                  
                  
                  (44,920
                  )
                  
                  (122,570
                  )
                  
                  (13,719
                  )Accounts
                      payable
                  
                  
                  685,278
                  
                  
                  695,732
                  
                  
                  (12,188
                  )Warranty
                      reserve
                  
                  
                  (154,667
                  )
                  
                  (89,254
                  )
                  
                  -Accrued
                      liabilities
                  
                  
                  316,956
                  
                  
                  (14,059
                  )
                  
                  696,680Net
                      cash used in operating activities
                  
                  
                  (8,801,922
                  )
                  
                  (6,030,043
                  )
                  
                  (5,457,369
                  )**Investing
                      Activities:**Purchase
                      of equipment
                  
                  
                  (480,926
                  )
                  
                  (395,932
                  )
                  
                  (108,246
                  )Patent
                      costs paid
                  
                  
                  (275,587
                  )
                  
                  (346,818
                  )
                  
                  (112,007
                  )Net
                      cash used in investing activities
                  
                  
                  (756,513
                  )
                  
                  (742,750
                  )
                  
                  (220,253
                  )**Financing
                      Activities:**Offering
                      Costs Paid
                  
                  
                  (828,176
                  )
                  
                  -
                  
                  
                  (721,225
                  )Proceeds
                      from issuance of preferred stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  2,432,500Proceeds
                      from issuance of common stock
                  
                  
                  14,000,000
                  
                  
                  -
                  
                  
                  10,000,000Payments
                      on capital lease
                  
                  
                  (10,967
                  )
                  
                  (9,914
                  )
                  
                  (8,963
                  )Proceeds
                      from issuance of unsecured promissory notes
                  
                  
                  2,000,000
                  
                  
                  -
                  
                  
                  -Payments
                      on unsecured promissory notes
                  
                  
                  (2,000,000
                  )
                  
                  -
                  
                  
                  -Payments
                      on senior secured promissory notes
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (318,155
                  )Proceeds
                      from exercise of common stock warrants
                  
                  
                  1,736,275
                  
                  
                  50,000
                  
                  
                  221,876Proceeds
                      from issuance of senior secured promissory notes
                  
                  
                  -
                  
                  
                  -
                  
                  
                  500,000Proceeds
                      from exercise of stock options
                  
                  
                  830,114
                  
                  
                  1,061,317
                  
                  
                  1,614,227Net
                      cash provided by financing activities
                  
                  
                  15,727,246
                  
                  
                  1,101,403
                  
                  
                  13,720,260Net
                      increase/(decrease) in cash
                  
                  
                  6,168,811
                  
                  
                  (5,671,390
                  )
                  
                  8,042,638Cash,
                      beginning of period
                  
                  
                  4,178,968
                  
                  
                  9,850,358
                  
                  
                  1,807,720Cash,
                      end of period
                  
                  $
                  10,347,779
                  
                  $
                  4,178,968
                  
                  $
                  9,850,358
 See
              accompanying notes to financial statements
 F-10
 Table
              of Contents
  **American
                Technology CorporationSummary of Accounting
                Policies**
   **ORGANIZATION
        AND BUSINESS**
 American
        Technology Corporation (the “Company”), a Delaware corporation, is engaged in
        design, development and commercialization of sound, acoustic and other
        technologies. The Company produces products based on its HyperSonic Sound
        (HSS),
        Long Range Acoustic Device (LRAD), NeoPlanar and other sound
        technologies.
 
 The
        Company’s principal markets for its proprietary sound reproduction technologies
        and products are in North America, Europe and Asia.
 
 **LIQUIDITY
        AND MANAGEMENT’S PLAN**
 The
        Company incurred net losses of $9,086,707, $5,960,436, and $8,227,013 and
        negative cash flow from operations of $8,801,922, $6,030,043 and $5,457,369
        in
        the years ended September 30, 2005, 2004 and 2003, respectively.  The
        Company had working capital of $9,726,309 and cash on hand of $10,347,779
        at
        September 30, 2005. The Company historically has financed its operations
        primarily through the sale of capital stock, exercise of stock options,
        sale of notes, proceeds from the sale of investment securities and margins
        from
        product sales and licensing.  Management expects to incur additional
        operating losses in fiscal 2006 as a result of expenditures for research
        and
        development and marketing costs for sound products.  The timing and amounts
        of these expenditures and the extent of the Company’s operating losses will
        depend on future product sales levels and other factors, some of which are
        beyond management’s control. Based on the Company’s cash position, and assuming
        currently planned expenditures and level of operations, management believes
        the
        Company will have sufficient capital resources for the next twelve months. 
Management’s operating plans are based on the Company continuing to increase
        revenues and generate positive cash flows from operations.  If required,
        management has significant flexibility to adjust the level of research and
        development and selling and administrative expenses based on the availability
        of
        resources.
 
 **USE
        OF ESTIMATES**
 The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions (e.g. reserves for accounts receivable and inventory,
        patent realizability and warranty reserves) that affect the reported amounts
        of
        assets and liabilities, and disclosure of contingent assets and liabilities
        at
        the date of the financial statements and affect the reported amounts of revenues
        and expenses during the reporting period. Actual results could materially
        differ
        from those estimates.
 
 **FINANCIAL
        INSTRUMENTS AND CONCENTRATION OF CREDIT RISK**
 The
        Company’s financial instruments that are exposed to concentrations of credit
        risk consist primarily of cash and trade accounts receivable.
 
 The
        Company’s cash is placed in quality money market accounts with major financial
        institutions. This investment policy limits the Company’s exposure to
        concentrations of credit risk. Such deposit accounts at times may exceed
        federally insured limits. The Company has not experienced any losses in such
        accounts.
 
 Concentration
        of credit risk with respect to the trade accounts receivable are limited
        due to
        the wide variety of customers and markets that comprise the Company’s customer
        base, as well as their dispersion across many different geographic areas.
        The
        Company routinely assesses the financial strength of its customers and, as
        a
        consequence, believes that the trade accounts receivable credit risk exposure
        is
        limited. Generally, the Company does not require collateral or other security
        to
        support customer receivables.
 
 **FAIR
        VALUE OF FINANCIAL INSTRUMENTS**
 The
        carrying amounts of cash and cash equivalents, accounts receivables, accounts
        payable and accrued liabilities approximate fair values due to the short-term
        maturities of these instruments.
  F-11
 Table
            of Contents
  **American
            Technology Corporation**
 **Summary
            of Accounting Policies**
  **ALLOWANCE
        FOR DOUBTFUL ACCOUNTS**
 The
        Company maintains allowances for doubtful accounts for estimated losses
        resulting from the inability of the Company’s customers to make required
        payments. The Company considers the following factors when determining if
        collection of a fee is reasonably assured: customer credit-worthiness, past
        transaction history with the customer, current economic industry trends and
        changes in customer payment terms. If the Company has no previous experience
        with the customer, the Company may obtain reports from various credit
        organizations to ensure that the customer has a history of paying its creditors.
        The Company may also request financial information, including financial
        statements or other documents (e.g., bank statements) to ensure that the
        customer has the means of making payment. If these factors do not indicate
        collection is reasonably assured, revenue is deferred until collection becomes
        reasonably assured, which is generally upon receipt of cash. If the financial
        condition of the Company’s customers were to deteriorate, adversely affecting
        their ability to make payments, additional allowances would be required.
        The
        Company determines delinquency on a case by case basis.
 
 **CONTRACT
        MANUFACTURERS**
 The
        Company employs contract manufacturers for production of HSS and LRAD
        components, sub-assemblies and products. The Company may provide parts and
        components to such parties from time to time but recognizes no revenue or
        markup
        on such transactions. During fiscal 2005 the Company used various contract
        manufacturers and is currently assessing alternative providers of contract
        manufacturing services. At September 30, 2005 and 2004, one contract
        manufacturer owed the Company $-0- and $393,636, respectively, for
        materials provided to the manufacturer without markup. As of September 30,
        2004,
        this amount was netted against the payable to the contract manufacturer of
        $530,970, and the net amount was included in accounts payable.
 
 **INVENTORIES**
 Inventories
        are valued at the lower of cost or net realizable value. Cost is determined
        on a
        first-in, first-out basis. Our
        inventory is comprised of raw materials, assemblies and finished products
        that
        we intend to sell to our**customers*.*The
        Companyperiodically
        makes judgments and estimates regarding the future utility and carrying value
        of
        our inventory.  The carrying value of our inventory is periodically
        reviewed and impairments, if any, are recognized when the expected future
        benefit from our inventory is less than its carrying value. The
        Company has inventory reserves for estimated obsolescence or unmarketable
        inventory which is equal to the difference between the cost of inventory
        and the
        estimated market value based upon assumptions about future demand and market
        conditions. For the period ended September 30, 2005, the Company increased
        its
        inventory reserve to $691,206.
 
 **EQUIPMENT
        AND DEPRECIATION**
 Equipment
        is stated at cost. Depreciation on machinery and equipment and office furniture
        and equipment is computed over the estimated useful lives of three to five
        years using the straight-line method. Leasehold improvements are amortized
        over
        the life of the lease. Upon retirement or disposition of equipment, the
        related cost and accumulated depreciation or amortization are removed and
        the
        gain or loss is recorded.
 
 **INTANGIBLES**
 Purchased
        technology is carried at cost, and was amortized over three years. Patents
        are
        carried at cost and, when granted, are amortized over their estimated useful
        lives, which have been estimated to be 15 years. The carrying value of patents
        is periodically reviewed and impairments, if any, are recognized when the
        expected future benefit to be derived from an individual intangible asset
        is
        less than its carrying value. The Company wrote off $40,916, $37,798 and
        $-0- of
        previously capitalized patent costs during the years ended September 30,
        2005,
        2004 and 2003, respectively.
 
 **LEASES**
 Leases
        entered into are classified as either capital or operating leases. At the
        time a
        capital lease is entered into, an asset is recorded together with its related
        long-term obligation to reflect the purchase and financing. At September
        30,
        2005, the Company had recorded $12,131 in short-term and $-0- in long-term
        capital lease obligations.
  **LEGAL
          SETTLEMENTS**
 Liabilities
          relating to pending litigation are estimated, where the amount and range
          of loss
          can be reasonably determined.   Where a liability is probable and
          there is a range of estimated loss with no best estimate in the range,
          the
          minimum estimated liability related to the claim is recorded.  As
          additional information becomes available, the potential liability related
          to the
          pending litigation is assessed and estimates are revised.  As of
          September 30, 2005 and 2004, the Company recorded accruals of $71,900 and
          $150,000 for contingent liability associated with legal
          proceedings.
 
 **GUARANTEES
        AND INDEMNIFICATIONS**
 In
        November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
        Interpretation ("FIN") No. 45 "Guarantor's Accounting and Disclosure
        Requirements for Guarantees, including Indirect Guarantees of Indebtedness
        of
        Others -- an interpretation of FASB Statements No. 5, 57 and 107 and rescission
        of FIN 34." The following is a summary of the Company's agreements determined
        to
        be within the scope of FIN No. 45:
  The
        Company provides a one-year warranty for most of its products. See “Warranty
        Reserves.”
  Under
        its bylaws, the Company has agreed to indemnify its officers and directors
        for
        certain events or occurrences arising as a result of the officer or director
        serving in such capacity. The term of the indemnification period is for the
        officer or director's lifetime. The maximum potential amount of future payments
        the Company could be required to make under these indemnification agreements
        is
        unlimited. However, the Company has a directors and officers’ liability
        insurance policy that limits its exposure and enables it to recover a portion
        of
        any future amounts paid. As a result of its insurance policy coverage, the
        Company believes the estimated fair value of these indemnification agreements
        is
        minimal and has no liabilities recorded for these agreements as of September
        30,
        2005.
  F-12
 Table
              of Contents
  **American
                Technology Corporation**
 **Summary
                of Accounting Policies**
  The
        Company enters into indemnification provisions under (i) its agreements with
        other companies in its ordinary course of business, typically with business
        partners, contractors, customers and landlords and (ii) its agreements with
        investors. Under these provisions the Company generally indemnifies and holds
        harmless the indemnified party for losses suffered or incurred by the
        indemnified party as a result of the Company's activities or, in some cases,
        as
        a result of the indemnified party's activities under the agreement. The maximum
        potential amount of future payments the Company could be required to make
        under
        these indemnification provisions is unlimited. The Company has not incurred
        material costs to defend lawsuits or settle claims related to these
        indemnification agreements. As a result, the Company believes the estimated
        fair
        value of these agreements is minimal. Accordingly, the Company has no
        liabilities recorded for these agreements as of September 30, 2005.
  **REVENUE
        RECOGNITION**
 The
        Company derives its revenue primarily from two sources: (i) component and
        product sale revenues and associated engineering and installation ,and (ii)
        contract and license fee revenue.
 
 Component
        and product revenues are recognized in the periods that products are shipped
        to
        customers, FOB shipping point or destination, when a signed contract exists,
        the
        fee is fixed and determinable, collection of resulting receivables is probable
        and there are no remaining obligations on the part of the Company. Revenues
        from
        associated engineering and installation contracts are recognized based on
        milestones or completion of the contracted services.
 
 The
        Company provides research and development services and licenses its technology
        to third parties. Revenues from up-front license and other fees and annual
        license fees are evaluated for multiple elements but are generally recognized
        ratably over the specified term of the particular license or agreement. Revenues
        from ongoing per unit license fees are earned based on units shipped
        incorporating the Company’s patented proprietary technologies and are recognized
        in the period when the ultimate customer accepts the product and collectibility
        is reasonably assured.
 
 Deferred
        revenue balances of $395,833 and $322,344 at September 30, 2005 and 2004,
        respectively, represent amounts received or billed in connection with contract
        development and license agreements. During fiscal 2005, the Company entered
        into
        a technology license agreement and recorded $54,167 of revenue and $95,833
        of
        deferred revenue.
 
 **SHIPPING
        AND HANDLING COSTS**
 Amounts
        invoiced to customers for shipping and handling are included in product
        revenues. Actual shipping and handling costs are included in product cost
        of
        revenues. Shipping and handling costs were $130,763, $211,502 and $62,810
        for
        the fiscal years ended September 30, 2005, 2004 and 2003,
        respectively.
 
 **ADVERTISING**
 Advertising
        costs are charged to expenses as incurred. The Company expensed $67,964,
        $69,893
        and $8,695 for the years ended September 2005, 2004 and 2003,
        respectively.
 
 **RESEARCH
        AND DEVELOPMENT COSTS**
 Research
        and development costs are expensed as incurred.
 
 **WARRANTY
        RESERVES**
 The
        Company warrants its products to be free from defects in materials and
        workmanship for a period of one year from the date of purchase, depending
        on the
        product. The warranty is generally a limited warranty, and in some instances
        imposes certain shipping costs on the customer. The Company currently provides
        direct warranty service. Some agreements with OEM customers from time to
        time
        may require that certain quantities of product be made available for use
        as
        warranty replacements. International market warranties are generally similar
        to
        the U.S. market.
 
 The
        Company establishes a warranty reserve based on anticipated warranty claims
        at
        the time product revenue is recognized. Factors affecting warranty reserve
        levels include the number of units sold and anticipated cost of warranty
        repairs
        and anticipated rates of warranty claims. The Company evaluates the adequacy
        of
        the provision for warranty costs each reporting period. See Note 9 for
        additional information regarding warranties.
 
 **INTEREST
        EXPENSE**
 Interest
        expense includes interest expense, redemption premiums and non-cash amortization
        of debt discount.
  F-13
 Table
              of Contents
 **American
                Technology Corporation**
 **Summary
                of Accounting Policies**
 **INCOME
        TAXES**
 The
        Company accounts for income taxes under Statement of Financial Accounting
        Standards (“SFAS”) No. 109. Temporary differences are differences between the
        tax basis of assets and liabilities and their reported amounts in the financial
        statements that will result in taxable or deductible amounts in future years.
        A
        valuation allowance is recorded by the Company to the extent it is more likely
        than not that a deferred tax asset will not be realized.
 
 **COMPREHENSIVE
        INCOME**
 The
        Company follows the provisions of SFAS No. 130, Reporting Comprehensive Income.
        Comprehensive income is defined as the change in equity of a business enterprise
        during a period from transactions and other events and circumstances from
        non-owner sources. There were no differences between net loss and comprehensive
        loss for any of the periods presented.
 
 **DERIVATIVE
        FINANCIAL INSTRUMENTS**
 In
        December 2004, the Company entered into a common stock purchase agreement,
        registration rights agreement and warrant as part of a Committed Equity
        Financing Facility (CEFF) (Note 6). As part of the arrangement, the Company
        issued a warrant to purchase 275,000 shares of its common stock at a price
        of
        $8.60 per share. As the warrant was initially unregistered, and did not specify
        how it would be settled prior to registration, the warrant was initially
        reported as a liability of $843,103 in accordance with Emerging Issues Task
        Force (EITF) 00-19 “Accounting for Derivative Financial Instruments, Indexed to,
        and Potentially Settled in a Company’s Own Stock.” The following variables were
        used to determine the fair value of the warrant under the Black-Scholes option
        pricing model: volatility of 56%, term of 5.5 years, risk free interest of
        2.97%
        and underlying stock price equal to fair market value at the time of issuance.
        The value was recorded as prepaid transaction costs. The warrants were revalued
        each period as non-cash income or expense pending registration and transfer
        to
        permanent equity. However, the CEFF and the warrant were cancelled in July
        2005
        and there was an unrealized gain of $183,259 for the change in value of the
        warrant from issuance to cancellation. There was a corresponding warrant
        impairment expense of $183,259 at termination.
 
 In
        July
        2005, the Company entered into a common stock purchase agreement, registration
        rights agreement and warrants in connection with an equity financing (Note
        6).
        In connection with the financing, the Company issued warrants to purchase
        an
        aggregate of 1,581,919 shares of common stock. The Company accounted for
        the
        value of the warrants as a deemed liability in accordance with the interpretive
        guidance in EITF Issue No. 05-4. The Effect of a Liquidated Damages Clause
        on a
        Freestanding Financial Instrument Subject to EITF Issue No. 00-19, ‘Accounting
        for Derivative Financial Instruments Indexed to, and Potentially Settled
        in, a
        Company’s Own Stock’. The consensus of EITF Issue No. 05-4 has not been
        finalized. The aggregate liability at issuance was $2,896,000 using the
        following variables under the Black-Scholes option pricing model: volatility
        of
        59%, term of each warrant, risk free interest rate of 3.53% and 3.95% and
        underlying stock price equal to fair market value at the time of issuance.
        EITF
        Issue 00-19 also requires the Company to revalue the warrants as a derivative
        instrument periodically in connection with changes in the underlying stock
        price
        and other assumptions, with the change in value recorded as non-cash income
        or
        expense. At September 30, 2005, there was an unrealized gain of $1,050,000
        to
        reflect the change in value of the warrants since issuance.
 
 **IMPAIRMENT
        OF LONG-LIVED ASSETS**
 Long-lived
        assets and identifiable intangibles held for use are reviewed for impairment
        whenever events or changes in circumstances indicate that the carrying amount
        may not be recoverable. If the sum of undiscounted expected future cash flows
        is
        less than the carrying amount of the asset or if changes in facts and
        circumstances indicate, an impairment loss is recognized and measured using
        the
        asset’s fair value.
 
 **SEGMENT
        INFORMATION**
 In
        the
        fourth quarter of fiscal 2003, the Company organized operations into two
        segments by the end-user markets they serve. The Commercial Products and
        Licensing Group (Commercial Group) licenses and markets HSS and NeoPlanar
        sound
        products to companies that employ audio in consumer, commercial and professional
        applications. The Government and Force Protection Systems Group (Government
        Group) markets LRAD, NeoPlanar and HSS sound products to government and military
        customers and to the growing force protection and commercial security markets.
        See Note 13.
 
 **NET
        LOSS PER SHARE**
 Basic
        earnings (loss) per share includes no dilution and is computed by dividing
        income (loss) available to common stockholders, after deduction for cumulative
        imputed and accreted dividends, by the weighted average number of common
        shares
        outstanding for the period. Diluted earnings (loss) per share reflect the
        potential dilution of securities that could share in the earnings of an entity.
        The Company’s losses for the years presented cause the inclusion of potential
        common stock instruments outstanding to be anti-dilutive. Stock options and
        warrants exercisable into 5,648,463 shares of common stock were outstanding
        at
        September 30, 2005. Stock options, warrants and convertible preferred stock
        exercisable into 5,197,557 shares of common stock were outstanding at September
        30, 2004. Stock options, warrants and convertible preferred stock and notes
        exercisable into 4,999,522 shares of common stock were outstanding at September
        30, 2003. These securities were not included in the computation of diluted
        earnings (loss) per share because of the losses but could potentially dilute
        earnings (loss) per share in future periods.
  F-14
 Table
              of Contents
 **American
                Technology Corporation**
 **Summary
                of Accounting Policies**
  Net
        loss
        available to common stockholders was increased during fiscal 2005, 2004 and
        2003
        in computing net loss per share by imputed deemed dividends based on the
        value
        of warrants issued and the computed beneficial conversion amount of convertible
        preferred stock (see Note 6). Such non-cash imputed deemed dividends are
        not
        included in the Company’s stockholders’ equity as the Company has an accumulated
        deficit and therefore were reflected as an increase and a related decrease
        to
        additional paid in capital. Amounts are included in net loss available to
        common
        stockholders. The imputed deemed dividends are not contractual obligations
        of
        the Company to pay such imputed dividends.
  The
        provisions of each of the Company’s series of preferred stock also provided for
        a 6% per annum accretion in the conversion value (similar to a dividend).
        Such
        accretions are not included in the Company's stockholders' equity as the
        Company
        has an accumulated deficit and therefore they were reflected as an increase
        and
        a related decrease to additional paid in capital. These non-cash amounts
        also
        increased the net loss available to common stockholders. Net loss available
        to
        common stockholders is computed as follows:
  **Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Net
                    loss
                
                $
                (9,086,707
                )
                $
                (5,960,436
                )
                $
                (8,227,013
                )Imputed
                    deemed dividends on Series D and Ewarrants
                    issued with preferred stock [note 5]
                
                
                (592,137
                )
                
                (448,572
                )
                
                (538,070
                )Imputed
                    deemed dividends on Series D and Epreferred
                    stock [note 5]
                
                
                (1,146,917
                )
                
                (736,449
                )
                
                (1,683,500
                )Accretion
                    on preferred stock at 6% stated rate [note 6]:Series
                    C preferred stock
                
                
                -
                
                
                -
                
                
                (6,000
                )Series
                    D preferred stock
                
                
                (9,167
                )
                
                (30,171
                )
                
                (65,844
                )Series
                    E preferred stock
                
                
                (48,205
                )
                
                (150,157
                )
                
                (115,814
                )Net
                    loss available to common stockholders
                
                $
                (10,883,133
                )
                $
                (7,325,785
                )
                $
                (10,636,241
                )
 **STOCK-BASED
        COMPENSATION**
 In
        December 2002, the FASB issued FAS No. 148, “Accounting for Stock-Based
        Compensation — Transition and Disclosure”, which amended FAS No. 123,
“Accounting for Stock-Based Compensation.” The new standard provides alternative
        methods of transition for a voluntary change to the fair market value based
        method for accounting for stock-based employee compensation. Additionally,
        the
        statement amends the disclosure requirements of FAS No. 123 to require prominent
        disclosures in both annual and interim financial statements about the method
        of
        accounting for stock-based employee compensation and the effect of the method
        used on reported results. This statement is effective for the Company’s
        financial statements for the fiscal year ended September 30, 2003 and the
        Company adopted the disclosure requirements effective October 1, 2002.  In
        compliance with FAS No. 148, the Company has elected to continue to follow
        the
        intrinsic value method in accounting for its stock-based employee compensation
        plan as defined by APB No. 25.
 
 The
        Company accounts for employee stock-based compensation using the intrinsic
        value
        method. In most cases, the Company does not recognize compensation expense
        for
        its employee stock option grants, as they have been granted at the fair market
        value of the underlying common stock at the grant date.
  F-15
 Table
              of Contents
 **American
                Technology Corporation**
 **Summary
                of Accounting Policies**
  Had
        compensation expense for the Company’s employee stock option grants been
        determined based on the fair value at the grant date for awards through
        September 30, 2005 consistent with the provisions of Statement of Financial
        Accounting Standards No. 123, its after-tax net income and after-tax net
        income
        per share would have been reduced to the pro forma amounts indicated
        below:
  **Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Net
                    loss available to common stockholders
                
                $
                (10,883,133
                )
                $
                (7,325,785
                )
                $
                (10,636,241
                )Deduct:
                    Stock-based employee compensationexpense
                    included in reported net loss
                
                
                266,963
                
                
                65,863
                
                
                -Add:
                    Total stock-based employee compensation expensedetermined
                    using fair value based method
                
                
                (1,279,441
                )
                
                (940,111
                )
                
                (972,896
                )Pro
                    forma net loss available to common stockholders
                
                $
                (11,895,611
                )
                $
                (8,200,033
                )
                $
                (11,609,137
                )Net
                    loss per common share - basicand
                    diluted - pro forma
                
                $
                (0.55
                )
                $
                (0.42
                )
                $
                (0.73
                )Net
                    loss per common share - basicand
                    diluted - as reported
                
                $
                (0.50
                )
                $
                (0.37
                )
                $
                (0.67
                )
  The
        Company estimates the fair value of each stock award at the grant date by
        using
        the Black-Scholes option-pricing model with the following weighted average
        assumptions used for grants in 2005, 2004 and 2003, respectively: dividend
        yield
        of zero percent for all years; expected volatility of 53 to 61 percent in
        2005,
        57 to 75 percent in 2004 and 68 to 84 percent in 2003; risk-free interest
        rates of 1.83 to 6.72 percent; and expected lives of 2.21 to
        5 years.
  **COMMON
        STOCK ISSUED FOR SERVICES**
 The
        Company records compensation expense for common stock issued for services
        based
        on the estimated fair market value. Estimated fair market value is determined
        based on the quoted closing stock price on the day prior to the date of
        issuance.
 
 **STATEMENT
        OF CASH FLOWS**
 For
        purposes of the statement of cash flows, the Company considers all highly
        liquid
        investments purchased with an original maturity of three months or less,
        when
        purchased, to be cash equivalents. The Company had no cash equivalents at
        September 30, 2005 and 2004.
  **RECENT
        ACCOUNTING PRONOUNCEMENTS**
 In
        June 2005, the Financial Accounting Standards Board (FASB) issued SFAS
        No. 154, “Accounting Changes and Error Corrections”, applying to all
        voluntary accounting principle changes as well as the accounting for and
        reporting of such changes. SFAS No. 154 replaces APB Opinion No. 20,
“Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in
        Interim Financial Statements.” SFAS No. 154 is effective for accounting
        changes and corrections of errors made in fiscal years beginning after
        December 15, 2005. The Company does not expect SFAS No. 154
        to affect the Company’s financial condition or results of
        operations.
 
 In
        March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting
        for Conditional Asset Retirement Obligations.” FIN 47 clarifies that an entity
        must record a liability for a “conditional” asset retirement obligation if the
        fair value of the obligation can be reasonably estimated. The provision is
        effective no later than the end of fiscal years ending after December 15,
        2005. The Company does not expect FIN 47 to affect the Company’s financial
        condition or results of operations.
  F-16
 Table
              of Contents
 **American
                Technology Corporation**
 **Summary
                of Accounting Policies**
  In
        December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary
        Assets, an Amendment of APB Opinion No. 29”, which is effective for
        non-monetary exchanges occurring in fiscal periods beginning after June 15,
        2005. SFAS
        No. 153 amends APB Opinion No. 29, “Accounting for Non-monetary
        Transactions” to eliminate the exception for non-monetary exchanges of similar
        productive assets and replaces it with a general exception for exchanges
        of
        non-monetary assets that do not have commercial substance. A non-monetary
        exchange has commercial substance if the future cash flows of the entity
        are
        expected to change significantly as a result of the exchange. The Company
        does
        not expect SFAS No. 153 to affect the Company’s financial condition or
        results of operations.
 
 In
        December 2004, the FASB finalized SFAS No. 123R Share-Based Payment, amending
        SFAS No. 123, effective beginning our first quarter of fiscal 2006. SFAS
        123R
        requires the Company to expense stock options based on grant date fair value
        in
        its financial statements. Further, SFAS 123R requires additional accounting
        related to the income tax effects and additional disclosure regarding the
        cash
        flow effects resulting from share-based payment arrangements. In March 2005,
        the
        U.S. Securities and Exchange Commission (the “SEC”) issued Staff Accounting
        Bulletin (“SAB”) No. 107, which expresses views of the SEC staff regarding the
        interaction between SFAS 123R and certain SEC rules and regulations, and
        provides the staff’s views regarding the valuation of share-based payment
        arrangements for public companies. The Company is considering the guidance
        of
        this SAB in the adoption of SFAS 123R. The effect of expensing stock options
        on
        results of operations using a Black-Scholes option-pricing model is presented
        in
        these financial statements above under Stock Based Compensation. Under SFAS
        123R, the Company must determine the appropriate fair value model to be used
        for
        valuing share-based payments, the amortization method for compensation cost
        and
        the transition method to be used at date of adoption. The transition methods
        include prospective and retroactive adoption options. The Company expects
        to
        utilize the prospective method which requires that compensation expense begin
        being recorded for all unvested stock options and restricted stock at the
        beginning of the first quarter of adoption of SFAS 123R. The Company is
        evaluating the requirements of SFAS 123R and expects the adoption of SFAS
        123R
        will have a material impact on results of operations and earnings (loss)
        per
        share. The Company has not determined whether the adoption will result in
        amounts similar to the current pro-forma disclosures under SFAS
        123.
  In
        November 2004, the FASB issued SFAS No. 151, “Inventory Costs an amendment of
        ARB 43, Chapter 4.” SFAS No. 151 clarifies that abnormal amounts of idle
        facility expense, freight, handling costs, and wasted materials (spoilage)
        should be recognized as current-period charges and requires the allocation
        of
        fixed production overheads to inventory based on the normal capacity of the
        production facilities. SFAS No. 151 is effective for fiscal years beginning
        after June 15, 2005. The Company is currently evaluating the financial statement
        impact of the implementation of SFAS No. 151.
 
 **RECLASSIFICATIONS**
 Where
        necessary, the prior year’s information has been reclassified to conform with
        the fiscal 2005 statement presentation.
  F-17
 Table
            of Contents
 **American
              Technology Corporation**
 **Notes
              to the Financial Statements**
 **1.
                    INVENTORIES**Inventories
                    consisted of the following at September 30,
                
                2005
                
                2004Finished
                    goods
                
                $
                790,707
                
                $
                342,647Work
                    in process
                
                
                -
                
                
                -Raw
                    materials
                
                
                1,699,946
                
                
                418,4482,490,653
                
                
                761,095Reserve
                    for obsolescence
                
                
                (691,206
                )
                
                (110,000
                )$
                1,799,447
                
                $
                651,095
  At
        September 30, 2005, $148,826 of raw materials and $-0- of finished goods
        were
        located at contract manufacturing locations. At September 30, 2004, $79,036
        of
        raw materials and $355,879 of finished goods were located at a contract
        manufacturing location.
 
 The
        Company is reliant on one supplier for film for its HSS product and is making
        efforts to obtain alternative suppliers to reduce its reliance thereon. The
        Company could be materially impacted if it loses its current film supplier
        and
        is unable to find an alternative supplier.
  **2.
                    EQUIPMENT**Equipment
                    consisted of the following at September 30,
                
                2005
                
                2004Machinery
                    and equipment
                
                $
                321,198
                
                $
                604,994Office
                    furniture and equipment
                
                
                963,005
                
                
                816,714Leasehold
                    improvements
                
                
                202,987
                
                
                225,1781,487,190
                
                
                1,646,886Accumulated
                    depreciation
                
                
                (880,319
                )
                
                (1,193,531
                )Net
                    equipment
                
                $
                606,871
                
                $
                453,355
  Included
        in office furniture and equipment for the years ended September 30, 2005
        and
        2004, respectively are $472,277 and $335,691 for purchased software, which
        is
        amortized over three years. The unamortized portion of software for the years
        ended September 30, 2005 and 2004, are $206,639 and $177,930,
        respectively.
 
 Depreciation
        expense, excluding amortization of software, was $192,347, $96,164 and
        $130,916 for the years ended September 30, 2005, 2004 and 2003,
        respectively. Amortization of purchased software was $111,999, $46,675 and
        $26,488 for the years ended September 30, 2005, 2004 and 2003,
        respectively.
 
 **3.
        INTANGIBLES**
 
 Purchased
        Technology
 In
        April
        2000, the Company acquired all rights to certain loudspeaker technology for
        cash
        and common stock valued at an aggregate of $1,262,500. During fiscal 2002
        the
        Company issued 50,000 shares of the contingent common stock, which was issuable
        contingent upon the achievement of certain performance milestones, recording
        compensation expense of $210,000 at an estimated fair market value of $4.20
        per
        share, and during fiscal 2003 issued 109,844 shares of the contingent common
        stock, recording compensation expense of $410,816. The purchase price was
        fully
        amortized at September 30, 2003.
  F-18
 Table
                of Contents
 **American
                  Technology Corporation**
 **Notes
                  to the Financial Statements**
 Patents
  Patents
        consisted of the following at September 30, 2005 and 2004:
  **At
                    September 30,**
                
                2005
                
                2004Cost
                
                $
                1,792,619
                
                $
                1,578,578Accumulated
                    amortization
                
                
                (419,461
                )
                
                (299,871
                )Net
                    patent
                
                $
                1,373,158
                
                $
                1,278,707
  Aggregate
        amortization expense for the Company’s intangible assets is summarized as
        follows:
  **Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Purchased
                    technology
                
                $
                -
                
                $
                -
                
                $
                315,636Patents
                
                
                140,220
                
                
                97,109
                
                
                79,544$
                140,220
                
                $
                97,109
                
                $
                395,180
 
 In
          addition to amortization, the Company wrote off $40,916, $37,798 and $-0-
          of
          patent costs during the years ended September 30, 2005, 2004 and 2003,
          respectively.
 
 **Estimated
                    Amortization Expense Years Ended September 30,**2006
                
                $
                119,5082007
                
                $
                119,5082008
                
                $
                119,5082009
                
                $
                119,5082010
                
                $
                119,508Thereafter
                
                $
                775,618
 F-19
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  **4.
                    INCOME TAXES**Income
                    taxes consisted of the following:**Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Deferred
                    (benefit)Federal
                
                $
                (3,311,000
                )
                $
                (2,033,000
                )
                $
                (2,801,000
                )State
                
                
                (584,000
                )
                
                (359,000
                )
                
                (494,000
                )(3,895,000
                )
                
                (2,392,000
                )
                
                (3,295,000
                )Change
                    in valuation allowance
                
                
                3,895,000
                
                
                2,392,000
                
                
                3,295,000$
                -
                
                $
                -
                
                $
                -
 
 A
          reconciliation of income taxes at the federal statutory rate of 34% to
          the
          effective tax rate is as follows:
 
 **Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Income
                    taxes (benefit) computed at thefederal
                    stautory rate
                
                $
                (3,089,000
                )
                $
                (2,027,000
                )
                $
                (2,797,000
                )Tax
                    effect of change in valuation allowance
                
                
                3,895,000
                
                
                2,392,000
                
                
                3,019,000Nondeductible
                    compensation,interest
                    expense and other
                
                
                15,000
                
                
                30,000
                
                
                306,000State
                    income taxes (benefit), net of federal tax benefit
                
                
                (545,000
                )
                
                (358,000
                )
                
                (494,000
                )Other
                
                
                (276,000
                )
                
                (37,000
                )
                
                (34,000
                )$
                -
                
                $
                -
                
                $
                -
 
 The
        types
        of temporary differences between the tax basis of assets and liabilities
        and
        their approximate tax effects that give rise to a significant portion of
        the net
        deferred tax asset (liability) at September 30, 2005 and 2004 are as
        follows:
  **At
                    September 30,****Deferred
                    tax assets:**
                
                **2005**
                
                **2004**Net
                    operating loss carryforwards
                
                $
                18,789,000
                
                $
                14,982,000Research
                    and development credit
                
                
                350,000
                
                
                228,000Equipment
                
                
                111,000
                
                
                75,000Patents
                
                
                119,000
                
                
                59,000Purchased
                    technology
                
                
                -
                
                
                75,000Accruals
                    and other
                
                
                540,000
                
                
                365,000Allowances
                
                
                326,000
                
                
                46,000Gross
                    deferred tax asset
                
                
                20,235,000
                
                
                15,830,000Less
                    valuation allowance
                
                
                (20,235,000
                )
                
                (15,830,000
                )$
                -
                
                $
                -
  The
        utilization of the net operating loss carry-forwards and research and
        experimental credits could be substantially limited due to restrictions imposed
        under federal and state laws upon a change of ownership. The amount of the
        limitation, if any, has not been determined at this time.
 
 A
        valuation allowance has been recorded to offset the net deferred tax asset
        as
        management has been unable to determine that it is more likely than not that
        the
        deferred tax asset will be realized.
  F-20
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  At
        September 30, 2005, the Company, for federal income tax purposes, has net
        operating loss carry-forwards of approximately $46,972,000, which expire
        through
        2026, of which certain amounts are subject to limitations under the Internal
        Revenue Code of 1986, as amended.
 
 **5.  UNSECURED
        SUBORDINATED PROMISSORY NOTES AND RELATED PARTY
        TRANSACTIONS**
  In
        December 2004, the Company sold an aggregate of $2,000,000 of 8% unsecured
        subordinated promissory notes due December 31, 2006. Interest on these notes
        accrued at the rate of 8% per year and was due and payable quarterly. The
        Company was required to use 40% of the net proceeds of any future equity
        financing to prepay these notes, and accordingly the notes and accrued interest
        were retired in July 2005 (see Note 6).
 
 In
        connection with the issuance of the notes, the purchasers were granted warrants
        to purchase an aggregate of 150,000 shares of common stock. The exercise
        price
        of the warrants was $9.28 per share for purchasers who were directors, officers,
        employees or consultants of the Company, or affiliates of such persons, and
        $8.60 per share for other purchasers. Warrants exercisable for 75,000 shares
        were issued at each such exercise price. The fair value of such warrants,
        which
        amounted to $723,000, and closing costs of $20,977  were
        recorded as debt discount and amortized over the term of the notes and fully
        amortized at repayment. The following variables were used to determine the
        fair
        value of the warrants under the Black-Scholes option pricing model: volatility
        of 56%, term of five years, risk free interest of 2.97% and underlying stock
        price equal to fair market value at the time of grant.
  A
        trust affiliated with an officer, director and significant stockholder of
        the
        Company purchased one of the aforementioned promissory notes in the principal
        amount of $500,000 and received a warrant exercisable for 37,500 shares with
        an
        exercise price of $9.28 per share.
  The
          Company is also obligated to pay Elwood G. Norris, our Chairman, a 2% royalty
          on
          net sales from certain of our technologies, of which only HSS is a current
          offering of our company. The royalty obligation continues until at least
          March
          1, 2007, and for any longer period during which we sell products or license
          technologies subject to any patent assigned to us by Mr. Norris. No royalties
          were paid or recorded under this agreement in the fiscal years ended September
          30, 2005, 2004, or 2003, as these royalties were immaterial and were waived
          by
          Mr. Norris.
  **6.
        CAPITAL STOCK**
 
 Common
        Stock
 In
        July
        2003, the Company obtained gross proceeds of $10,000,000 from an offering
        of
        common stock and warrants. The offering included 1,818,180 shares of common
        stock at a purchase price of $5.50 per share and warrants to purchase 454,547
        shares of common stock with an exercise price of $6.75 per share. The warrants
        are exercisable until July 10, 2007. The warrants contain certain antidilution
        rights if the Company sells common stock equivalents, as defined, for less
        than
        $6.75 and were repriced to $6.55 as a result of the July 2005 financing
        described below. Offering costs were $545,000.
 
 In
        December 2004, the Company entered into a common stock purchase agreement,
        registration rights agreement and warrant as part of a Committed Equity
        Financing Facility (CEFF) for up to $25 million of the Company’s common stock.
        As part of the arrangement, the Company issued a warrant to purchase 275,000
        shares of its common stock at a price of $8.60 per share. This
        CEFF and the related warrant was terminated in July 2005 and the Company
        expensed an aggregate of $293,826 of legal, audit and related costs associated
        with this financing and registration. The Company issued no shares of common
        stock related to this transaction. The remaining derivative liability value
        of
        the warrant of $659,846 was credited against related prepaid transaction
        costs.
 
 In
        July
        2005, the Company obtained gross proceeds of $14,000,000 from an offering
        of
        common stock and warrants. The offering included 2,868,851 shares of common
        stock at a purchase price of $4.88 per share and warrants in two series to
        purchase 1,581,919 shares of common stock. Offering costs were $828,176 and
        an
        additional $2,896,000 was allocated as the deemed value of the warrants as
        described below. The “A” Warrants are exercisable for an aggregate of 717,213
        shares of common stock at an exercise price of $6.36 per share until July
        18,
        2009. The “B” Warrants are exercisable for an aggregate of 864,706 shares of
        common stock at an exercise price of $7.23 per share and are exercisable
        until
        March 28, 2006. The warrants contain certain antidilution rights adjusting
        the
        price and number of shares if the Company sells common stock equivalents
        or for
        certain other specified transactions, for less than the exercise price of
        the
        warrants. The Company has the right to redeem the “B” Warrants if the closing
        price of the shares of its common stock is $10.00 or greater for 15 consecutive
        trading days and the holder does not exercise within 20 days after the Company
        gives notice of redemption. The registration statement for these securities
        was
        declared effective in September 2005.
  F-21
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  Although
        the Company can deliver unregistered shares on exercise of the warrants and
        is
        not obligated to cash settle the warrants, the Company may be required to
        pay a
        monthly penalty to the purchasers of up to $140,000 (maximum of $70,000 per
        month through December 2005), with no contractual maximum, should the
        registration statement not remain effective for the securities. The Company
        has
        determined this penalty does not represent a reasonable difference between
        the
        value of registered and unregistered shares, that the events to deliver
        registered shares are not entirely controlled by the Company and that settling
        with unregistered shares is not an economically reasonable alternative.
        Accordingly, following the interpretive guidance in EITF Issue No. 05-4,
‘The
        Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument
        Subject to EITF Issue No. 00-19, Accounting for Derivative Financial Instruments
        Indexed to, and Potentially Settled in, a Company’s Own Stock’, the Company
        allocated $2,896,000 of the offering proceeds as a deemed liability for the
        value of the warrants at the time of issuance. The consensus of EITF Issue
        No.
        05-4 has not been finalized.
 
 EITF
        Issue 00-19 also requires the Company to revalue the warrants as a derivative
        instrument periodically to compute the value in connection with changes in
        the
        underlying stock price and other assumptions, with the change in value recorded
        as non-cash income or expense. From the issuance date to September 30, 2005,
        non-cash income of $1,050,000 was recorded as unrealized gain on derivative
        revaluation to reflect the change in value of the warrants. Upon the earlier
        of
        warrant exercise, expiration or the warrants no longer being subject to
        penalties, the corresponding warrant liability will be reclassified into
        warrant
        stockholders’ equity. At September 30, 2005, the “B” Warrants have a six-month
        term and therefore the related derivative liability of $282,000 is included
        in
        current liabilities. The “A” Warrant derivative liability of $1,564,000 is
        treated as a long-term liability.
 
 Preferred
        Stock
 The
        Company is authorized to issue 5,000,000 shares of preferred stock, $0.00001
        par
        value, without any action by the stockholders. The board of directors has
        the
        authority to divide any and all shares of preferred stock into series and
        to fix
        and determine the relative rights and preferences of the preferred stock,
        such
        as the designation of series and the number of shares constituting such series,
        dividend rights, redemption and sinking fund provisions, liquidation and
        dissolution preferences, conversion or exchange rights and voting rights,
        if
        any. Issuance of preferred stock by the board of directors could result in
        such
        shares having dividend and or liquidation preferences senior to the rights
        of
        the holders of common stock and could dilute the voting rights of the holders
        of
        common stock.
 
 In
        accordance with the terms of the Series D and E preferred stock, in January
        2005, the Company gave notice of mandatory conversion and all remaining shares
        of preferred stock were converted to common stock. Accordingly, no shares
        of
        preferred stock were outstanding at September 30, 2005. The following is
        a
        summary of the terms of previous preferred stock series outstanding during
        the
        last three fiscal years.
  F-22
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**




**Number
                    of****Shares****Preferred**
                **Issuance**
                **Aggregate**
                **Authorized/****Series**
                **Date**
                **Purchase
                    Price**
                **Originally
                    Issued**
                **Terms**6%
                    Series C issued at $20.00 per share
                March
                    2000
                $6,000,000
                300,000/300,000
                Purchase
                    price plus 6% accretion convertible at lower of $8.00 per share
                    or 92% of
                    market but not less than $5.75 per share. Callable at market
                    price of
                    $20.00 per share. Automatic conversion to common stock on March
                    31,
                    2003.6%
                    Series D issued at $10.00 per share
                May
                    2002
                $2,354,000
                250,000/235,400
                
                Purchase
                    price plus 6% accretion convertible at lower of $4.50 per share
                    or 90% of
                    market but not less than $2.00 per share, subject to antidilution
                    adjustment. Callable at market price of $9.50 per share. Automatic
                    conversion to common stock on March 31, 20076%
                    Series E issued at $10.00 per share
                March
                    2003
                $3,432,500
                350,000/343,250
                
                Purchase
                    price plus 6% accretion convertible at lower of $3.25 per share
                    or 90% of
                    market but not less than $2.00 per share, subject to antidilution
                    adjustment. Callable at market price of $9.50 per share. Automatic
                    conversion to common stock on December 31,
                    2007
  The
        above
        preferred shares were sold for cash except that $1,000,000 of the Series
        E Stock
        purchase price resulted from the conversion of senior notes payable. In
        connection with the Series C preferred stock financing, the Company issued
        a
        warrant to purchase 75,000 shares of common stock at $11.00 per share until
        March 31, 2005 as a placement fee. The value assigned to the warrant was
        $468,783.
  The
        Company granted warrants to the purchasers with each issuance of preferred
        stock. In accordance with the provisions of EITF
        Issue No. 98-5, “Accounting for Convertible Securities with the Beneficial
        Conversion Features or Contingently Adjustable Conversion Ratios” and EITF Issue
        No. 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments,” the
        cash
        proceeds of the preferred stock were allocated prorata between the relative
        fair
        values of the preferred stock and warrants at issuance using the Black-Scholes
        valuation model for valuing the warrants. After allocating the proceeds between
        the preferred stock and warrant, an effective conversion price was calculated
        for the convertible preferred stock to determine the beneficial conversion
        discount for each share. The value of the beneficial conversion discount
        and the
        value of the warrants was recorded as a deemed dividend and accreted over
        the
        conversion period of the preferred stock or upon exercise of the related
        warrant, if earlier. The following table summarizes values assigned as a
        deemed
        dividend for the value of the warrants, the beneficial conversion feature
        on
        each preferred stock issuance and the accretion included to compute the net
        loss
        available to common stockholders in each of the three fiscal years ended
        September 30, 2005.
  **Deemed
                    Dividend****Value**
                **Value
                    Of****Warrant**
                **Warrant**
                **Assigned**
                **Beneficial**
                **Accretion****Preferred**
                **Issuance**
                **Number**
                **Exercise**
                **Expiration**
                **To**
                **Conversion**
                **Fiscal
                    Year Ended September 30,****Series**
                **Date**
                **Of
                    Warrants**
                **Price**
                **Date**
                **Warrants**
                **Discount**
                **2005**
                **2004**
                **2003**6%
                    Series C
                March
                    2000
                300,000
                $11.00
                3/31/2003
                $
                    1,478,000
                $ 
                    2,509,000
                $          -
                $        -
                $          -6%
                    Series D
                May
                    2002
                517,880
                $3.01
                3/31/2007
                $
                    1,029,519
                $ 
                       994,310
                $  
                     363,527
                $
                     322,555
                $
                    1,027,0636%
                    Series E
                March
                    2003
                514,875
                $3.25
                12/31/2007
                $  
                     755,500
                $ 
                    2,677,000
                $
                    1,375,527
                $ 
                    862,466
                $
                    1,194,507
  The
        Series D warrants were originally exercisable at $4.50 per common share and
        valued at $871,000. The Series E financing resulted in a repricing of the
        Series
        D Warrants to $3.01 per common share and an additional $158,519 was assigned
        to
        the warrant value. The Series D Warrants were valued using the Black-Scholes
        model with a dividend yield of zero percent; expected volatility of 78 percent;
        risk free interest rate of 4.94 percent; and an expected life of five years.
        The
        Series E Warrants were valued using the Black-Scholes model with a dividend
        yield of zero percent; expected volatility of 76.5 percent; risk free interest
        rate of 4.0 percent; and an expected life of five years.
  F-23
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  Stock
        Purchase Warrants
 A
        summary of the status of outstanding purchase warrants
        outstanding as of September 30, 2003, 2004 and 2005 and the changes during
        the
        years then ended is presented below:
  **Average****Purchase****Number**
                
                **Price**Shares
                    purchasable under outstanding warrants at October 1, 2002
                
                
                2,105,380
                
                $
                4.85Stock
                    purchase warrants issued
                
                
                1,019,422
                
                $
                4.83Stock
                    purchase warrants exercised
                
                
                (347,000
                )
                $
                2.60Stock
                    purchase warrants expired
                
                
                (350,000
                )
                $
                11.71Shares
                    purchasable under outstanding warrants at September 30,
                    2003
                
                
                2,427,802
                
                $
                3.85Stock
                    purchase warrants exercised
                
                
                (25,000
                )
                $
                2.00Stock
                    purchase warrants expired
                
                
                (50,000
                )
                $
                10.00Shares
                    purchasable under outstanding warrants at September 30,
                    2004
                
                
                2,352,802
                
                $
                3.74Stock
                    purchase warrants issued
                
                
                2,006,919
                
                $
                7.23Stock
                    purchase warrants exercised
                
                
                (432,068
                )
                $
                4.13Stock
                    purchase warrants expired
                
                
                (350,000
                )
                $
                9.11Shares
                    purchasable under outstanding warrants at September 30,
                    2005
                
                
                3,577,653
                
                $
                5.11
 
 At
        September 30, 2005, the following stock purchase warrants were outstanding
        arising from offerings and other transactions, each exercisable into one
        common
        share:
  **Exercise**
                
                **Expiration****Number**
                
                **Price**
                
                **Date**864,706
                
                $7.23
                
                March
                    28, 2006617,500
                
                $2.00
                
                September
                    30, 2006451,880
                
                $3.01
                
                March
                    31, 2007272,729
                
                $6.55
                
                July
                    10, 2007100,000
                
                $4.25
                
                September
                    30, 2007353,625
                
                $3.25
                
                December
                    31, 200750,000
                
                $3.63
                
                April
                    8, 2008717,213
                
                $6.36
                
                July
                    18, 200975,000
                
                $8.60
                
                December
                    31, 200975,000
                
                $9.28
                
                December
                    31, 20093,577,653
  The
        $3.01
        warrants, the $3.25 warrants, the $6.36 warrants, the $6.55 warrants and
        the
        $7.23 warrants contain certain antidilution rights if the Company sells
        securities for less than the exercise price.
 
 **7.
        BENEFIT PLANS**
 
 Stock
        Option Plans
 The
        2005
        Equity Incentive Plan (“2005 Equity Plan”) became effective in April 2005, and
        authorizes for issuance as stock options, stock appreciation rights, or stock
        awards an aggregate of 1,500,000 new shares of common stock to employees,
        directors or consultants.  The reserve under the 2005 Equity Plan
        will include any shares subject to options under the Company’s prior plans
        that expire or become unexercisable for any reason without having been exercised
        in full. As a result of the effectiveness of the 2005 Equity Plan, the 2002
        Plan
        is no longer available for new option grants.
  F-24
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  At
        the
        effective date of the 2005 Equity Plan, approximately 1,660,811 shares were
        subject to option under prior plans. The total plan reserve, including the
        new
        shares and shares currently reserved under prior plans, allows for the issuance
        of up to 3,312,501 shares. At September 30, 2005, there were options
        outstanding covering 250,000 shares of common stock and 1,500,228 shares
        available for future option grants under the 2005 Equity Plan.
  The
        2002
        Plan reserved for issuance 2,350,000 shares of common stock. The 2002 Plan
        was
        terminated with respect to new grants in April 2005 but remains in effect
        for
        grants prior to that time. At September 30, 2005, there were options outstanding
        covering 1,151,810 shares of common stock under the 2002 Plan. The Company’s
        1997 Stock Option Plan (“1997 Plan”) reserved for issuance 1,000,000 shares of
        common stock. The 1997 Plan was terminated with respect to new grants in
        August
        2002, but remains in effect for grants prior to that time.
 
 Shares
        subject to options under the 1997 Plan or the 2002 Plan that expire, are
        cancelled or are terminated without being exercised, become available for
        future
        grants under the 2005 Equity Plan. At September 30, 2005, there were options
        outstanding covering 292,000 shares of common stock under the 1997
        plan.
 
 Other
        Employee Stock Options
 The
        Company has granted options outside the above plans as inducements to employment
        to new employees. During the fiscal years ended September 30, 2005 and 2004,
        options to purchase 281,500 and 147,000 shares of common stock, respectively,
        were granted exercisable at prices ranging from $6.21 to $10.06 per share
        in
        2005 and $5.92 to $6.14 per share in 2004. At September 30, 2005, there were
        options outstanding covering 377,000 shares of common stock from grants outside
        the stock option plans.
 
 Non-Cash
        Compensation Expense
  During
        the fiscal years ended September 30, 2005 and 2004, the Company recorded
        non-cash compensation expense of $266,963 and $65,863, respectively, for
        the extension of time to exercise stock options for former employees relating
        to
        an aggregate of 92,675 and 28,438 shares of common stock, respectively, and
        in the fiscal year ended September 30, 2005, the Company recorded $57,619
        for
        option expense relating to options for 68,125 shares held by an officer of
        the
        Company, who transitioned from employee to consultant. For the fiscal year
        ended
        September 30, 2005, the Company also recorded $6,160 of non-cash compensation
        expense for the value of 10,000 options granted to non-employees, which were
        valued in the same manner as described in “Summary of Accounting Policies” for
        employee options. For the fiscal year ended September 30, 2003, the Company
        recorded non-cash compensation expense of $25,597 for the granting of options
        to
        purchase 13,000 shares of common stock under its stock options plans to
        non-employees.
  In
          October 2001, the Company granted options to purchase a total of 110,000
          shares
          of common stock to a consultant under the 1997 Plan in conjunction with
          related
          development and manufacturing agreements. The stock options include options
          to
          purchase 65,000 shares of common stock which vest upon completion of certain
          project milestones. The Company has estimated the period required to complete
          the specified milestones each reporting period and recorded consulting
          expense
          based on the market price of the Company’s stock and the estimated percentage of
          the work completed. Consulting expense was adjusted each reporting period
          until
          vesting occurs. The Company recorded consulting expense of $87,179 for
          the
          Black-Scholes value of milestone options for 30,000 shares vested in fiscal
          year
          2002 and consulting expense of $47,782 for the Black-Scholes value of 10,000
          milestone options vested in fiscal year 2003. As of September 30, 2005
          and 2004,
          there remained stock options to purchase 25,000 shares that were non-vested
          due
          to unmet project milestones. In addition, there remained options to purchase
          45,000 shares of common stock that vested based on the consultant meeting
          certain performance criteria. The Company records consulting expense at
          each
          vesting date. The Company recorded consulting expense of $96,655 for the
          Black-Scholes value of performance options for 45,000 shares vested during
          the
          year ended September 30, 2002.
  On
        April
        8, 2003, the Company granted a warrant exercisable for 50,000 common shares
        at
        $3.63 per share to a consultant for consulting services. The Company recorded
        non-cash consulting expense of $106,616 for the value of this
        warrant.
 
 Stock
        Option Summary Information
 A
        summary
        of activity for the Company’s stock option plans as well as options granted
        outside the plans as of September 30, 2005, 2004 and 2003, is presented
        below:
  F-25
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
 **Weighted****Average****Exercise****Number**
                
                **Price****Fiscal
                    2003:**Outstanding
                    October 1, 2002
                
                
                1,459,175
                
                $
                3.97Granted
                
                
                979,000
                
                $
                3.96Canceled/expired
                
                
                (416,950
                )
                $
                3.86Exercised
                
                
                (408,951
                )
                $
                3.95Outstanding
                    September 30, 2003
                
                
                1,612,274
                
                $
                4.00Exercisable
                    at September 30, 2003
                
                
                998,722
                
                $
                3.79Weighted
                    average fair value of options granted during the year
                $
                1.78**Fiscal
                    2004:**Outstanding
                    October 1, 2003
                
                
                1,612,274
                
                $
                4.00Granted
                
                
                1,073,500
                
                $
                5.80Canceled/expired
                
                
                (553,703
                )
                $
                3.63Exercised
                
                
                (292,573
                )
                $
                5.49Outstanding
                    September 30, 2004
                
                
                1,839,498
                
                $
                4.68Exercisable
                    at September 30, 2004
                
                
                916,884
                
                $
                3.60Weighted
                    average fair value of options granted during the year
                $
                2.37**Fiscal
                    2005:**Outstanding
                    October 1, 2004
                
                
                1,839,498
                
                $
                4.68Granted
                
                
                847,500
                
                $
                7.49Canceled/expired
                
                
                (378,576
                )
                $
                6.21Exercised
                
                
                (237,612
                )
                $
                3.49Outstanding
                    September 30, 2005
                
                
                2,070,810
                
                $
                5.68Exercisable
                    at September 30, 2005
                
                
                1,026,690
                
                $
                4.43Weighted
                    average fair value of options granted during the year
                $
                2.74
 
 The
          following table summarizes information about stock options outstanding
          at
          September 30, 2005:
 
 Weighted
                    Average
                Weighted
                
                
                WeightedRange
                    of
                
                Remaining
                Average
                
                
                AverageExercise
                Number
                Contractual
                Exercise
                Number
                
                ExercisePrices
                Outstanding
                Life
                Price
                Exercisable
                
                Price$2.50-$4.00
                565,561
                1.39
                $  
                     3.12
                530,561
                
                $  
                     3.16$4.01-$5.50
                341,249
                3.05
                $   
                    4.91
                237,896
                
                $  
                     4.83$5.51-$7.00
                742,250
                4.01
                $  
                     6.31
                176,668
                
                $   
                    6.39$7.01-$8.50
                121,250
                3.34
                $   
                    7.45
                66,252
                
                $   
                    7.23$8.51-$10.10
                300,500
                4.37
                $   
                    9.14
                15,313
                
                $   
                    8.96$2.50-$10.10
                2,070,810
                3.15
                $   
                    5.69
                1,026,690
                
                $  
                     4.45
 Employee
          Benefit - 401K Plan
 On
        January 1, 1998, the Company established a 401(k) plan covering its employees.
        The plan originated service effectively in June 1998. Matching contributions
        are
        made on behalf of all participants at the discretion of the Board of Directors.
        During the fiscal years ended September 30, 2005, 2004 and 2003, the Company
        made matching contributions of $41,793, $28,385 and $18,675 respectively.
  F-26
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  **8.
        COMMITMENTS AND CONTINGENCIES**
 
 Facility
        Leases
 The
        Company’s executive offices, research and development and operational facilities
        in San Diego, California, are occupied under a sublease agreement that
        commenced in January 2004 and was to expire in July 2006. The Company
        currently occupies approximately 23,500 square feet of office, laboratory,
        production and warehouse space with aggregate monthly payments of approximately
        $28,000, exclusive of utilities and costs. In August 2005, the sublease was
        terminated and the Company entered into an attornment agreement providing
        for a
        facility lease through December 31, 2005 with an option to continue on a
        month-to-month basis after that date with the consent of the landlord. In
        November 2005 the Company entered into an amendment to the attornment agreement
        providing for an extension of the lease until January 31, 2006.
 
 On
        December 20, 2005, the Company entered into a sublease agreement with Anacomp,
        Inc., as sublandlord, to sublease approximately 23,698 square feet of office,
        warehousing, product assembly, and research and development space. The sublease
        is for a term commencing January 1, 2006 and expiring May 31, 2011, with
        monthly
        payments of approximately $29,623 per month plus certain costs and charges
        specified in the sublease, including the Company’s proportionate share of the
        building operating expenses and real estate taxes.
  The
        Company rents on a monthly basis space utilized for development and production
        of its NeoPlanar technology in Carson City, Nevada. The Company occupies
        approximately 2,200 square feet with a monthly payment of approximately $1,200
        excluding utilities. The Company leases sales office space in Topsham, Maine
        consisting of approximately 1,700 square feet with a monthly payment of $2,592,
        excluding utilities. The lease expires on December 31, 2005 and the Company
        is
        negotiating the renewal of the lease.
  Other
        Operating Leases
 In
        addition to the facility lease, the Company has one automobile lease obligation
        expiring in May 2006. The Company also has three business equipment leases
        expiring from November 2006 to December 2008. These leases are reported as
        operating leases.
  Total
        operating lease expense, including facilities, automobile and business equipment
        leases, recorded by the Company for the years ended September 30, 2005, 2004
        and
        2003 was $368,219, $345,330 and $206,084, respectively.
 
 The
        obligations under all operating leases are as follows:
  Year
                    ending September 30:2006
                
                $
                254,7512007
                
                $
                367,9432008
                
                $
                362,5442009
                
                $
                356,5842010
                
                $
                355,470
  Employment
        Agreements
 The
        Company entered into an employment agreement in October, 2005 with its president
        and chief operating officer that provides for severance benefits in the form
        of
        up to a maximum of six months of salary and health benefit continuation if
        his
        employment is terminated without cause or he resigns for good reason (Note
        14).
        There are no other employment agreements with executive officers or other
        employees providing future benefits or severance arrangements. The Company
        has
        an agreement with an officer that provides for a royalty if the Company uses
        his
        technology. The terms of that agreement are currently under renegotiation.
 
 Commission
        and Bonus Plans
 The
        Company has established a sales commission plan, approved by the Compensation
        Committee of the Board of Directors, providing cash incentives to certain
        of the
        Company’s sales employees based on revenues recognized or amounts invoiced. In
        fiscal 2005 and 2004, the Company recorded $315,822 and $95,500 of commission
        expense, respectively.
  Purchase
        Committments
 The
        Company has a non-cancelable purchase agreement of $304,250 at September
        30,
        2005, for the purchase of raw materials used in the production of LRAD finished
        goods. The Company expects to fulfill this committment within the next year.
        For
        the year ended September 30, 2005, the Company incurred a cancellation fee
        of
        $195,200 relating to a prior purchase committment.
  F-27
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
 Certain
          of the Company’s employees, in accordance with their terms of employment, may
          earn cash bonuses based on the overall financial performance of the Company.
          In
          fiscal 2005 and 2004, $170,456 and $-0- of bonuses were paid or accrued
          for
          payment.
 Litigation
 In
        September 2003, the Company filed a complaint against eSoundIdeas, Inc.,
        in the
        Superior Court of California, County of San Diego, alleging breach of contract
        and seeking a declaratory judgment to the effect that a License, Purchase
        and
        Marketing Agreement dated September 28, 2000 (the “ESI License Agreement”) with
        eSoundIdeas, a California partnership, was properly terminated in May 2003.
        The
        principals of eSoundIdeas are Greg O. Endsley and Douglas J. Paschall. The
        principals also founded a corporation, eSoundIdeas, Inc., (“ESI”, and, together
        with Endsley, Paschall, the “ESI Parties”), which purported to assume the
        contractual obligations of eSoundIdeas.
  In
        April
        2005, the Company and the ESI Parties entered into a Settlement Agreement
        and
        Mutual Release. As part of the settlement, the Company agreed to pay $150,000,
        which was previously accrued and recorded as a general and administrative
        expense, and to issue 17,500 shares of common stock to the ESI Parties. The
        fair
        market value of the 17,500 shares as of April 27, 2005 of $140,175, was recorded
        in the quarter ended March 31, 2005 as a general and administrative expense.
        In
        addition the ESI Parties will be entitled to receive an aggregate commission
        equal to 1% of net sales from April 1, 2005 to September 28, 2007, of the
        Company’s HSS products specifically targeted for use in North America in the
        point of sale/purchase, kiosk, display, event, trade show and exhibit markets,
        subject to a maximum aggregate commission of $500,000.
  Related
        to the Company’s April 2000 purchase of the NeoPlanar speaker technology, the
        Company was in dispute with a predecessor owner of the technology regarding
        a
        minimum film royalty. In March 2004, the Company settled this matter for
        a
        payment of $25,000 and the issuance of 50,000 shares of common stock, which
        included a buyout of all future royalties.
 
 In
        February 2004, the Company gave notice of termination of two licensing and
        sales
        agreements with General Dynamics Armament and Technical Products, Inc. (GD-ATP),
        originally entered into in February 2003. GD-ATP was the original licensee
        under
        one agreement, and took assignment of the rights of Bath Iron Works Corporation,
        another subsidiary of General Dynamics Corporation, under the other agreement.
        The agreements gave GD-ATP the right to purchase, market and resell NeoPlanar
        and HIDA (High Intensity Directional Acoustics) products and components with
        exclusive rights for specified applications to certain government customers,
        including the Department of Defense, Department of Homeland Security and
        certain
        Federal, State and local agencies. GD-ATP disputed the Company’s right to
        terminate the agreements and demanded arbitration. In April 2004, the Company
        announced that it and GD-ATP had mutually agreed to resolve their disputes
        in an
        amicable manner, and to dismiss the arbitration proceedings. GD-ATP and the
        Company agreed that neither was liable to the other and that no party engaged
        in
        any wrongdoing. The resolution resulted in the termination of the two
        agreements, and in the Company assuming GD-ATP’s role in servicing certain LRAD
        customers previously serviced by GD-ATP.
 
 In
        August
        2003, the Company reached an agreement and in September 2003, the Company
        settled litigation related to the termination of an outside contract
        manufacturer, Horizon Sports Technologies, Inc. d/b/a HST. As part of the
        settlement the Company acquired raw materials and equipment for production
        valued at approximately $145,000. The Company paid settlement costs of $313,000
        and recorded additional settlement costs for the $585,000 value assigned
        to
        100,000 shares of common stock issued to HST. As part of the settlement,
        HST
        also entered into a nonexclusive royalty-bearing license to manufacture and
        sell
        speakers based on the Company’s Stratified Field technology and PureBass
        subwoofer technology and the Company transferred to HST tooling valued at
        approximately $43,000.
 
 The
        Company may at times be involved in litigation in the ordinary course of
        business. The Company will also, from time to time, when appropriate in
        management’s estimation, record adequate reserves in the Company’s financial
        statements for pending litigation. Except as set forth above, there are no
        pending material legal proceedings to which the Company is a party or to
        which
        any of its property is subject.
 
 Royalties
 The
        Company is obligated to pay a $2.50 per unit royalty on one electronic component
        for its HSS product. The Company is also obligated to pay an officer and
        director a 2% royalty on net sales from certain of its technologies, of which
        only HSS is a current offering of the Company. The royalty obligation continues
        until at least March 1, 2007, and for any longer period during which the
        Company
        sells products or licenses technologies subject to any patent assigned to
        it by
        the officer/director. No royalties were paid under this agreement in the
        fiscal
        years ended September 30, 2005, 2004 and 2003, as such royalties were waived
        by
        the officer and director. The Company may owe royalties in future periods
        based
        on actual sales or technology revenues.
  F-28
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  Liquidated
        Damages
 In
        connection with the registration rights agreement entered into in connection
        with the sale of common stock in July 2005 (Note 6), the Company may be
        obligated to pay liquidated damages if it fails to maintain the effectiveness
        of
        the registration statement declared effective in September 2005. The maximum
        obligation, assuming all holders retained all their shares, would be $140,000
        per month (maximum of $70,000 per month through December 2005) computed daily
        for any period a registration statement is not effective. The Company believes
        any such obligation will cease or substantially reduce in July 2007 when
        most if
        not all registrable securities may be sold under Rule 144(k) without
        registration.
  **9.
        WARRANTY RESERVE**
  Details
        of the estimated warranty liability are as follows:
  **Years
                    Ended September 30:**
                
                2005
                
                2004Beginning
                    balance
                
                $
                331,917
                
                $
                319,500Warranty
                    provision
                
                
                71,731
                
                
                101,671Warranty
                    deductions
                
                
                (154,667
                )
                
                (89,254
                )Ending
                    balance
                
                $
                248,981
                
                $
                331,917
  **10.
        EQUIPMENT UNDER CAPITAL LEASE**
  On
        October 1, 2001, the Company entered into a capital lease obligation for
        the
        purchase of a phone system. The lease expires September 11, 2006 and bears
        interest at 10.1%, with monthly principal and interest payments of $1,067.
        Future minimum lease payments and the present value of the minimum lease
        payments under the noncancelable lease obligation as of September 30, 2005
        are
        as follows:
  Year
                    ending September 30:2006
                
                $
                12,806Total:
                
                $
                12,806Total
                    future minimum lease payments
                
                $
                12,806Less
                    amounts representing interest
                
                
                (675
                )Present
                    value of minimum lease payments
                
                
                12,131Less
                    current maturities
                
                
                (12,131
                )Total
                    long-term obligations
                
                $
                -
 
 At
        September 30, 2005, there was property and equipment under capital lease
        obligations with a total cost of $50,612 and accumulated amortization of
        $50,612.
 
 **11.
        MAJOR CUSTOMERS**
 
 For
        the
        fiscal year ended September 30, 2005, revenues from one customer in the
        Government Group accounted for 69% of revenues with no other single customer
        accounting for more than 10% of revenues. For the fiscal year ended September
        30, 2004, revenues from two customers, both in the Government Group, accounted
        for 47% and 11% of revenues with no other single customer accounting for
        more
        than 10% of revenues. For the fiscal year ended September 30, 2003, revenues
        from one customer in the Government Group accounted for 24% of total
        revenue.
  F-29
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
 At
        September 30, 2005, accounts receivable from two customers accounted for
        18% and
        14% of total accounts receivable with no other single customer accounting
        for
        more than 10% of the accounts receivable balance. At September 30, 2004,
        accounts receivable from three customers accounted for 52%, 19% and 13% of
        total
        accounts receivable with no other single customer accounting for more than
        10%
        of the accounts receivable balance.
 
 **12.
        SUPPLIER AGREEMENTS**
 
 The
        Company is reliant on contract manufacturers for production of certain HSS
        and
        LRAD components, sub-assemblies and products. The Company currently coordinates
        and manages production of its products with these suppliers but has in the
        past
        and may in the future arrange for turnkey production.
 
 **13.
        BUSINESS SEGMENT DATA**
 
 The
        Company is engaged in design, development and commercialization of sound,
        acoustic and other technologies. In the fourth quarter of fiscal 2003, the
        Company organized operations into two segments by the end-user markets they
        serve. The Company’s reportable segments are strategic business units that sell
        the Company’s products to distinct distribution channels. The Commercial
        Products Group (Commercial Group) licenses and markets HSS, LRAD, NeoPlanar
        and
        other sound products to companies that employ audio in consumer, commercial
        and
        professional applications. The Government & Military Group (Government
        Group) markets LRAD, NeoPlanar, and other sound products to government and
        military customers and to the expanding force protection and commercial security
        markets. The segments are managed separately because each segment requires
        different selling and marketing strategies as the class of customers within
        each
        segment is different.
 
 The
        accounting policies of the segments are the same as those described in the
        summary of significant accounting policies. The Company does not allocate
        operating expenses or assets between its two reportable segments. Accordingly
        the measure of profit for each reportable segment is based on gross profit.
        Although the segments became separately managed only in the last quarter
        of
        fiscal 2003, the Company has segmented historical operations for comparable
        customers for comparison.
  **Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Revenues:Commercial
                    Group
                
                $
                891,745
                
                $
                933,373
                
                $
                861,091Government
                    Group
                
                
                9,303,801
                
                
                4,819,176
                
                
                454,335$
                10,195,546
                
                $
                5,752,549
                
                $
                1,315,426Gross
                    Profit (Loss):Commercial
                    Group
                
                $
                (924,018
                )
                $
                (534,174
                )
                $
                (501,748
                )Government
                    Group
                
                
                5,495,204
                
                
                2,816,902
                
                
                273,097$
                4,571,186
                
                $
                2,282,728
                
                $
                (228,651
                )
 The
        following table summarizes revenues by geographic region. Revenues are
        attributed to countries based on location of customer.
  **Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Revenues:United
                    States
                
                $
                9,866,583
                
                $
                5,675,088
                
                $
                1,167,120Other
                
                
                328,963
                
                
                77,461
                
                
                148,306$
                10,195,546
                
                $
                5,752,549
                
                $
                1,315,426
  F-30
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
 
 **14.
        SUBSEQUENT EVENTS**
  In
        October 2005, the Company entered into a letter agreement with John R. Zavoli
        as
        President and Chief Operating Officer, effective November 1, 2005. The letter
        agreement provides for an annual base salary of $250,000 and eligibility
        for an
        annual bonus. Mr. Zavoli was granted an option to purchase 100,000 shares
        of
        common stock exercisable at $4.78 per share vesting over four years. Mr.
        Zavoli
        is entitled to severance benefits in the form of up to a maximum of six months
        of salary and health benefit continuation if employment is terminated without
        cause or he resigns for good reason.
 
 In
        October 2005, the Company entered into a separation and release agreement
        with
        its former president and chief operating officer. The agreement provided
        that
        the Company would make a one-time payment of $82,500 and would pay health
        benefit premiums for a period not to extend beyond February 28, 2006. The
        Company also extended until February 15, 2006 the period of time for which
        the
        vested portion of his stock options may be exercised.
  Michael
        A. Russell, the Company’s Chief Financial Officer, resigned from his employment
        on December 16, 2005. On
        December 16, 2005, the board of directors appointed John R. Zavoli as the
        Interim Chief Financial Officer to replace Mr. Michael A. Russell. Mr. Zavoli's
        employment terms did not change as a result of this appointment.
 
 On
        December 16, 2005, Karen Jordan was appointed as Chief Accounting Officer.
        Ms.
        Jordan, joined the Company in November 2005 as Director of Finance.
  On
        December 20, 2005, the Company entered into a sublease agreement with Anacomp,
        Inc., as sublandlord, to sublease approximately 23,698 square feet of office,
        warehousing, product assembly, and research space located at 15378 Avenue
        of
        Science, San Diego, California 92118. The sublease is for a term commencing
        January 1, 2006 and expiring May 31, 2011. The agreement provides for a monthly
        expense of $29,622.50 (i.e., $1.25 per rentable square foot) during the term.
        In
        addition to the monthly base rental expense, we will be responsible for certain
        costs and charges specified in the sublease, including the Company’s
        proportionate share of the building operating expenses and real estate taxes.
  In
        addition, the sublease provides that the Company has a right of first refusal
        on
        additional space in the building, which contains a total of 68,910 square
        feet
        including our premises. Anacomp will also provide a $10,000 tenant improvement
        allowance towards the completion of lobby improvements and a $50,000 letter
        of
        credit in the Company’s favor which we may draw upon to the extent necessary to
        offset any increase in our rent or relocation costs that is incurred due
        to
        Anacomp's failure to maintain the lease with the master landlord for the
        building.
  F-31
 Table
              of Contents
 **American
                Technology Corporation**
 **Notes
                to the Financial Statements**
  **15.
                    SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION****Years
                    Ended September 30,**
                
                **2005**
                
                **2004**
                
                **2003**Supplemental
                    Information:Cash
                    paid for interest
                
                $
                93,457
                
                $
                2,889
                
                $
                111,886Cash
                    paid for taxes
                
                $
                11,076
                
                $
                14,537
                
                $
                2,467Non-cash
                    financing activities:Senior
                    notes applied to warrant exercise
                
                $
                -
                
                $
                -
                
                $
                681,845Senior
                    notes applied to purchase of Series E stock
                
                $
                -
                
                $
                -
                
                $
                1,000,00012%
                    subordinated notes and interestconverted
                    to common stock
                
                $
                -
                
                $
                -
                
                $
                2,435,032Sale
                    of equipment for accounts payable
                
                $
                -
                
                $
                -
                
                $
                117,000Warrants
                    issued for offering costs
                
                $
                2,896,000
                
                $
                -
                
                $
                -Warrants
                    issued for debt financing
                
                $
                723,000
                
                $
                -
                
                $
                -Common
                    stock issued on conversion of Series C stock
                
                $
                -
                
                $
                -
                
                $
                236,498Common
                    stock issued on conversion of Series D stock
                
                $
                581,666
                
                $
                -
                
                $
                1,935,559Common
                    stock issued on conversion of Series E stock
                
                $
                2,604,238
                
                $
                320,414
                
                $
                823,208Common
                    stock issued for legal settlement
                
                $
                140,175
                
                $
                248,000
                
                $
                -
  **16.
        SUMMARIZED QUARTERLY RESULTS (unaudited)**
 The
        following table presents unaudited operating results for each quarter within
        the
        two most recent years. The Company believes that all necessary adjustments
        consisting only of normal recurring adjustments, have been included in the
        amounts stated below to present fairly the following quarterly results when
        read
        in conjunction with the financial statements included elsewhere in this report.
        Results of operations for any particular quarter are not necessarily indicative
        of results of operations for a full fiscal year.
  **First**
                
                **Second**
                
                **Third**
                
                **Fourth**
                
                **Total****Quarter**
                
                **Quarter**
                
                **Quarter**
                
                **Quarter**
                
                **Year****Fiscal
                    2005**Revenues
                
                $
                4,408,913
                
                $
                2,817,393
                
                $
                1,393,798
                
                $
                1,575,442
                
                $
                10,195,546Gross
                    profit (loss) (1)
                
                $
                2,881,210
                
                $
                1,363,427
                
                $
                402,006
                
                $
                (75,458
                )
                $
                4,571,185Net
                    loss
                
                $
                (1,526,850
                )
                $
                (1,613,016
                )
                $
                (3,592,769
                )
                $
                (2,354,072
                )
                $
                (9,086,707
                )Loss
                    per Share (2)
                
                $
                (0.09
                )
                $
                (0.15
                )
                $
                (0.17
                )
                $
                (0.09
                )
                $
                (0.50
                )**First**
                
                
                **Second**
                
                
                **Third**
                
                
                **Fourth**
                
                
                **Total****Quarter**
                
                
                **Quarter**
                
                
                **Quarter**
                
                
                **Quarter**
                
                
                **Year****Fiscal
                    2004**Revenues
                
                $
                774,778
                
                $
                1,493,250
                
                $
                2,107,281
                
                $
                1,377,240
                
                $
                5,752,549Gross
                    profit (loss) (1)
                
                $
                366,300
                
                $
                548,026
                
                $
                1,100,962
                
                $
                267,440
                
                $
                2,282,728Net
                    loss
                
                $
                (1,136,427
                )
                $
                (1,165,196
                )
                $
                (1,390,411
                )
                $
                (2,268,402
                )
                $
                (5,960,436
                )Loss
                    per Share (2)
                
                $
                (0.07
                )
                $
                (0.08
                )
                $
                (0.09
                )
                $
                (0.11
                )
                $
                (0.37
                )
  (1)
              Gross
                  profit is calculated by subtracting cost of revenues from total
                  revenues.
 (2)
              Loss
                  per share is computed independently for each quarter and the full
                  year
                  based on respective average shares outstanding. Therefore the sum
                  of the
                  quarterly net loss per share amounts may not equal the annual amounts
                  reported.
 
 F-32
 Table
            of Contents
 
 **Schedule
        II - Valuation and Qualifying Accounts**
  **ALLOWANCE
                    FOR DOUBTFUL ACCOUNTS**Balance
                    at
                
                Charged
                    to
                
                
                
                BalanceBeginning
                
                Cost
                    and
                
                
                
                at
                    End ofDescription
                
                of
                    Period
                
                Expenses
                
                Deductions
                
                PeriodYear
                    ended September 30, 2005
                
                $
                25,000
                
                $
                102,492
                
                $
                2,492
                
                $
                125,000Year
                    ended September 30, 2004
                
                $
                25,000
                
                $
                -
                
                $
                -
                
                $
                25,000Year
                    ended September 30, 2003
                
                $
                20,191
                
                $
                4,809
                
                $
                -
                
                $
                25,000**RESERVE
                    FOR OBSOLESCENCE**Balance
                    at
                
                
                Charged
                    to
                
                
                
                
                
                BalanceBeginning
                
                
                Cost
                    and
                
                
                
                
                
                at
                    End ofDescription
                
                
                of
                    Period
                
                
                Expenses
                
                
                Deductions
                
                
                PeriodYear
                    ended September 30, 2005
                
                $
                110,000
                
                $
                784,150
                
                $
                202,944
                
                $
                691,206Year
                    ended September 30, 2004
                
                $
                20,000
                
                $
                90,000
                
                $
                -
                
                $
                110,000Year
                    ended September 30, 2003
                
                $
                20,000
                
                $
                -
                
                $
                -
                
                $
                20,000**WARRANTY
                    RESERVE**Balance
                    at
                
                
                Charged
                    to
                
                
                
                
                
                BalanceBeginning
                
                
                Cost
                    and
                
                
                
                
                
                at
                    End ofDescription
                
                
                of
                    Period
                
                
                Expenses
                
                
                Deductions
                
                
                PeriodYear
                    ended September 30, 2005
                
                $
                331,917
                
                $
                71,731
                
                $
                154,667
                
                $
                248,981Year
                    ended September 30, 2004
                
                $
                319,500
                
                $
                101,671
                
                $
                89,254
                
                $
                331,917Year
                    ended September 30, 2003
                
                $
                6,313
                
                $
                313,187
                
                $
                -
                
                $
                319,500
 F-33
 Table
            of Contents
 
 **SIGNATURES**
  Pursuant
        to the requirements of Section 13 or 15(d) of the Securities Exchange Act
        of
        1934, the registrant has duly caused this report to be signed on its behalf
        by
        the undersigned, thereunto duly authorized.
  **AMERICAN
                TECHNOLOGY CORPORATION**December 29, 2005By:
              /s/ ELWOOD
                G.
                NORRISElwood
                G. NorrisChairman of the Board
 
 **POWER
        OF ATTORNEY**
  Know
        all persons by these presents, that each person whose signature appears below
        constitutes and appoints Elwood G. Norris and John R. Zavoli, and each of
        them, as his true and lawful attorneys-in-fact and agents, with full power
        of
        substitution and resubstitution, for him and in his name, place, and stead,
        in
        any and all capacities, to sign any and all amendments to this report, and
        to
        file the same, with all exhibits thereto, and other documents in connection
        therewith, with the Securities and Exchange Commission, granting unto said
        attorneys-in-fact and agents, and each of them, full power and authority
        to do
        and perform each and every act and thing requisite and necessary to be done
        in
        connection therewith, as fully to all intents and purposes as he might or
        could
        do in person, hereby ratifying and confirming that all said attorneys-in-fact
        and agents, or any of them or their or his substitute or substituted, may
        lawfully do or cause to be done by virtue thereof.
  Pursuant
        to the requirements of the Securities Exchange Act of 1934, this report has
        been
        signed below by the following persons on behalf of registrant in the capacities
        and on the dates indicated.
  Date: 
                    December 29, 2005
                
                By:
                /s/
                    ELWOOD G. NORRISElwood
                    G. NorrisChairman
                    of the Board and Director(Co-Principal
                    Executive Officer)Date: 
                    December 29, 2005
                
                By:
                /s/
                    JOHN R. ZAVOLIJohn
                    R. ZavoliPresident,
                    Chief Operating Officer and DirectorInterim
                    Chief Financial Officer(Co-Principal
                    Executive Officer and Principal Financial Officer)Date: 
                    December 29, 2005
                
                By:
                /s/
                    KAREN JORDANKaren
                    Jordan,Chief
                    Accounting Officer(Principal
                    Accounting Officer)Date: 
                    December 29, 2005
                
                By:
                /s/
                    RICHARD M. WAGNERRichard
                    M. WagnerDirectorDate: 
                    December 29, 2005
                
                By:
                /s/
                    DAVID J. CARTERDavid
                    J. CarterDirectorDate: 
                    December 29, 2005
                
                By:
                /s/
                    DANIEL HUNTERDaniel
                    HunterDirector
 Table
              of Contents


**Exhibits
        included with this filing:**
  **10. 
                            Material Contracts**10.3.2
                        
                        Attornment
                            Agreement between ATC and LBA Realty Fund-Holding Co.
                            I, LLC dated August
                            1, 2005.*10.3.3
                        
                        First
                            Amendment to Attornment Agreement between ATC and LBA
                            Realty Fund-Holding
                            Co. I, LLC dated November 15, 2005.*
 10.13.1
                          
                          Separation
                              and Release Agreement with Kalani Jones dated October
                              20,
                              2005.+*10.16
                          
                          Table
                              of Inducement Grants.+*
 10.31
                            
                            Summary
                                Sheet of Director and Executive Officer Compensation.*10.34
                            
                            Commission
                                Plan for Bruce Gray pursuant to Employment letter
                                dated March 21, 2005,
                                approved by the board of directors on September 28,
                                2005.+*^10.46
                            
                            Employment
                                Agreement with James Croft III dated February 28,
                                2000.+*10.47
                            
                            Employment
                                Letter Agreement with John R. Zavoli dated October
                                17,
                                2005.+*10.48
                            
                            Employment
                                letter of Alan J. Ballard dated November 21, 2003.+*10.49
                            
                            Employment
                                letter of Rose Tomich-Litz dated November 29, 2005.+*10.50
                            
                            Employment
                                letter of Karen Jordan dated October 26, 2005, 2005.+*10.51
                            
                            Sublease
                                between ATC and Anacomp, Inc. dated December 13,
                                2005.*10.52
                            
                            Separation
                                Agreement between ATC and Michael A. Russell dated
                                December 23,
                                2005.*
 **23.  Consents
                                of Experts and Counsel**23.1
                            
                            Consent
                                of BDO Seidman, LLP.*23.2
                            
                            Consent
                                of Swenson Advisors, LLP.***Certifications**31.1
                            
                            Certification
                                of Elwood G. Norris, Co-Principal Executive Officer,
                                pursuant to Rule
                                13a-14(a) or 15d-14(a) of the Securities and Exchange
                                Act of 1934, as
                                adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                                2002.*31.2
                            
                            Certification
                                of John R. Zavoli, Co-Principal Executive Officer
                                and Principal Financial
                                Officer pursuant to Rule 13a-14(a) or 15d-14(a) of
                                the Securities and
                                Exchange Act of 1934, as adopted pursuant to Section 302 of the
                                Sarbanes-Oxley Act of 2002.*32.1
                            
                            Certification
                                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                                Section 906 of the Sarbanes-Oxley Act of 2002, executed by
                                Elwood G.
                                Norris, Co-Principal Executive Officer, John R. Zavoli,
                                Co-Principal
                                Executive Officer and Principal Financial Officer.**  Filed
                                concurrently herewith+  Management
                                contract or compensatory plan or arrangement. Exhibits
                                10.28, 10.29 and
                                10.30 are included as a management contract given
                                that a trust affiliated
                                with an officer, director and significant stockholder
                                purchased a note and
                                received a warrant in connection with that financing
                                and is a party to
                                those exhibits.^ 
                              Confidential treatment has been requested with respect
                              to certain portions
                              of this exhibit. Omitted portions have been filed separately with the
                              Securities and Exchange Commission.