UNITED STATES**SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549**

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**FORM 10-K/A(AmendmentNo. 2)**

** **

** ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004**

** **

 

**Commission File Number 0-24248**

 

AMERICANTECHNOLOGY CORPORATION

(Exact name ofregistrant as specified in its charter)

 

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

 

Registrant's' telephonenumber, 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) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding in 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

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

 

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

 

Theaggregate market value of the voting and non-voting common equity held bynon-affiliates of the registrant (based on the closing price as reported on theNASDAQ SmallCap Market on March 31, 2004) was $94,391,214.*

 

The number of shares of Common Stock, $.00001 par value, outstanding on March15, 2005, was 21,317,239.

 

* Excludes the Common Stock held by executive officers, directors andstockholders whose ownership exceeds 5% of the Common Stock outstanding atMarch 31, 2004. This calculation does not reflect a determination that suchpersons are affiliates for any other purpose.

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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     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| **PART I** |
|            | Explanatory Note  | 1
ITEM 1.

Business

2

 

       Overview

  3

 

       Recent  Developments

 3

 

       Segment Reporting

  3

 

        Our  Technology and Products

4

 

       Operating Segment Information

  6

 

       Business Group

  6

 

       Government Group

  7

 

       Manufacturing and Suppliers

9

 

       Selling, Marketing and Customers

10

 

       Warranties

10

 

       Competition

  10

 

       Seasonality

  11

 

       Government Regulation and Environmental Matters

  11

 

       Intellectual Property Rights and Proprietary Information

  12

 

       Research and Development

  14

 

       Executive Officers

  14

 

       Employees

15

ITEM 2.

Properties

  15

ITEM 3.

Legal  Proceedings

  16

ITEM 4.

Submission of Matters to a Vote of Security  Holders

  16

 

 

 

 **PART II**

ITEM 5.

Market for Registrant’s Common Equity, Related

 

 

      Stockholder Matters and Issuers Purchases of Equity Securities

  16

ITEM 6.  

Selected Financial Data

  18

ITEM 7.

Management's Discussion and Analysis of  Financial Condition

 

 

   and  Results of Operations

  18

ITEM 7A.

Quantitative and Qualitative Disclosures About  Market Risk

  37

ITEM 8.

Financial Statements and Supplementary Data

  37

ITEM 9. 

Changes in and Disagreements with Accountants  on 

 

 

      Accounting and Financial Disclosure

  37

ITEM 9A.

Controls and Procedures

  37

ITEM 9B.

Other Information

37

 

 

 

 **PART III**

ITEM 10.

Directors and Executive Officers of the  Registrant

  39

ITEM 11. 

Executive Compensation

  40

ITEM 12. 

Security Ownership of Certain Beneficial  Owners and Management

 

 

   and  Related Stockholder Matters

  44

ITEM 13. 

Certain Relationships and Related Transactions

  47

ITEM 14. 

Principal Accounting Fees and Services

  48

 

 

 

 **PART IV**

ITEM 15. 

Exhibits, Financial Statement Schedules

  49

 

Financial Statements and Financial Statement  Schedules

F-1
   Signatures
54
 

Exhibit Index

  55
    
EXPLANATORYNOTE

 

**This Amendment No. 2 to Form 10-K/A for American Technology Corporation for the year ended September 30, 2004, which amends and restates the Form 10-K in its entirety, is being filed solely (a) to correct information in Part III, Item 10 regarding Section 16(a) Beneficial Ownership Reporting Compliance to include information previously omitted regarding one late filing by an executive officer, (b) to update the disclosure in Part II, Item 9A concerning controls and procedures, and (c) to include updated certifications pursuant to Section 302 and Section 906 of the Sarbanes-Oxley Act of 2002. Our Form 10-K was originally filed on December 28, 2004, and was amended on January 28, 2005. In order to preserve the nature and character of the disclosures set forth in the Form 10-K, as amended, this Amendment No. 2 does not reflect events occurring after the filing of the original Form 10-K on December 28, 2004, with respect to Parts I and II and the Financial Statements and related notes, or events occurring after the filing of Amendment No. 1 on Form 10-K/A on January 28, 2005, with respect to Parts III and IV.**

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PART I
 

**ForwardLooking 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.*

 

**Item1. Business**

 

**Overview**

AmericanTechnology Corporation is an innovator of proprietary sound reproductiontechnologies and products. We believe our innovative proprietary soundtechnologies provide us a significant competitive advantage in our principalmarkets. We believe we are the leader in developing and commercializingparametric loudspeakers, branded as HyperSonic® sound or HSS®. We believe weare also the leader in developing and commercializing high intensity directedacoustical devices, branded as our Long Range Acoustic Device or LRADTM. We havefiled over 70 patent applications in the United States, and over 90 patentapplications internationally covering our various sound technologies andproducts. 

 

Wemake significant investments in research and development to expand ourtechnology and product portfolio. We are expanding our LRAD product family,introducing a new NeoPlanar product line for emergency notification and generalannouncing markets which require high intelligibility, and are utilizing ourproducts to provide solutions for difficult acoustic challenges.  We offer our products for sale worldwide,but expect the largest markets to be the United States, Europe and Asia.

 

Ourfour major products from our technology portfolio are listed below.

 
- Our     HyperSonic sound, or HSS, technology is a new parametric speaker     technology that creates sound “in the air.” Sound is generated along an     air column using ultrasonic frequencies, which are those above the normal     range of hearing. The HSS sound beam is highly directional and maintains     sound volume over longer distances than traditional loudspeakers. 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. In October 2004, we released     our HSS Generation III (T120 and T220) product family, which has higher     reliability, lower distortion and higher output levels than previous     models of our HSS products.
- Our     Long Range Acoustic Device, or LRAD technology produces variable intensity     acoustical sound intended for use in long-range delivery of directional     sound information, which is effectively a supercharged megaphone. LRAD     products are designed and used as directed long-range hailing and warning     systems by both government and commercial customers. We believe our LRAD     product innovation, our growing engineering capabilities, and our     manufacturing and marketing competencies have established us as the leader     in this new marketplace. We are marketing LRAD throughout the U.S.     Department of Defense as “The Sound of Force ProtectionTM”, and our markets     are expanding to include law enforcement and commercial customers with     significant security concerns. In fiscal 2004, we developed a remote     controlled pan/tilt version of LRAD for critical infrastructure force     protection applications, and we demonstrated our competency to engineer     additional new sound solutions for the U.S. Department of Defense.
- Our     NeoPlanar® technology is a thin film magnetic speaker that produces sound     of high quality, low distortion and high volume.  NeoPlanar applications include high-end sound,     emergency notification and public address systems. In fiscal 2004, we began     marketing NeoPlanar for use in large indoor spaces and in outdoor environments     for emergency notification. NeoPlanar offers customers a new capability by     delivering remarkably intelligible communications in difficult spaces such     as aircraft hangar bays and at distances up to one-half mile. 

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- Our SoundClusterTM     technology is a new multi-element speaker cluster optimized for even sound     coverage over large areas. Our SoundCluster product offers an improved     level of intelligibility and clarity in high ambient noise environments.     The SoundCluster satisfies flight deck safety and large area emergency     notification requirements. The flexible and ruggedized SoundCluster design     lends itself to installation in harsh environments, where conventional     speakers may fail. During fiscal 2004, we deployed the first SoundCluster     for use on a U.S. naval warship.

Inorder to capitalize on our technology leadership position, we continue to focuson our organization, management processes and business relationships.

 
- Organization:    - In fiscal 2004, we      created a new Quality Department reporting directly to the President to      ensure that we develop products that meet the high standards that our      customers require.
  - During      fiscal 2004, we increased the size of our engineering and quality      organization to 20 people to more rapidly expand our product      portfolio.    Management     Processes:- In fiscal 2004, we      continued to refine our phase gate development process. This process      provides executive review of each project at key phases within the      development cycle. The goal is to ensure development of products that      meet our cost, reliability and business goals. Our new product      developments use the phase gate development process.
- In      2005, we intend to begin the ISO 9001 certification process to meet the      needs of our customers.
Business     Relationships:
We will continue to seek relationships with      national or global partners for sales, manufacturing and distribution to      accelerate the worldwide adoption of our products.
The Business Group, described below, intends to      expand HSS sales into Western Europe and Asia. The Government      Group intends to expand LRAD and other product sales into Western Europe,      Asia and the Middle East.
**Recent Developments**

In December 2004, we received a firm order for $4.5million in LRAD products from ADS, Inc. for use by the U.S. Army 3rd InfantryDivision, Fort Stewart, Georgia.  The order also includes $0.4 million inancillary products which we are providing on a value-added reseller basis alongwith the LRAD units.  The order calls for deliveries in December 2004 andJanuary 2005 and customary payment terms.   
**Segment Reporting**

Weorganize our business into two reporting segments by the end-user markets weserve. Our Business Products and Licensing Group, or Business Group, licensesand markets HSS and NeoPlanar products to companies that employ audio inconsumer, commercial and professional applications. Our primary focus in theBusiness Group has been expanding sales of HSS. We are concentrating ourefforts on the following vertical markets:

 
- Digital Signage,     sometimes referred to as “In Store Television”;
- Command and Control     Centers;
- Museums and     Displays; 
- Trade Shows and     Conventions; and
- Kiosks.

OurGovernment and Force Protection Systems Group, or Government Group, marketsLRAD, NeoPlanar, SoundCluster and HSS products to government and militarycustomers and to the expanding force protection and commercial securitymarkets. We also engineer custom sound solutions for these customers. Based oninitial market response for long range hailing and warning, emergency response,and engineered acoustic solutions, we expect significant continued revenuegrowth for this segment in fiscal 2005. 

During fiscal 2004, we improved the quality,performance and manufacturability of our HSS products, and starting in Octoberof 2004, we began deliveries of our HSS Generation III (T120 and T220)products. We also expanded our Government Group product line by adding new LRADfeatures and new products. During fiscal 2004, we also expanded our AdvancedDevelopment and Engineering departments to accelerate new product developmentand support custom engineering solutions.

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We believe we are uniquely equipped to provideour technologies and products in rapidly growing markets for new sound applicationsnot currently served by conventional sound devices and as an alternative toconventional loudspeakers. We believe market factors such as the rapid growthof plasma and flat panel screens offer significant growth opportunities for ourHSS focused sound solutions. We also believe that the growth in defense andhomeland security and related protection spending by commercial customersprovides a growing market for our sound products to be used for intelligiblecommunication over long distances.

Our shares of common stock trade through theNASDAQ SmallCap Market under the symbol “ATCO.”  Our address is 13114 Evening Creek Drive South, San Diego,California, our telephone number is 858-679-2114 and our internet website islocated at www.atcsd.com. We make available, free of charge through ourwebsite, our annual report on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K, reports filed by our directors, executive officers andcertain significant shareholders pursuant to Section 16 of the SecuritiesExchange Act and all amendments to those reports filed or furnished pursuant toSection 13(a) or 15(d) of the Exchange Act of 1934 as soon as reasonablypractical after the reports are electronically filed with or furnished to theSecurities and Exchange Commission.  Theinformation on our website is not incorporated by reference into this reportnor is it part of this report.

 

**Our Technology and Products**

 

HyperSonicSound

We believe we havepioneered a new paradigm in sound production based on well-known principles ofphysics. The common speaker types in use today such as dynamic, electrostatic,ribbon and other transducer-based designs, are direct radiating, which arefundamentally a piston action directly pumping air molecules into motion to createaudible sound waves we hear. Parametric or nonlinear acoustics use changingpressures in air to produce sound indirectly. We believe we are the firstcompany to employ the "non-linearity" of air into a commercial soundproduct. 

 

HSS employs ultrasonicfrequencies to carry content, e.g. music and voice, into the air. Proprietaryultrasonic emitters, or transducers which convert electrical energy to highfrequency acoustical energy, produce these ultrasonic frequencies beyond therange of hearing.  We have developed the ability to use such devices in lieu ofloudspeakers to emit a custom-generated ultrasonic wave with the properdifference frequency characteristics to produce audible sound within andthroughout an invisible beam. Sound does not appear on the surface of theultrasonic emitter, which is a significant departure from a direct radiatingloudspeaker.  For example, if the beam is directed towards a wall, the soundfirst emanates from the surface of the wall, or if the beam is directed to aperson, the sound is created at the person. This directionality allows sound to be manipulated inspace or diffused from a surface in a wide variety of ways to produce desiredeffects. The sound does not dissipate at the same rate over distance as it doeswith traditional speakers. This unique feature provides greater sound volume atselected distant points with less energy than traditional speakers, creatingthe ability to communicate directed sound at distances up to hundreds of feet.

 

With the rapid growth ofalternative advertising such as digital signage, point-of-purchase and in-storeTV networks, there is a trend towards sound clutter and even sound pollution.In-store display advertising tends to irritate customers if too intrusive andannoy workers due to the repetition. We have tested our sound with plasmadisplays to achieve focused controlled sound such that only those customersinterested in the promotion are tuned in and nearby clerks do not hear themessage. We believe this ability to locate sound will be a driving feature of HSS systems. We believe our HSS technology offers a number of advantages:

 
- The ability to     create a beam of sound and place it only where you want it;
- 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;
- Ability to     penetrate other competing sounds; and
- Elimination of feedback     from live microphones.

We expect additional HSSapplications to become evident as our products become more widely known. Webelieve HSS will ultimately have application in much broader consumer, home,vehicle, commercial and industrial environments.

 

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We are currentlyproducing and selling our HSS Generation III hypersonic sound directed audiosystems,  (Model T120 and T220), whichhave important improvements over prior generations including:

 
- Reduced distortion;
- Slimmer package;
- Wired remote     control;
- Volume thumb wheel     with digital volume display;
- Universal mounting     studs;
- Swivel mount; and
- Choice of audio     inputs including, XLR Microphone, RCA and Mini-Jack.

We expect to developimproved electronics and emitters and introduce new HSS systems in fiscal 2005.We seek to minimize distortion, improve output, reduce electronic packagingsize, and trim production costs to expand the applications of HSS to newmarkets.

 

Long Range AcousticDevice

We believe our LongRange Acoustic Device, or LRAD, technology is a breakthrough directed acousticbeam device for long-range hailing and warning.  LRAD was developed to communicate at operationally-effectiveranges with authority and superior intelligibility, even in high ambient noiseenvironments. LRAD meets the need for clear voice communications at a distanceto issue instructions, influence behavior, and determine intent.  LRAD was developed to support the securityneeds of military, government, law enforcement and commercial customersworldwide. Through intense marketing efforts, successful product deploymentsand extensive product demonstrations, we believe that LRAD is becoming wellknown by the U.S. Department of Defense as “The Sound of Force ProtectionTM”.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.  Operational feedback by the U.S.Navy, U.S. Marine Corps. and U.S. Army from LRAD deployment in Operation IraqiFreedom has been favorable. LRAD also supports applications for the Departmentof Homeland Security, other government and law enforcement agencies andcustomers where there is a need to protect critical high-value commercialinfrastructure, such as buildings, bridges, tunnels, dams, power plants,pipelines, airports, sea ports, communications towers and other similarimportant commercial facilities. 

 

LRAD was developed inparallel with the release of Naval Vessel Protection Zone requirements toenforce 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.LRAD provides the critical long range communication and intense but not harmfulability to warn away friendlies,classify non-compliants as hostile and support lethal rules ofengagement.  This ability also allowsthe LRAD operator to execute proactive responses at extended distances, whichin turn increases safety and the time to diffuse tense situations, thereby potentiallysaving lives on both sides of the device. In the remote-operation pan/tiltconfiguration, LRAD provides a first responder, immediately escalatingnon-lethal capability for protecting important commercial facilities.

 

LRAD’s features include:

 
- High source level     acoustic transmissions with a series of phase coherent transducers;
- Sound pressure     levels in excess of 146 dB, or decibels during continuous operation at a     distance of 1 meter with instantaneous peaks at 151 dB;
- Limits to 120 dB at     1 meter in normal operation, with a battle override key to allow maximum     power to achieve longer hailing and warning distances for certain     applications and ambient noise conditions;
- A beam center of 16     degrees on either side of center line;
- Effective hailing     distances in excess of 500 yards, warning distances in excess of 750     yards;
- Both voice and     warning tones for determining intent for multiple applications;
- Low operating power     requirement, (400 watts); easily powered by 12/24 volt invertors;
- Input flexibility from     networks, individual microphones, and audio output hand held and wearable     computers;
-  Easily transportable or vehicle mounted, 33” diameter x 4” thickness, lightweight at 45 lbs.; 
- Powerful and safe when used properly; and 
-   Highly directional at distance.

We also have othercustomized LRAD applications under development to meet specific customerrequirements each with broad government and commercial applications.

 

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NeoPlanar Speakers

OurNeoPlanar technology is a thin film planar magnetic type speaker that usesnovel films, magnetic materials and a manufacturing process that we believeprovides improved cost/performance benefits. Traditional planar magneticspeakers use materials with limited power handling ability and are generallyassociated with high distortion. Our NeoPlanar technology provides the abilityto build flat and thin speakers with the following distinguishing features:

 
- High power handling;     
- Low mass;
- High durability; 
- Superior sound     quality; 
- High sensitivity; 
- High sound pressure     levels; 
- Extended high     frequency output compatible with new compact disk standards; and
- Exceptional clarity     over long distances.

Atpresent, we assemble NeoPlanar panels in 3, 8, and 24-inch segments of 3 inchwidth. Other lengths and widths are manufacturable. Our NeoPlanar Sound Barproduct uses panels in an upright column and our NeoPlanar Sound Squaresproduct organizes panels in a square box configuration. Both products aredesigned for public address with high intelligibility at very high outputlevels. NeoPlanar products can be engineered and customized to fit the needs ofa particular facility or outdoor application. NeoPlanar speakers have beenemployed successfully for military and government installations in ships andhangars, and for outdoor public address and emergency response applications.

 

NeoPlanartechnology provides a loud and clear outdoor and indoor public address andemergency response communication system for military, government and commercialfacilities and areas.  Due to theirunique intelligibility in high ambient noise environments and robustsurvivability in most operational environments, NeoPlanar products are usefulfor multiple military, government and force protection applications. Indoors,particularly in large spaces such as aircraft hangars, NeoPlanar provides ahigh level of clarity due to engineered reduction of multi-path and distortion.Outdoors, NeoPlanar provides an effective range, up to approximately a half mile, ofclear high fidelity-quality communication even over high ambient noise.

 

SoundCluster

SoundClusteris a series of specifically engineered clusters of conventional high intensityruggedized speakers modeled and designed to provide scalable highly intelligibleand even sound coverage across the large areas.  For example, our first SoundCluster installation was for theflight deck of the USS Stennis (CVN-74), one of the most challenging acousticenvironments anywhere.  The U.S. Navy isconsidering SoundCluster as a permanent replacement for the aging 5MC flightdeck system. With this product, we have demonstrated that in addition to coreproprietary technologies, we possess the core competency to provide acomprehensive engineered solution for unique industry acoustic challenges.  

Other ProprietaryTechnologies

We have other soundinventions and technologies in various stages of development including ourPureBass® Woofer technology for low frequency speakers, our Stratified FieldTechnology, or SFT®, that employs a thin form, non-magnetic film to producehigh quality sound, and other technologies and products in various stages ofdevelopment. In 2005, we expect our sales efforts to be focused on HSS, LRAD,NeoPlanar and SoundCluster.

 

**Operating Segment Information**

We organize our businessinto two reportable segments by the end-user markets we serve. Our BusinessProducts and Licensing Group (Business Group) licenses and markets HSS andNeoPlanar speakers to companies that employ audio in consumer, commercial andprofessional applications. Our Government and Force Protection Systems Group (GovernmentGroup) markets LRAD, NeoPlanar, SoundCluster and HSS products to government andmilitary customers and to the expanding force protection and commercialsecurity markets.

 

**Business Group**

Our Business Grouplicenses and markets HSS and NeoPlanar technology and products to companieswhich employ audio in consumer, commercial, industrial and professionalapplications.  Our Business Group'sprimary marketing focus in fiscal 2005 will be on HSS product sales. Consumerapplications for our products include home theater, consumer electronics,vehicle and computer multimedia sound systems. Commercial and industrialapplications include digital signage, public address systems, point-of-purchaseadvertising, entertainment and messaging systems. Professional applicationsinclude sound systems for theaters, stadiums, production studios and indoor andoutdoor entertainment venues.

 

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We sell our products toa range of customers including end-users, Original Equipment Manufacturers, orOEMs, who package our sound products with other products and system solutions,and to distributors who sell our products to others.

 

Our HSS strategy is todrive use in growing markets that can benefit from directed or narrowcastsound. The following are some key growing markets: 
-  **Digital Signage** - Digital Signage is a generic term used to describe the replacement of static, or passive, signs or displays with video screens such as cathode ray tube, or CRT, plasma, liquid crystal display, or LCD, or light-emitting diode, or LED, which may contain still or motion video images.  The image content, usually advertising or informational, can be changed via network control of each individual sign. Directional audio is required to contain the audio program within a defined space, to eliminate objections to the material from local workers, and to lower the overall audio noise level in a confined space.**Command and Control Centers**– Command and Control Centers require directed audio so that a person monitoring a control station can clearly hear alarms and notifications without disturbing someone that is monitoring an adjacent control station.**Museums and Comparable Display Facilities**- Directional audio is required in museums and similar facilities to focus audio information in targeted areas without distracting other patrons.  It is also required to allow multiple audio programs to be played within a confined space. **Trade Show and Conventions**- Trade shows and conventions require directional audio to lessen the overall room noise, attract patrons, focus instructional audio to individual displays, and contain audio programs within defined booth spaces. **Kiosks** - Retail point of purchase or information kiosks require directional audio to contain sound within the immediate space of the kiosk and to maintain some privacy for each individual listener. 

 OurNeoPlanar strategy is to seek customers requiring a simple, rugged, thin, lowdistortion, high-clarity sound solution. We target customers to use NeoPlanarpanels for:
-  Industrial applications such as factories, airports and other large facilities;Vehicles;Coupling with flat panel displays;Multimedia;Public address systems; andHigh-end audio. 
In August 2001, weentered into a non-exclusive license agreement with Harman InternationalIndustries to manufacture and use NeoPlanar technology in the OEM automotivemarket. The term of the agreement is perpetual unless terminated by eitherparty for cause, or terminated by Harman with 30 days advance written notice.

 

**Government Group**

Late in fiscal 2003, we organized our Government Group to design, manufacture and market LRAD, NeoPlanar and HSS products for military, government and the developing force protection and emergency response markets, including commercial applications. During fiscal 2004, we demonstrated the market potential for LRAD, particularly with wartime implementations in Operation Iraqi Freedom.  We also completed key projects featuring the unique capabilities of NeoPlanar that have established our capabilities as an acoustic engineered solution provider. We are actively expanding relationships with the U.S. Department of Defense, U.S. Department of Homeland Security, other U.S. government agencies, major port authorities and police departments, international government agencies and commercial infrastructure security systems integrators.  

 

During fiscal 2004, we developed an automated pan/tilt model of LRAD for use in a wide variety of applications requiring a remotely operated force protection capability.  Our initial customer was the Naval Surface Warfare Center (NSWC), Crane, Indiana, for integration into the Integrated Radar Sighting Surveillance System, or IROS3, for surface combatants, and the Aircraft Carrier Situational Awareness System, or ACSAS.  ACSAS and IROS3 are the U.S. Navy’s shipboard force protections systems, expected to be installed on all aircraft carriers and surface combatants to protect against small boat threats in port, restricted waters and littoral zones. LRAD adds capability to the integrated optics, command and control, and lethal weapon suite by providing a simple, repeatable and reliable way to determine intent through long range hailing and warning. Our LRADmodels are also positioned to support a first responder capability for criticalinfrastructure protection for buildings, dams, bridges, tunnels, airports, powerplants, pipelines, ports, communication towers, water treatment facilities andother similar important commercial facilities.

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In December 2004,we received a firm order for $4.5 million in LRAD products from ADS, Inc. foruse by the U.S. Army 3rd Infantry Division, Fort Stewart, Georgia.  The order alsoincludes $0.4 million in ancillary products which we are providing on avalue-added reseller basis along with the LRAD units.

 

During fiscal 2004, wealso developed SoundCluster, a new product for which the initial implementationwas on the flight deck of a U.S. Navy aircraft carrier.

 

Thelandscape of the global defense industry continues to evolve as events, such asthose of September 11, 2001 and Operation Iraqi Freedom, demandalternative strategic defense initiatives. The defense requirements of theUnited States have shifted from defending against Cold War era threats tofocusing on the management of one or more regional conflicts, homeland securityand proactive threat identification. As a result of this shift towards lowintensity conflicts and military operations other than war, the defenseindustry is influenced by several key factors which also may impact ourGovernment Group, such as those factors listed below.

 
-  New funding is     available to implement new technologies to meet modern threats.There is increased     focus on force protection through threat identification, and non-lethal     capabilities. As a result of     consolidation in the industry, domestic prime contractors are relying on     others to provide subsystems and components.The U.S. military     is developing lighter, 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. 

Our strategy is toposition LRAD, NeoPlanar, and our other engineered solutions as the premiumsound solution product suite for force protection, emergency response, andadvanced audio systems throughout government and the security industry, firstin the U.S. and then internationally. The following are examples of how ourproducts are being used in force protection.

 
- LRAD    -    Sold and installed on ships in the 5th fleet in and around the Basra,      Iraq, area of the Persian Gulf to support maritime interdiction, such as      board, search and seizure operations and oil terminal protection      operations.Sold and delivered      units to the 1st Marine Expeditionary Force and 3rd      Marine Aircraft Wing deployed in and around Fallujah, Iraq, for Operation      Iraqi Freedom.  LRAD has been      added to the force protection kits, and deployed with several Marine      Expeditionary Units.Sold and delivered      units to the U.S. Army Rapid Expeditionary Force, and to the 3rd      Battalion, 2nd Infantry Division Stryker force deployed in and      around Mosul, Iraq in support of Operation Iraqi Freedom.Delivered units to      the New York Police Department for use in crowd control for the      Republican National Convention.Developed a      remotely operated pan/tilt model for use in protecting U.S Navy vessels      against small boat terrorist threats. Sold the remotely      operated pan/tilt model to the Port Authority of New York/New Jersey for      an initial infrastructure protection system project on the critical rail      Hackensack Bridge.  Received a large order for LRAD  units to be deployed by the U.S. Army 3rd Infantry Division, Fort Stewart,  Georgia.
 
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 -  NeoPlanar-  Delivered and      installed a waterfront hailing system for shipyard protection sponsored      by the Naval Sea Systems Command to demonstrate improved communication      intelligibility at long distances over varying levels of ambient noise. Delivered and      installed NeoPlanar Sound Bars for a newly constructed Navy aircraft      hangar sponsored by the Naval Facilities Command.Delivered and      installed NeoPlanar Sound Bars in a secure building sponsored by the      Naval Facilities Command.Delivered and      installed NeoPlanar Sound Bars and Sound Squares to a private academy for  a campus emergency response system and to replace existing athletic      field systems.
 -  SoundCluster-  Delivered a      SoundCluster system to the U.S. Navy for evaluation on the USS Stennis      (CVN-74) to replace the aging 5MC carrier flight deck sound system.-  HSS:-  Supported      evaluations by government agencies for next generation command center      communications.
Webelieve other military branches, government agencies and allied forces willincreasingly employ LRAD systems for long range hailing and warning as part oftheir force protection strategies.

 

OurGovernment Group sells products directly to end-user customers and also toagents and distributors specializing in military, government and commercialsecurity sales.

 

**Manufacturing and Suppliers**

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

 

Duringfiscal 2004, our manufacturing was spread amongst several internal and externalresources. NeoPlanar manufacturing for both commercial and government systemsremains located in our Carson City, Nevada facility. LRAD and HSS manufacturingtransitioned from our San Diego facility to a contract manufacturer, Pemstar,Inc. in San Jose California.  

We  currently purchase completed products from Pemstar.  These units are stored inPemstar warehouses and are shipped directly to our customers as required.  Our strategy is to increasingly utilize Pemstar's global contractmanufacturing capabilities to allow us to meet our growing production needs.

 

We have refined our internal business processes to improve how we design, testand qualify product designs.  We have implemented more rigorous manufacturingand quality processes to track production and field failures.  Key metrics forline yields, warranty returns, root cause analysis and ongoing reliabilitytesting are being tracked. Weexpect HSS, LRAD and NeoPlanar product lines to ramp production during 2005. 

 

Suppliersare key members of our production chain and are selected and managedaccordingly.  Of particular importanceis our HSS piezo-film supplier, which provides significant expertise in thefabrication of component material used in our proprietary HSS emitters. We haverecently implemented more stringent testing of this crucial material. 

 

Our HSS emitters andNeoPlanar panels employ film as a key part of the product. LRAD systems employcustomized emitters. We have identified suppliers for film and other key parts, butsome are on a sole source basis. Although other suppliers are believed to beavailable, the disruption and cost of changing suppliers could have a materialadverse effect on our financial condition and results of operations.

 

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**Selling, Marketing and Customers**

We market and sell productsand services through our direct sales force based in San Diego, California andTopsham, Maine, and our administrative offices are located in San Diego,California.  Our sales and marketingstrategy is to secure orders for our products and services by, among otherthings, providing high performance products that meet customer’s need forcommunication and notification in acoustically challenging environments.  Sales and marketing expenses includecommission expense for our in-house sales people and the cost of participationin technical conferences, preparation of marketing collateral materials, andthe acquisition of studies and other materials pertaining to our target marketsand customers.

 

For fiscal year ended September 30, 2004, sales of sound products to two Government Group customers, ADS, Inc. and General Dynamics, Armaments and Technical Products, Inc. accounted for 47% and 11% of revenuesrespectively, 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 yearended September 30, 2003, sales to one customer, Bath Iron Works Corporation,accounted for 24% of revenues, with no other single customer accounting formore than 10% of revenues.

 

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

 

We do not consider orderbacklog to be an important measure of future performance at this time.  Our order backlog was approximately $316,000at September 30, 2004. Backlog orders are subject to cancellation orrescheduling by our customers.

 

**Warranties**

We generally warrant ourproducts to be free from defects in materials and workmanship for a period upto one year from the date of purchase, depending on the product. The warrantyis generally a limited warranty, and in some instances imposes certain shippingcosts on the customer. To date we have been providing direct warranty servicebut in the future may establish warranty service, through OEM customers orothers. Some of our agreements require OEM customers to stock certain quantities ofproduct for use as warranty replacements. International market warranties aregenerally similar to the U.S. market.

 

In fiscal 2003, due toperformance failures of some of our first generation of HSS systems resultingprimarily from a vacuum emitter component, we agreed to replace emitters onapproximately 700 HSS Generation I units. At September 30, 2004, we had awarranty reserve of $331,917 of which $186,454 was for HSS Generation I units.Warranty costs on other products have not been material.

 

**Competition**

Our technologies andproducts compete with those of other companies. The consumer, commercial andgovernment audio industry markets are fragmented and competitive and includenumerous manufacturers with audio products that vary widely in price, qualityand distribution channels. Manufacturers of consumer and commercial speakersinclude Harman International, Bose, Boston Acoustics and many others. Suppliersof government audio industry speakers include IML Sound Commander, TechnomadInc, ATI, Dynalec, Henschel and others. Many of our present and potentialfuture competitors have, or may have, substantially greater resources to devoteto further technological and new product developments. We believe we competeprimarily on the originality of our concepts, the uniqueness and quality of ourtechnology and designs, the ease and cost of manufacturing and of implementingour technologies, the ability to meet customer needs to differentiate theirproducts, the strength of our intellectual property and the strength oflicensee and contract supply arrangements. We may not, however, be competitivewith the existing or future products, technologies or services of ourcompetitors.

 

Our HSS and NeoPlanarproducts are offered by both our Business Group and our Government Group. Webelieve HSS is the leading parametric speaker with limited direct competitionto date. Although others have attempted to use parametric speaker concepts toproduce sound, we do not believe they have progressed to the point ofcost-effective and directly competitive commercial products who compared to HSS. HolosonicResearch Labs, Inc. produces a parametric speaker called the Audio Spotlight.Sennheiser Electronics has announced a parametric speaker product called theAudioBeam Master. These companies employ electrostatic and piezoelectricemitter devices, which we believe are less efficient and more expensive than ourproprietary emitters. However, these parametric speaker competitors or othersmay introduce products with features and performance competitive to ourproducts. 

 

We believe our patentportfolio will be a barrier to entrants to penetrate the directed sound marketusing parametric acoustics. Other companies such as Brown Innovations andothers have employed domes and other techniques to try to focus or containsound for directed sound applications such as point-of-sale. We do not believethese methods are directly competitive to HSS in ease of use, cost andperformance. 

 

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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, (ii) NXT Plc and its licensees employing the NXT flat panel technology, which uses a magnetic actuator to produce vibrations over a rigid panel, (iii) NCT Group, Inc. and their Gekko line of flat panel speakers using a comparable actuated 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. 

 

Our LRAD and SoundCluster technology and products are offered by our Government Group. We are not aware of competitors who have achieved the sound output for both voice and warning tone, high directivity, light weight and other attributes necessary to accomplish the government's desired specifications for force protection hailing and non-lethal weapon applications. However, other companies supply a variety of sound products for government customers varying in performance, quality, price and distribution channels, and these products may become more competitive to our products.  Others may also modify existing products or offer new products with features and performance competitive to our LRAD and SoundCluster products.

 

There are alsocontinuing attempts by a large number of competitors to innovate new methods ofsound reproduction to overcome limitations of traditional loudspeakers. It ispossible that alternate technologies and systems that would be directlycompetitive with our sound technology have been developed but are unknown tous. Such systems may also currently be in development, and may be developed byothers in the future.

 

**Seasonality**

We have not experiencedany 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 usuallyproducing relatively higher sales and the quarter ending December 31 usuallyproducing relatively lower sales.  OurGovernment Group business has not experienced this seasonality during calendaryear 2004, but we expect increasing seasonality in the future.

 

**Government Regulation and Environmental Matters**

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

 

Our HyperSonic Soundtechnology is subject to control under the Radiation Control for Health andSafety Act of 1968, and the associated regulations promulgated by the Food andDrug Administration, as an electrical emitter of ultrasonic vibrations. Underthe terms of such regulations, we were required to provide an abbreviated reportto the FDA describing the technology, which we submitted in August 2001. TheFDA may respond to such report and request changes or safeguards to thetechnology, but it has not done so to date. We will also be required to notifythe FDA in writing should an HSS product be found to have a defect relating tosafety of use due to the emission of electronic product radiation. We do notbelieve our HSS technology poses any human health risks. However, it ispossible that we, or one of our OEM customers or licensees, could be requiredto modify the technology, or a product incorporating the technology, to complywith requirements that may be imposed by the FDA.

 

Our products are beingproduced to standard product safety requirements for sale in the United Statesand to similar requirements for sale in Europe and Canada. We expect to meetthe electrical and other regulatory requirements for electronic systems orcomponents we sell throughout the world.

 

Some of our products maybe subject to certain export controls by the U.S. government in accordance withvarious statutory authorities (including, for example the Trading with theEnemy Act of 1917, the Arms Export Control Act of 1976, the ExportAdministration 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 foreigncustomers and foreign business partners, in addition to exports to foreignpersons generally (including ATC employees who are foreign persons or foreignregulatory bodies). 

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

The first mainregulatory system is administered by the U.S. Department of Treasury, Office ofForeign Asset Control (OFAC), which administers and enforces economic andtrade sanctions based on U.S. foreign policy and national security goalsagainst targeted individuals and specifically identified foreigncountries.  None of our current businessdealings or business plans implicates the OFAC regulations.  
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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.  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.  For products, services or technology 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 mainregulatory system is administered by the U.S. Department of Commerce, Bureau ofIndustry and Security (BIS), which administers the Export AdministrationRegulations (EAR).  The EAR requireslicenses only for certain products, services or technology that potentiallyhave both commercial and military uses. Whether a license is required involves analysis of the end use of theproduct, as well as the destination country for the product, service or technology.  We believe that products such as HSS, LRADand NeoPlanar are subject to the EAR because they have commercial applicationsand, unless specifically customized for military applications, were not, intheir 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 withthese regulations. 

We intend to comply withall applicable laws and regulations, as required, in the export of ourproducts.  

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

We do not believe we arematerially affected, nor do we expect to be materially affected, by the costsand effects of compliance with environmental laws.

 

**Intellectual Property Rights and Proprietary Information**

We operate in anindustry where innovations, investment in new ideas and protection of resultingintellectual property rights are important to success. We rely on a variety ofintellectual property protections for our products and technologies, includingpatent, copyright, trademark and trade secret laws, and contractualobligations, and we pursue a policy of vigorously enforcing such rights.

 

We have a substantialbase of intellectual property assets. We have 38 issued U.S. patents and 4issued international patents.  We alsohave approximately 33 U.S. and 91 international patents pending on ourproprietary sound technologies. Our issued patents expire between 2006 and2021. We are preparing and intend to file other sound technology patentapplications. We own one U.S. patent on a portable consumer product and two U.S.patents on other technology. We purchased and own one patent on transducertechnology primarily targeted for government applications. We target our patentcoverage to provide protection in the major manufacturing and commercialcenters of the world.

 

In addition to suchfactors as innovation, technological expertise and experienced personnel, webelieve that a strong patent position is important to compete effectively inthe sound reproduction industry. We believe this is especially important toprotect our leadership position in parametric acoustics (HSS). The followingtable lists some of our key HSS patents and patent applications and theinventions they cover:

 

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  Key Patent Title  
 
  Coverage  
  Acoustic Heterodyne Device and Method
   
  Virtual loudspeaker projection, controlling virtualprojection attributes and direction with a computer driver and in ear applications for HSS 
  Piezoelectric Film Sonic Emitter
  
  Piezoelectric film based emitters 
  Parametric Loudspeaker w/ Electro-Acoustical  Onestage Diaphragm Transducer   
  
  All film type transducers for HSS
 

  Modulator Processing for a Parametric  Loudspeaker 
     
  Advanced distortion correction
  Parametric Loudspeaker with Improved Phase  Characteristics  
     
  Ideal tuning of parametric carriers for   maximum efficiency
  Power Amplification for Parametric Loudspeakers
     
  All high efficiency switch-mode power amplifiersfor HSS 
  Parametric Virtual Speaker and Surround Sound System 
     
HSS for virtual surround sound 
  Pre-encoded Signals for Playback though a   Parametric  Loudspeaker System  
     
  Pre recorded HSS processing for   reduced processing cost and hardware 
  Dynamic Carrier System for Parametric Arrays
     
  Reduced power consumption and increasedefficiency in HSS 

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

 

  Key Patent Title   
 
  Coverage   
  Single End Planar Magnetic Speaker
     
  a) Single Ended, Planar Magnetic loudspeaker w/highenergy magnets  b) High speed/low cost planar magnetic diaphragmproduction  c) Specialized film for use in planar magneticloudspeakers 
  Acoustically Asymmetric Band-Pass Loudspeaker  With  Multiple Acoustic Filters  
  
  a) Low distortion/High Powered Subwoofer  b) Increased bandwidth subwoofer 
  Dynamic Power Sharing in a Multi-Channel  Sound  System  
  
  Power/cost savings, increased output in surround  sound/home theater systems 
 

We have an ongoingpolicy of filing patent applications to seek protection for novel features ofour products and technologies. Prior to the filing and granting of patents, ourpolicy is to disclose key features to patent counsel and maintain thesefeatures as trade secrets prior to product introduction. We cannot assure youthat any additional patents on our products or technology will be granted.

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We are investingsignificant management, legal and financial resources toward our technologypatents. The electronics industry is characterized by frequent litigationregarding patent and other intellectual property rights. Others, includingacademic institutions and competitors, hold numerous patents in electronics andsound reproduction. Although we are not aware of any existing patents thatwould materially inhibit our ability to commercialize our sound technology;others may assert claims in the future. Such claims, with or without merit, mayhave a material adverse effect on our financial condition or results ofoperations. 

 

The validity of ourexisting patents has not been adjudicated by any court. Competitors may bringlegal action to challenge the validity of our existing or future patents or mayattempt to circumvent the protection provided by such patents.  The failure to obtain patent protection orthe loss of patent protection on our existing and future technologies or thecircumvention of our patents by competitors could have a material adverseeffect on our ability to compete successfully.

 

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

 

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

 

Our policy is to enterinto nondisclosure agreements with each employee and consultant or third partyto whom any of our proprietary information is disclosed. These agreementsprohibit the disclosure of confidential information to others, both during andsubsequent to employment or the duration of the working relationship. There canbe no assurance, however, that these agreements will not be breached, that wewill have adequate remedies for any breach or that our trade secrets will nototherwise become known or be independently developed by competitors.

 

We are obligated to paya $2.50 per unit royalty on one electronic component for our HSS product. Weare also obligated to pay Elwood G. Norris, our Chairman, a 2% royalty on netsales from certain of our technologies, of which only HSS is a current offeringof our company. The royalty obligation continues until at least March 1, 2007,and for any longer period during which we sell products or license technologiessubject to any patent assigned to us by Mr. Norris. No royalties were paidor recorded under this agreement in the fiscal years ended September 30, 2004, 2003 or2002, as these royalties were immaterial and were waived by Mr. Norris. We may owe royalties infuture periods based on actual sales or technology revenues.

 

**Research and Development**

The sound reproductionmarket is subject to rapid changes in technology and designs with frequentimprovements and new product introductions. We believe our future success willdepend on our ability to enhance and improve existing technologies and tointroduce new technologies on a competitive basis. Accordingly, we have in thepast, and we expect in the future, to engage in significant research anddevelopment activities. 

 

For the fiscal yearsended September 30, 2004, 2003 and 2002 we spent $2,988,784, $2,437,591 and$3,537,355 respectively, on company-sponsored research and development, and$0, $55,760 and $84,708, on customer-sponsored research and development.Future levels of research and development expenditures will vary depending onthe timing of further new product development and the availability of funds tocarry on additional research and development on currently owned technologies orin other areas.

 

**Executive Officers**

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

 

***Elwood G. Norris,*******age 66, 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 over 44 U.S. patents, primarily in the fields of electrical and acoustical engineering. He is the inventor of our HyperSonic Sound and other technologies.

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***Kalani Jones,*** age 42, was appointed President of our company in April 2004.   He joined us as Vice President of Operations in September 2003 and later that month assumed the position of Chief Operating Officer. From October 1999 to November 2002, he was Vice President Engineering and Product Operations for Tachyon Inc., a San Diego provider of satellite networking solutions. From 1997 to 1999, he was Senior Director for Program Management at Iomega Corporation, a provider of removable computer storage solutions, and previously held engineering management positions at General Instrument and TRW. From November 2002 until being recruited by the Company, Mr. Jones was a self-employed entrepreneur developing technology based remote monitoring solutions. Mr. Jones obtained an M.S.E.E. degree in Digital Communications and Digital Signal Processing from USC (1988) and a B.S.E.E. in Electrical and Computer Engineering from California State Polytechnic University (1984).

 

***Michael A. Russell***, age 58, joined our company in June 2004 as our Chief Financial Officer.  From May 2000 until July 2003, he was the Chief Financial Officer of Metallic Power, Inc, a San Diego developer of zinc-air regenerative fuel cells.  From November 1998 until February of 2000, he was the Group Vice President of Finance for the Financial Solutions Group of HNC Software, Inc. (acquired by Fair Isaac Corporation in July 2002), a developer of fraud detection software. Mr. Russell obtained an M.B.A. degree (1971) and a B.S.E.E. degree in electrical engineering (1968) from the University of California at Los Angeles (UCLA). 

 

***Carl Gruenler,*** age 51, has served as our Vice President of Government and Force Protection Systems Group since July 2003.  During the period from November 2003 until June 2004, he assumed the additional responsibilities of Interim Chief Financial Officer. From May 1998 to June 2003, he served as Smart Wing Program Manager for the Combat Patrol and Reconnaissance Wing as a Captain in the United States Navy Reserve. He was responsible for identifying and developing new integrated systems for physical security/access control, waterside force protection and mobile computing. Mr. Gruenler’s prior business experience includes serving as president of Thomas D. Mangelsen, Inc., a national retail, manufacturing and distribution company; chief financial officer of Automated Monitoring and ControlInternational, Inc., a railroad systems technology company; and a project manager/financial analyst at Union Pacific Railroad. He holds an M.B.A. from the University of Nebraska-Lincoln (1981) and a B.S. in Business Administration from Oral Roberts University in (1975).

 

We are currently seeking an individual to serve as theVice President of our Business Group. We are actively recruiting qualified candidates at this time.

 

**Employees**

At September 30, 2004,we employed a total of 53 people. Of such employees, 15 were in research anddevelopment, 16 were in production, quality assurance and materials control, 11were in general and administrative and 11 were in marketing, sales andlicensing.  We also lease technicalpersonnel from time to time on an as needed basis and use outside consultantsfor various services.  We have notexperienced any work stoppages and are not a party to a collective bargainingagreement, and we consider our relations with our employees to be favorable.

 
**Item2. Properties.

 

Our executive officesand our research and development facilities for our Business Group andGovernment Group are located at 13114 Evening Creek Drive South, San Diego,California.  In January 2004, we amendedour lease agreement to increase the office, laboratory, production andwarehouse space we occupy to 23,548 square feet and extend the term of thelease until July 31, 2006.  In June2004, we exercised an option in the lease agreement to reduce the space weoccupy to 14,997 square feet. Our current aggregate monthly payments are $17,996, exclusive of utilities and costs.  In order to meet our ongoing needs, we mayincrease the space we occupy at this facility or seek new facilities duringfiscal 2005. 
 

We rent on a monthlybasis office space utilized for development and production of our NeoPlanartechnology for our Business Group and Government Group, located at 3170Research Way, Unit 81, Carson City, Nevada. We occupy approximately 2,200 square feet with a monthly payment of$1,250 excluding utilities.
 

Our East Coast salesoffice for the Government Group is located at 1 Main Street, Topsham, Maine. Wecurrently rent, on a month-to-month basis, 600 square feet of office space withmonthly payments of $919. We believe that we will be seeking additional spaceat this location to meet our needs for fiscal 2005.   We believe there is adequate availability of office anddevelopment space in the general vicinity to meet our future needs.  
 

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**Item3. Legal Proceedings.**

** **

In September 2003, we filed acomplaint against eSOUNDideas, Inc., in the Superior Court of California,County of San Diego, alleging breach of contract and seeking a declaratoryjudgment to the effect that a License, Purchase and Marketing Agreement datedSeptember 28, 2000, which we refer to as the ESI License Agreement witheSOUNDideas, a California partnership, was properly terminated in May 2003. Theprincipals of eSOUNDideas are Greg O. Endsley and Douglas J. Paschall. Theprincipals also founded a corporation, eSOUNDideas, Inc., which purported toassume the contractual obligations of eSOUNDideas. We amended the complaint inNovember 2003 to include eSOUNDideas (the general partnership), Mr. Endsley andMr. Paschall as defendants. For convenience, the following discussion refers toeSOUNDideas and eSOUNDideas, Inc. collectively as “ESI.” In November 2003, wefiled complaints in the Superior Court of California, County of San Diego,against Mr. Endsley and Paschall seeking declaratory judgments that optionsgranted to each of Mr. Endsley and Mr. Paschall in April 2001 were terminatedin October 2002. 

TheESI License Agreement formerly appointed ESI as an exclusive distributor of HSSproducts specifically targeted to the point of sale/purchase, kiosk anddisplay, and the event, trade show and exhibit markets in North America forfive years. In June 2002, we and ESI purported to enter into an amendment tothe ESI License Agreement, extending the term to ten years commencing on thefirst delivery of a commercial HSS product to an end user, and eliminatingminimum purchase requirements for the first three years. We believe theamendment was invalid as it was given in consideration for a large order fromESI, which was later withdrawn by ESI due to a dispute over the payment anddelivery terms of such order. In May 2003, we gave notice to ESI of terminationof the ESI License Agreement. We based our termination on our belief that ESIhad failed to fulfill certain covenants contained in the ESI License Agreementrelated to efforts and resources required to maximize the distribution andsales of HSS products in its product categories. Under the terms of the ESILicense Agreement, the termination was effective immediately, but ESI had sixtydays to cure conditions giving rise to termination and reinstate the agreement.ESI did not tender a cure within such sixty day period.

 

Thethree cases were consolidated upon motion by the defendants and order of thecourt. The defendants filed a cross-action in the consolidated action allegingfraud, breach of contract in connection with the ESI License Agreement and theoptions, breach of the implied covenant of good faith and fair dealing, intentionalinterference with contract, negligent interference with contract, intentionalinterference with prospective economic advantage, negligent interference withprospective economic advantage, defamation, and violation of CaliforniaBusiness and Professions Code §17200.  We filed our answer to the secondamended cross-complaint in August 2004.  Discovery is ongoing.  Trialhas been set for May 2005.

 

Weintend to vigorously pursue our complaint against the defendants in this caseand to vigorously challenge the defendant’s cross complaint.

 

Wemay at times be involved in litigation in the ordinary course of business.Except as set forth above, there are no pending material legal proceedings towhich we are a party or to which any of our property is subject.

 

 

**Item4. Submission of Matters to a Vote of Security Holders.**

** **

None.

** **
PARTII
 

**Item5. Market for Registrant’s Common Equity, Related Stockholder Matters andIssuers Purchases of Equity Securities.**

** **

**Market Information**

Our common stock istraded and quoted on NASDAQ SmallCap Market under the symbol “ATCO”. The marketfor our common stock has often been sporadic and limited.

 

- 16 -   
 

The following table setsforth the high and low bid quotations for our common stock for the fiscal yearsended September 30, 2003 and 2004: 

 

**Bid  Quotations**

 

**High**

** Low**

Fiscal Year Ending  September 30, 2003

 

 

                First Quarter

$4.77

$2.87

                Second Quarter

$3.99

$3.00

                Third Quarter

$6.56

$3.11

                Fourth Quarter

$7.65

$5.43

Fiscal Year Ending  September 30, 2004

 

 

                First Quarter

$6.19

$4.01

                Second Quarter

$6.07

$4.05

                Third Quarter

$7.77

$5.50

                Fourth Quarter

$6.70

$4.38

 

The above quotationsreflect inter-dealer prices, without retail markup, markdown or commission andmay not represent actual transactions.

 

We had 1,112 holders of record of our common stock at December 20, 2004 with 19,808,819 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.  The terms of our Series D and Series E Preferred Stock require preferred dividends be paid to the holders of such stock in preference to dividends to holders of our common stock.
 

**EquityCompensation Plan Information**

At September 30, 2004, we had two equity incentive plans under which equitysecurities are or have been authorized for issuance to our employees,consultants or directors: the 2002 Stock Option Plan and the 1997 Stock OptionPlan.  These plans have been approved byour stockholders. In addition, from time to time we issue to employees,directors and service providers special stock options, inducement grants andwarrants to purchase common shares, and these grants have not been approved bystockholders. The following table gives information as of September 30,2004:
 

** **

** **

** **

** **

** **

**Plan  Category**
   
** **

** **

**Number  of securities to be issued upon exercise of outstanding options, warrants and  rights**
   
** **

** **

**Weighted-average  exercise price of outstanding options, warrants and rights**
   
**Number  of securities remaining available for future issuance under equity  compensation plans (excluding securities reflected in column (a))**

 
   
**(a)**
   
**(b)**
   
**(c)**

 

Equity compensation plans approved by security holders
   
 

 

  1,652,498
   
 

 

  $4.59
   
 

 

284,928

 
Equity compensation plans not approved by security holders   
                 337,000 (1)
   
 

$4.84
   
 

--

Total
   
1,989,498
   
  $4.63
   
  284,928

(1)    Consists of 187,000 of individual stock option grants and 150,000 of warrant grants to employees, directors        and service providers approved by the Board of Directors from time to time.

 

**Recent Sales of Unregistered Securities**

In March 2004, we issued 32,733 shares of commonstock upon conversion of 10,000 shares of our Series E Preferred Stock.  Wereceived no consideration in connection with such issuance.  For this issuance,we relied on the exemption provided by Section 3(a)(9) of the Securities Act.

 

- 17 -   
In April 2004,we issued 65,856 shares of common stock upon conversion of 20,000 shares of ourSeries E Preferred Stock.  We received no consideration in connection with suchissuance.  For this issuance, we relied on the exemption provided by Section3(a)(9) of the Securities Act.

 

**Item6. Selected Financial Data.**

 

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

 

For the fiscal years ended September 30,   2004  2003  2002  2001  2000  **Statement of Operations:**           Net revenues  $5,752,549 $1,315,426 $1,010,752 $855,342 $1,433,050 Gross profit (loss)  $2,282,728 $(228,651)$326,908 $277,066 $382,155 Net loss  $(5,960,436)$(8,227,013)$(8,220,132)$(5,046,219)$(3,068,046)Net loss available to common stockholders  $(7,325,785)$(10,636,241)$(8,503,044)$(5,166,941)$(7,948,994)Net loss per share-basic and diluted  $(0.37)$(0.67)$(0.60)$(0.38)$(0.67)Weighted average number of shares-basic    and diluted   19,603,265   15,857,569   14,193,508   13,563,101   11,868,511               As of September 30,   2004  2003  2002  2001 2000  Working capital  $3,472,984 $8,484,210 $554,713 $892,040 $4,794,743 Total assets  $7,645,291 $11,744,371 $3,789,634 $3,837,284 $7,275,614 Long-term obligations  $12,131 $23,097 $3,153,012 $- $- Total stockholders' equity (deficit)  $5,192,915 $9,728,171 $(884,882)$2,993,495 $6,829,875  
 

**Item7. Management's Discussion and Analysis of Financial Condition and Results ofOperations.**

This discussion shouldbe read in conjunction with the information presented in other sections of thisreport on Form 10-K, including “Item 1. Business,” “Item 6. Selected FinancialData,” and “Item 8. Financial Statements and Supplementary Data.” Thisdiscussion contains forward-looking statements which are based on our currentexpectations and industry experience, as well as our perception of historicaltrends, current market conditions, current economic data, expected futuredevelopments and other factors that we believe are appropriate under thecircumstances. These statements involve risks and uncertainties that couldcause actual results to differ materially from those suggested in theforward-looking statements.

 

We begin this discussionwith an overview to give you an understanding of our business and the marketswe serve. We then discuss our critical accounting policies. This is followed bya discussion of our results of operations for the fiscal years endedSeptember 30, 2004, 2003 and 2002. We include in this discussionadditional disclosure regarding our two reportable business segments, the BusinessGroup and the Government Group. We then discuss our financial condition atSeptember 30, 2004 with a comparison to September 30, 2003 and 2002.This section includes information regarding our liquidity and capitalresources, cash flows, and contractual obligations. Finally, we provide riskfactors at the end of this discussion.

 

**Overview**

Weare an innovator of proprietary sound reproduction technologies and products.Our HyperSonic Sound, or HSS, technology is a new method of sound reproductionthat creates sound “in the air.”  Soundis generated along an air column using ultrasonic frequencies, which are thoseabove the normal range of hearing. The HSS sound beam is highly directional andmaintains sound volume over longer distances than traditional loudspeakers. Webelieve HyperSonic Sound’s unique features are useful in new soundapplications. We believe we are the leader in developing and commercializingparametric loudspeakers.

- 18 -   
 

OurLong Range Acoustic Device, or LRAD, technology produces variable intensityacoustical sound intended for use in long-range delivery of directional soundinformation, which is effectively a supercharged megaphone. LRAD products areused as directed long-range hailing and warning systems.

 

OurNeoPlanar technology is a thin film magnetic speaker that produces sound ofhigh quality, low distortion and high volume. NeoPlanar applications includehigh-end sound and public address systems. Our SoundCluster technology is a newmulti-transducer, speaker cluster optimized for even sound coverage over largeareas such as aircraft hangar decks.  Wehave other proprietary sound technologies and products in various stages ofdevelopment.

 

Our primary productssold to date have been LRAD and HSS products. These products are currentlymanufactured for us by Pemstar, Inc., an established contract manufacturer withmultiple locations worldwide. Our sales have been highly dependent on largeorders from a few customers.  We targetour products for sale worldwide, but expect the largest markets to be the U.S., Europeand Asia. To date, our sales have been made in U.S. dollars and we do notexpect currency fluctuations to have a material impact on our operations.

 

Fiscal 2004 was a goodyear for our company. We successfully introduced new products, transitioned tocontract manufacturing to allow for increased production capacity and achievedrecord revenues. Our Government Group established LRAD as an important newproduct for protection in defense and homeland security. To date, we haveincurred operating losses, as we have not yet achieved revenues sufficient tosupport our significant expenditures on research and development and ourgrowing sales and administrative support services.

 

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

 

We incurred net losses of$5,960,436, $8,227,013, and $8,220,132 in the fiscal years ended September 30,2004, 2003 and 2002.  We have substantial research and development and selling,marketing and general administrative expenses, and our margins from the sale ofour products have not yet been sufficient to offset these costs.  We may incuradditional operating losses during fiscal 2005, and we may need additionaloperating funds to support our growth.  See “Liquidity and Capital Resources”below. Based on our current plan and without drawing any additional funds fromthe CEFF described below, we anticipate that we will be able to meet our cash requirements forthe next twelve months.  We have significant flexibility to adjust the level ofresearch and development and selling and administrative expenses based on theavailability of resources.  However, reductions in expenditures could delaydevelopment and adversely affect our ability to generate future revenues.  
  

**Recent Developments**
In December 2004, we received a firmorder for $4.5 million in LRAD products from ADS, Inc. for use by the U.S. Army3rd Infantry Division, Fort Stewart, Georgia.  The order also includes $0.4million in ancillary products which we are providing on a value-added resellerbasis along with the LRAD units.  The order calls for deliveries in December2004 and January 2005 and customary payment terms.  We expect to recognizeapproximately 65% of the revenue for this order during the first quarter offiscal 2005 and the balance during the second quarter of fiscal 2005. 

In December 2004, we sold for cash in a privateoffering an aggregate of $2,000,000 of unsecured subordinated promissory notesdue December 31, 2006.  In connection with the financing, we also issuedfive-year warrants to purchase an aggregate of 150,000 shares, 75,000 of whichhave an exercise price of $9.28 per share, and 75,000 of which have an exerciseprice of $8.60 per share.  A trust affiliated with Elwood G. Norris, ourChairman and the beneficial owner of 19.5% of our common stock before thefinancing, purchased a note in the principal amount of $500,000 and received awarrant exercisable for 37,500 shares with an exercise price of $9.28 pershare.  For more information on this financing, see “Liquidity and CapitalResources–Financing Activities” below.

 

In December 2004,we entered into a Committed Equity Financing Facility (CEFF) with KingsbridgeCapital Ltd., pursuant to which Kingsbridge committed, subject to certainsignificant limiting conditions, to purchase up to$25,000,000 of our common stock, subject to various conditions, at a price thatis between 88% and 92% of the volume weighted average price during a 15 daypurchase period.  We are obligated to use 40% of the proceeds we may receivefrom the CEFF to prepay any outstanding interest and principal on the notes soldin December 2004.  We believe the CEFF will offer us flexibility to raisecapital to support our growth as required, at the time, price and in the amountsdeemed suitable to us.  For more information on the CEFF, see “Liquidity andCapital Resources” and “Risk Factors” below.

 

- 19 -   
 

**Business Outlook**

We produced recordrevenues for the fiscal year ended September 30, 2004 while reducing ouroperating losses. In fiscal 2005, we believe revenues will continue to growprimarily due to increased acceptance of our LRAD and other Government Groupproducts and from anticipated growth in HSS product sales. We also expect otherproducts such as NeoPlanar and SoundCluster products will support growth infiscal 2005. We expect our expenditure levels for research and development andfor selling, general and administrative purposes to increase as revenues grow.We are aggressively developing new versions of existing products and newproducts based on our proprietary sound technologies to support future growth.

 

We believe the successof our LRAD product, growing HSS product shipments and our significantinvestment in new technologies and new products provide a solid foundation forbusiness growth over the next several years. We also believe that LRAD, NeoPlanar and SoundCluster are positioned forsignificant long term contract awards in military, government and commercialmarkets during fiscal 2005.

 

**Critical Accounting Policies and Estimates**

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

 

The methods, estimatesand judgments we use in applying our accounting policies, in conformity withgenerally accepted accounting principles in the United States, have asignificant impact on the results we report in our financial statements. Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances. The estimates affect thecarrying values of assets and liabilities. Actual results may differ from theseestimates under different assumptions or conditions. We believe that thefollowing discussion addresses our most critical accounting policies, which arethose that are most important to the portrayal of our financial condition andresults of operations and require our most difficult, subjective, and complexjudgments, often as a result of the need to make estimates about the effect ofmatters 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 ongoing per unit license fees are earned based on units shipped incorporating our patented proprietary technologies and are recognized in the period when the ultimate customer accepts the product and collectibility is reasonably assured. Revenues from up-front license and other fees and annual license fees are generally recognized ratably over the specified term of the particular license or agreement.

 

*Valuation of Intangible Assets.*  Intangible assets include purchased technology and patents, which 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 2004, 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 timeproduct revenue is recognized. These warranties require us to make estimatesregarding the amount and costs of warranty repairs we expect tomake over a period of time. Factors affecting warranty reserve levels include the number of units sold andanticipated cost of warranty repairs and anticipated rates of warranty claims.We evaluate the adequacy of the provision for warranty costs each reportingperiod. See Note 8 to our financial statements for additional informationregarding warranties. The estimates we use have an impact on our financialstatements.

 

*Guarantees and Indemnifications.  Under our bylaws, we have agreed to indemnify our officers and directors for certain events. We also enter into certain indemnification agreements in the normal course of our business.We have no liabilities recorded for such indemnities. This estimate has an impact on our financial statements.
 

-20 -
   
*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 consolidated statement of operations. We evaluate the realizability of the deferred tax assets and assess the need for valuation allowance quarterly. The utilization of the net operating loss carryforwardscould be substantially limited due to restrictions imposed under federal andstate laws upon a change in ownership. Congress passed the American JobsCreation Act of 2004 in October 2004.  The new law containsnumerous changes to existing tax laws, including both domestic and foreign taxincentives.  We have not yet determined what impact, if any, this new law mayhave on our deferred tax asset, or our future results of operations andfinancial condition.
 

*LegalProceedings.*  We are currently involved in certain legal proceedings.  Although unfavorable outcomes in any of these matterscould have a material adverse effect on our operating results, liquidity or financial position, we believe the claims are without merit and intend to vigorously defend the actions. 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.  We have recorded an accrual of $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.

 

*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 andcarrying value of our inventory.  The carrying value of our inventory isperiodically reviewed and impairments, if any, are recognized when the expectedfuture benefit from our inventory is less than its carrying value.  In fiscal 2004 we reviewed the carrying value of our inventory and increased the reserve for obsolescence by $90,000 for raw materials that were used on our HSS Generation II products but are not required for our HSS Generation III products.

 

**Results of Operations**

 

***Revenues***

Revenuesincreased 337% in fiscal 2004 to $5,752,549 compared to $1,315,426 for fiscal2003. Fiscal 2003 revenues were 30% higher than fiscal 2002 revenues of$1,010,752. Fiscal 2004 revenues included $5,581,936 of product sales and$170,613 of contract and license revenues. Fiscal 2003 revenues included$1,070,645 of product sales and $244,781 of contract and license revenues.Fiscal 2002 revenues included $693,097 of product sales and $317,655 ofcontract and license revenues.

 

Duringfiscal 2002, we recorded revenues of $305,208 for portable consumer products.These revenues represented products sourced by us, private labeled under ourname and resold to sporting good stores and other retailers. In fiscal 2003, wereduced our marketing emphasis on portable consumer products in order to focusfinancial, personnel and facility resources on our proprietary soundtechnologies. As a result, sales of portable consumer products in fiscal 2003totaled $94,980. Sound products provided the balance of fiscal 2003 revenuesand all of fiscal 2004 revenues.

 

Latein fiscal 2003, with the addition of new personnel, we organized operationsinto two segments by the end-user markets they serve. Our Business Products andLicensing Group (Business Group) licenses and markets HSS and NeoPlanarspeakers to companies which employ audio in consumer, commercial andprofessional applications. Our Government and Force Protection Systems Group(Government Group) markets LRAD, NeoPlanar, SoundCluster and HSS products togovernment and military customers and to the expanding force protection andcommercial security markets. Although the segments became separately managed in the last quarter of fiscal 2003, we have alsosegmented historical operations for comparable end-user customers for comparisonpurposes.

 

Presentedbelow is a summary of revenues by business segment:

 

**Years Ended September  30, ** 

 

2004 

 

2003 

 

2002 

 

 Revenues: 

 

 

 

 

 

 

 

 

 

 
    Business Group 

 

$

933,373 

 

$

861,091 

 

$

922,542 

 
    Government Group 

 

 

4,819,176 

 

 

454,335 

 

 

88,210 

 
 

 

$

5,752,549 

 

$

1,315,426 

 

$

1,010,752 

 
 

 

 

 

 

 

 

 

 

 

 
 

- 21 -
   
*Business Group* - The Business Group reported net revenues of $933,373 in fiscal 2004, representing an 8% increase from net revenues of $861,091 in fiscal 2003. The fiscal 2003 net revenues represented a 7% decrease from net revenues of $922,542 in fiscal 2002. Sound product revenues were $933,373 in fiscal 2004, and there were no consumer portable product sales. Sound product revenues were $594,703 in fiscal 2003, consumer portable product sales were $95,730 and contract and licensing revenues were $170,658. The increase in sound product revenues in fiscal 2004 was primarily the result of increased HSS sales offset in part by reduced NeoPlanar sales in the personal boating market.  During most of fiscal 2004, we were developing and testing our new HSS Generation III product line and HSS sales were limited to certain older systems. We only recently began shipping HSS Generation III systems manufactured by our contract manufacturer to existing and new customers. Accordingly, we expect increased Business Group HSS revenues in fiscal 2005.

 

*Government Group* – Government Group net revenues for fiscal 2004 were $4,819,176 compared to $454,335 in fiscal 2003, a 961% increase.  Net revenues for fiscal 2003 were $454,335 compared to $88,210 in fiscal 2002, a 415% increase. Fiscal 2004 revenues included LRAD revenues of $3,907,291, NeoPlanar revenues of $265,520, SoundCluster revenues of $484,827 and contract fees and other fees of $161,538.  Fiscal 2003 revenues included LRAD revenues of $261,106, NeoPlanar revenues of $124,674 and contract fees and other fees of $68,555. LRADrevenues were $85,849 in fiscal 2002 and contract fees and other were$2,361.  The increase in LRAD revenues in fiscal 2004 was primarily the result of increased customer knowledge of the capabilities of LRAD products and their acceptance of the product.  Our marketing efforts, successful product deployments and extensive product demonstrations have contributed to customer acceptance of the force protection capabilities of LRAD.  We expect LRAD revenues to continue to grow in fiscal 2005 as market awarenessincreases and as we improve the product and introduce multiple versions with optional feature sets.

***Gross Profit***

Gross profit for fiscal2004 was $2,282,728 or 40% of revenues, compared to a gross loss on revenuesfor fiscal 2003 of $228,651. Thegross loss in fiscal 2003 was principally the result of our $319,500 for special warranty reserve for HSS Generation Iunits. We had a gross profit in fiscal 2002 of $326,908 or 32% of revenues.

 

Presented below is thegross profit or loss by business segment.
 

**Years Ended September  30, ** 

 

2004 

   
2003 

   
2002 

 

 Gross Profit (Loss):

 

 

 

 

 

 

 

 

 

    
    Business Group

 

$

  (534,174)
 

$
  (501,748)
 

$

256,779
 
    Government Group

 

 

  2,816,902 
 

 

  273,097 
 

 

70,129 
 
 

 

$

2,282,728 
 

$

(228,651)
 

$

326,908 
 
 

 

 

 

 

 

 

 

 

 

    
During fiscal year 2003and fiscal 2004 we changed our HSS Generation I emitter design to eliminate therequirement for a vacuum in the emitter, and we improved film quality. Duringfiscal 2004, we made further raw material improvements in the electronics andthe manner in which the film and emitters are produced.  We believe that our recently introduced HSSGeneration III product is more reliable. We therefore expect that warranty costswill decrease in fiscal 2005, and that HSS product sales will produce positivemargins. 

 

Gross profit for ourGovernment Group was $2,816,902 in fiscal 2004, or 58% of revenue.  Gross profit percentage continues to behighly dependent on sales prices, volumes, purchasing costs and overhead allocations.  Our various sound products have differentmargins, so product sales mix will materially affect gross profits. Inaddition, we continue to make model updates and changes including raw materialand component changes thus changing product costs. We therefore do not believethat historical gross profit margins should be relied upon as an indicator offuture gross profit margins.

 

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

Selling, general and administrative expenses asa percentage of sales were 92% in fiscal 2004, 370% in fiscal 2003 and 301% infiscal 2002. These costs in fiscal 2004 totaled $5,309,547, an increase of$445,836 from the $4,863,711 incurred in fiscal 2003. Legal and professionalcosts decreased $1,316,323 to $852,644 in fiscal 2004 compared to $2,168,967 infiscal 2003. Included in legal and professional costs in fiscal 2004 was anestimated settlement cost accrual of $150,000 associated with an ongoing legalaction with a former licensee. Included in legal and professional costs in fiscal2003 were settlement costs and accruals of $1,233,754 related to legalsettlements and a buyout of NeoPlanar royalties due. Personnel costs increasedfrom $1,562,852 in fiscal 2003 to $2,449,739 in fiscal 2004 as a result ofincreased headcount. 

 

We incurred non-cashselling, general and administrative expenses in each of the three years. Infiscal 2004 we incurred $65,863 of non-cash compensation from extending theexercise period of options for certain terminated employees due to stocktrading restrictions. In fiscal 2003, we incurred $410,816 of non-cashcompensation from the issuance of 109,844 common shares related to purchasedtechnology and $179,995 for the issuance of stock options and warrants tonon-employees. In fiscal 2002, we had non-cash compensation of $304,920 forservices paid through the issuance of 74,129 shares of common stock and$517,836 for the issuance of stock options and warrants to non-employees. 

 **** |