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

Overview

We are a pioneer of highly intelligible, high clarity directed sound technologies and products. We aggressively seek to create and expand markets for our products, and we are increasing our focus on and investment in worldwide sales and marketing activities while we continue to innovate.

Our revenues decreased to $14,792,338 in the fiscal year ended September 30, 2012, from $26,506,821 in the fiscal year ended September 30, 2011. Net income decreased as well from $5,022,902 in fiscal year 2011 to $1,462,020 in fiscal year 2012. The strong revenue in fiscal 2011 was largely driven by a $12,125,000 order from a foreign government, which was not repeated in fiscal 2012. Direct and indirect revenues from the U.S. Military, which declined by 40% in fiscal 2011, showed some improvement in fiscal 2012, though they still remained $2.0 million below the fiscal 2010 level due to ongoing federal budget uncertainty and the November 2012 Presidential elections. Revenues from municipalities for law enforcement improved during fiscal 2012 due to successful high profile LRAD deployments during the Occupy movement and G-20 summit demonstrations. We increased our working capital by $2.3 million during fiscal 2012. Future cash flows from operating activities are expected to fluctuate based on working capital requirements, operating expense levels and other factors. We believe we have adequate financial resources to fund operations for the next twelve months.

Our latest generation of LRAD products called the LRAD-X product line uses directionality and focused acoustic output to clearly transmit critical information, instructions and warnings more than 3,500 meters. The LRAD-X product line features improved voice intelligibility and is available in a number of packages that meet the military's stringent environmental requirements in a number of packages and form factors. Through the use of powerful voice commands and deterrent tones, large safety zones can be created while determining the intent and influencing the behavior of an intruder. We continue to expand our LRAD-X product line to provide a complete range of systems from single operator portable to permanently installed, remotely operated. Our LRAD products have been competitively selected over other commercially available systems by U.S. and several foreign militaries. Our current LRAD-X product line includes the following:

• LRAD 2000X-launched in fiscal 2012 to meet the requirements of larger security applications-is our largest and loudest acoustic hailing system and broadcasts highly intelligible voice communication that can be clearly heard and understood more than 3,500 meters away.

• LRAD 1000X-selected by the U.S. Navy as its AHD for Block 0 of the Shipboard Protection System-can be manually operated to provide long distance hailing and warning with highly intelligible communication. This unit is available in both fully integrated and remotely-operated electronics.

• LRAD 500X-selected by the U.S. Navy and U.S. Army as their AHD for small vessels and vehicles-is lightweight and can be easily transported to provide security personnel long-range communications and a highly effective hailing and warning capability where needed.

• LRAD 300X is a lightweight mid-range AHD developed for small vessels and manned and unmanned vehicles and aircraft. This unit is available in both fully-integrated and remotely-operated electronics.

• LRAD 100X is a self-contained, battery-powered, portable system designed for use in a variety of mass notification, law enforcement and commercial security applications. This unit is ideally suited for short-range perimeter security and communications.

• LRAD 360X-launched in fiscal 2012- broadcasts attention-commanding siren alarms and highly intelligible live announcements and pre-recorded messages in a uniform 360o pattern over distances up to two miles. The LRAD 360X is targeted for mass notification and emergency warning for campus, border and perimeter security applications, tsunami, hurricane and tornado warnings, bird safety and control, and asset protection.

We incurred $1,659,673 of research and development expense during fiscal 2012. During 2012, we developed and launched the LRAD 360X with various stacking configurations to target the large mass notification market. While the mass notification market is more mature than the AHD market, we believe the LRAD 360X, with its ability to clearly communicate messages over long distances, can compete favorably against existing systems being marketed today. The LRAD 2000X, which was developed in fiscal 2011, was released for sale in the first quarter of fiscal 2012. In addition, we focused on product cost reductions, feature enhancements and customized applications of existing products, and provided product certifications for some of our newer products. We continually improve the quality and manufacturability of our products to retain our competitive advantage in the AHD market. We believe these products provide increased sales opportunities into government and commercial markets and demonstrate our ability to remain the leader in the AHD market. We intend to continue to innovate during fiscal 2013 with consistent levels of research and development expenditures.

Business Outlook

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

Critical Accounting Policies and Estimates

We have identified the policies below as critical to our business operations and to understanding our results of operations. Our accounting policies are more fully described in our financial statements and related notes located in "Item
8. Financial Statements and Supplementary Data." The impact and any associated risks related to these policies on our business operations are discussed in "Item 1A. Risk Factors" and throughout "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" when such policies affect our reported and expected financial results.

The methods, estimates and judgments we use in applying our accounting policies, in conformity with generally accepted accounting principles in the United States, have a significant impact on the results we report

in our financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates affect the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition. The Company derives its revenues primarily from two sources: (i) product revenues, and (ii) contracts, license fees, other services, and freight. Product revenues from customers, including resellers and system integrators, are recognized in the periods that products are shipped (FOB shipping point) or received by customers (FOB destination), when the fee is fixed or determinable, when collection of resulting receivables is probable, and there are no remaining obligations for the Company. Most revenues to resellers and system integrators are based on firm commitments from the end user, and as a result, resellers and system integrators carry little or no inventory. Revenues from associated engineering and installation contracts are recognized based on milestones or completion of the contracted services. The Company's customers do not have the right to return product unless the product is found to be defective.

The Company licenses its technology to third parties. Revenues from up-front license fees are evaluated for multiple elements, but are generally recognized ratably over the specified term of the particular license or agreement. Revenues from ongoing per unit license fees are earned based on units shipped and are recognized in the period when the ultimate customer accepts the product, and collection is reasonably assured.

Share-Based Compensation. We account for share-based compensation in accordance with the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 718, "Compensation-Stock Compensation" ("ASC 718") using the modified prospective method which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. ASC 718 requires the use of subjective assumptions, including expected stock price volatility and the estimated term of each award. We estimate the fair value of stock options granted using the Black-Scholes option-pricing model, which is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. This model also utilizes the fair value of our common stock and requires that, at the date of grant, we use the expected term of the share-based award, the expected volatility of the price of our common stock over the expected term, the risk free interest rate and the expected dividend yield of our common stock to determine the estimated fair value. We determine the amount of share-based compensation expense based on awards that we ultimately expect to vest, reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Allowance for doubtful accounts. Our products are sold to customers in many different markets and geographic locations. We estimate our bad debt reserve on a case-by-case basis due to a limited number of customers. We base these estimates on many factors including customer credit worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. Our judgments and estimates regarding collectability of accounts receivable have an impact on our financial statements.

Valuation of Inventory. Our inventory is comprised of raw materials, assemblies and finished products. We must periodically make judgments and estimates regarding the future utility and carrying value of our inventory. The carrying value of our inventory is periodically reviewed and impairments, if any, are recognized when the expected future benefit from our inventory is less than its carrying value.

Valuation of Intangible Assets. Intangible assets consist of patents and trademarks that are amortized over their estimated useful lives. We must make judgments and estimates regarding the future utility and carrying value of intangible assets. The carrying values of such assets are periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than its carrying value. This generally occurs when certain assets are no longer consistent with our business strategy and whose expected future value has decreased.

Accrued Expenses. We establish a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. This reserve requires us to make estimates regarding the amount and costs of warranty repairs we expect to make over a period of time. Factors affecting warranty reserve levels include the number of units sold, anticipated cost of warranty repairs, and anticipated rates of warranty claims. Warranty expense is recorded in cost of revenues. We evaluate the adequacy of this reserve each reporting period.

We use the recognition criteria of ASC 450-20, "Loss Contingencies" to estimate the amount of bonuses when it becomes probable a bonus liability will be incurred and we recognize expense ratably over the service period. We accrued bonus expense each quarter based on estimated year-end results, and then adjusted the actual in the fourth quarter based on our final results compared to targets.

Derivative Liability Valuation. We used the guidance under ASC 815-40, "Derivatives and Hedging; Contracts in Entity's Own Entity" to classify and value our warrant liabilities. Warrants classified as derivative liabilities are recorded at their estimated fair value on the date of issuance. The warrant liability is required to be measured at fair value on a recurring basis each quarter-end based on current assumptions using the Black-Scholes valuation model, with the change in value recognized in current earnings.

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 quarterly the realizability of the deferred tax assets and assess the need for a valuation allowance. Utilizing the net operating loss ("NOL") carry forwards in future years could be substantially limited due to restrictions imposed under federal and state laws upon a change in ownership or control. Included in the NOL carryforward are deductions from stock options that, if recognized, will be recorded as a credit to additional paid-in capital rather than through our results of operations.

Recent Accounting Pronouncements

A number of new pronouncements have been issued for future implementation as discussed in the notes to our consolidated financial statements located in "Item
8. Financial Statements and Supplementary Data." See Note 3 to our consolidated financial statements for further discussion.

Segment and Related Information

We are engaged in the design, development and commercialization of directed sound technologies and products. We present our business as one reportable segment due to the similarity in nature of products marketed, financial performance measures (revenue growth and gross margin), methods of distribution (direct and indirect) and customer markets (each product is sold by the same personnel to government and commercial customers, domestically and internationally). Our chief operating decision making officer reviews financial information on sound products on a consolidated basis. See Note 16 to our consolidated financial statements for further discussion.

Comparison of Results of Operations for Fiscal Years Ended September 30, 2012 and 2011

The following table provides for the periods indicated certain items of our consolidated statements of operations expressed in dollars and as a percentage of net sales. The financial information and discussion below should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report.

                                                            Year ended
                                      September 30, 2012                   September 30, 2011
                                                    % of  Net                            % of  Net            Increase/(Decrease)
                                   Amount            Revenue             Amount           Revenue            Amount              %
Revenues:
Product sales                   $ 14,218,766              96.1 %      $ 26,020,385             98.2 %     $ (11,801,619 )        (45.4 %)
Contract and other                   573,572               3.9 %           486,436              1.8 %            87,136           17.9 %

Total revenues                    14,792,338             100.0 %        26,506,821            100.0 %       (11,714,483 )        (44.2 %)
Cost of revenues                   7,313,762              49.4 %        10,577,370             39.9 %        (3,263,608 )        (30.9 %)

Gross profit                       7,478,576              50.6 %        15,929,451             60.1 %        (8,450,875 )        (53.1 %)
Operating expenses:
Selling, general and
administrative                     4,541,594              30.7 %         8,463,842             31.9 %        (3,922,248 )        (46.3 %)
Research and development           1,659,673              11.2 %         2,483,938              9.4 %          (824,265 )        (33.2 %)

Total operating expenses           6,201,267              41.9 %        10,947,780             41.3 %        (4,746,513 )        (43.4 %)

Income from operations             1,277,309               8.7 %         4,981,671             18.8 %        (3,704,362 )        (74.4 %)
Other Income                          33,895               0.2 %            46,967              0.2 %           (13,072 )        (27.8 %)

Income from continuing
operations before income
taxes                              1,311,204               8.9 %         5,028,638             19.0 %        (3,717,434 )        (73.9 %)
Income tax (benefit) expense        (150,816 )            (1.0 %)           75,190              0.3 %          (226,006 )       (300.6 %)
Income from discontinued
operations                                -                0.0 %            69,454              0.2 %           (69,454 )       (100.0 %)

Net income                      $  1,462,020               9.9 %      $  5,022,902             18.9 %     $  (3,560,882 )        (70.9 %)

Revenues

Revenues decreased $11,714,483, or 44%, in the fiscal year ended September 30, 2012 to $14,792,338 compared to $26,506,821 in the fiscal year ended September 30, 2011. Revenues in 2011 included a large order to a foreign government in the amount of $12,125,000, which was not repeated in fiscal 2012. LRAD revenues accounted for $14,411,374 of the total revenues in fiscal 2012 and $26,196,063 in fiscal 2011.

Gross Profit

Gross profit for the year ended September 30, 2012 was $7,478,576, or 51% of total revenues, compared to $15,929,451, or 60% of total revenues for the year ended September 30, 2011. The decrease in gross profit is primarily due to decreased revenues, lower fixed cost absorption, and increased amortization of prepaid expenses to support warranty and maintenance required under the large foreign government sale in fiscal 2011. These decreases are partially offset by lower manufacturing overhead spending due to reduced freight and a reduction in bonus expense as a result of not meeting current year performance targets, and lower warranty expense.

Our products have varying gross margins, so product sales mix materially affects gross profit. In addition, the margins differ based on the channel of trade that we sell through. We continue to implement product updates and changes, including raw material and component changes that may impact product costs. With product updates and changes, we have limited warranty cost experience and estimated future warranty costs can impact

our gross margins. We could also have increased competition in our market that could cause pricing pressure for us. We do not believe that historical gross profit margins should be relied upon as an indicator of future gross profit margins.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the year ended September 30, 2012 decreased $3,922,248 to $4,541,594, or 31% of total revenues, compared to $8,463,842, or 32% of total revenues, for the year ended September 30, 2011. The decrease is primarily due to $3,077,265 for sales commissions, primarily related to the large foreign government sale in fiscal 2011, and $1,255,019 for bonus expense based on not meeting annual performance targets in fiscal 2012, partially offset by an increase of $268,193 for non-cash share-based compensation expense, $134,978 for salary and consulting expense primarily related to increased business development staffing and $62,561 of legal fees related to the recent lawsuit.

We incurred non-cash share-based compensation expenses of $603,989 and $335,796 in selling, general and administrative expenses in the fiscal years ended September 30, 2012 and 2011, respectively. The increase in expenses is due to new options granted to key employees as older grants expired.

We may expend additional resources on marketing our products in future periods, which may increase selling, general and administrative expenses. Also, commission expense will fluctuate based on the level of commissionable sales incurred.

Research and Development Expenses

Research and development expenses decreased $824,265 to $1,659,673, or 11% of total revenues, for the year ended September 30, 2012, compared to $2,483,938, or 9% of total revenues, for the year ended September 30, 2011. This decrease was primarily due to $651,365 in bonus expense for not meeting annual performance targets, $99,612 for lower prototype costs and certification fees and $88,423 for staffing.

Included in research and development expenses for the year ended September 30, 2012 was $58,800 of non-cash share-based compensation expenses, compared to $60,919 for the year ended September 30, 2011.

During fiscal years 2012 and 2011, we reviewed the ongoing value of our capitalized intangible assets and identified some of these assets as being no longer consistent with our business strategy. As a result of this review, we reduced the value of these patents by $41,621 and $22,551 for the fiscal years ended September 30, 2012 and 2011, respectively.

Research and development expenses vary period to period due to the timing of projects, the availability of funds, and the timing, extent and use of outside consulting, design and development firms. In fiscal 2012, research and development expenses were primarily for in-house development, but we have, in the past, supplemented our in-house development with third party consulting resulting in higher expenses. Based on current plans and engineering staffing, we expect fiscal year 2013 research and development expenses to be comparable to expenditures made in fiscal year 2012.

Income From Operations

Income from operations was $1,277,309 for the year ended September 30, 2012, compared to income from operations of $4,981,671 for the year ended September 30, 2011, primarily from decreased revenue and lower margins, partially offset by lower operating expenses.

Other Income

During the year ended September 30, 2012, we earned $33,895 of interest income on our cash balances compared to $32,354 in the year ended September 30, 2011. We also recorded other income of $14,613 in the year ended September 30, 2011 primarily for proceeds from an insurance claim.

Net Income

Our net income decreased $3,560,882 to $1,462,020, or $0.04 per diluted share for the year ended September 30, 2012, compared to net income of $5,022,902, or $0.15 per diluted share, for the year ended September 30, 2011 due to decreased revenue and gross margin, partially offset by decreased operating expenses. We also recognized an income tax benefit of $150,816 during fiscal 2012, compared to an expense of $75,190 in fiscal 2011 as a result of our election under
Section 172(b)(1)(H) of the Internal Revenue Code of 1986, as amended per the American Recovery and Reinvestment Tax Act of 2009 for eligible small businesses, which allows us to carry back the fiscal year ended September 30, 2008 applicable NOL for a period of 3 years, and carry forward the loss for up to 20 years. We have amended tax returns for fiscal years ended 2009 and 2010 and reversed previously recorded federal income tax expense for fiscal years 2009 through 2011 during fiscal 2012 to correspond with the timing of the
Section 172 election and the filing of the amended tax returns.

Liquidity and Capital Resources

Cash and cash equivalents at September 30, 2012 was $13,859,505, compared to $13,870,762 at September 30, 2011. In addition, during the year ended September 30, 2012, we released a bank guarantee which transferred $606,250 from restricted cash to cash and cash equivalents upon completion of the first year of product warranty for a customer contract, and we reclassified $39,406 from cash and cash equivalents to restricted cash during the year to support a bank guarantee related to the same customer's seven year maintenance contract. Net cash provided by operating activities was $194,178, which was offset by a $201,804 investment in product tooling, leasehold improvements and computer equipment related to our move to a new office and manufacturing facility in July 2012. The increase in cash and cash equivalents in the year ended September 30, 2011 primarily resulted from strong net income generating $3,886,017 from operations, which includes $606,250 reclassified to restricted cash as described above, and the exercise of certain warrants to purchase common stock, which generated $4,346,613 in cash. Other than cash and cash equivalents and expected . . .