Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion in conjunction with the financial statements and other financial information included elsewhere in this Quarterly Report on Form 10-Q. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012 previously filed with the Securities and Exchange Commission ("SEC"), particularly in the section entitled "Risk Factors".

Business Overview

We are a technology company with a substantial body of intellectual property focused on delivering novel audio solutions. Our HSS technology pioneered the practical application of parametric acoustic technology for generating sound along a directional ultrasonic column. After our September 2010 spin-off from LRAD Corporation we completed development of a new product line and in July 2011 commenced sales of our HSS-3000 audio systems. The HSS-3000 product line delivers directed audio solutions to customers primarily for digital signage, point-of-purchase, in-store network and related applications that benefit from focused sound targeted to specific locations. Our principal markets are North America, Europe and Asia. We are targeting our technology for new uses in commercial and consumer markets including kiosks and point-of-sale terminals, electronic gaming, computers, video gaming, televisions, home audio, health care, movies and cinema and mobile devices.

We are seeking to expand into new markets through both product sales and licensing. Our licensing strategy is to identify large or high-growth markets, develop needed technology solutions and features, and work with established industry participants and OEMs to make products incorporating our technologies widely available to consumers.

Business Outlook

We believe we are experiencing positive response to our licensing initiative and increased acceptance of our HSS-3000 products. We believe we have a solid technology and product foundation, and we are targeting new markets and applications for business growth. We believe we have strong commercial and consumer market opportunities worldwide. In fiscal 2012 we expanded our business development and selling force both internally and through a network of distributors, integrators and agents. We also added to our engineering and technical staff to support licensees and product sales. We expect increased product sales during the balance of fiscal 2013 and additional licensing and/or co-development arrangements as a result of our licensing initiative.

We are unable to predict the level of future product sales in our current markets or the timing of future licensing revenues, if any. We are also unable to predict the acceptance of our technology or resulting products by consumers as we target new commercial and consumer markets through licensing.

We face significant challenges in growing our business in existing and targeted markets. The continued global economic downturn could increase the challenges in operating our business. We expect we will need to continue to innovate new applications for our sound technology, develop new products to meet customer requirements and identify and develop new markets for our products and planned licensing activities.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based upon our financial statements located in Item 1 of Part I, "Financial Statements," and in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report of Form 10-K for the year ended September 30, 2012 previously filed with the SEC. The preparation of these financial statements prepared in accordance with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to valuation of accounts receivable and inventory, warranty liabilities, impairment of intangible assets, contingencies, the grant date fair value of stock options and warrants, share-based compensation expense, valuation of acquired intangible assets and valuation allowance related to deferred tax assets. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

Some of our accounting policies require higher degrees of judgment than others in their application. These include revenue recognition, warranty liabilities, impairments, share-based compensation and valuation of acquired intangible assets. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. There were no significant changes or modification of our critical accounting policies and estimates involving management valuation adjustments affecting our results for the three months ended December 31, 2012. For further information on our critical accounting policies, refer to Note 1 to the financial statements in our Annual Report on Form 10-K for the year ended September 30, 2012.

Segment and Related Information

We operate as a single reportable segment on an enterprise-wide basis. We generate revenue by selling our technology-based products and expect future licensing revenues from such technology.

Results of Operations

Comparison of Results of Operations for the Three Months Ended December 31, 2012 and 2011

The following is a discussion of the results of our operations for the three months ended December 31, 2012 and 2011.

Revenues

Revenues were $108,674 for the three months ended December 31, 2012 representing a 68% increase over revenues of $64,781 for the comparable three months of the prior year ended December 31, 2011. In June 2012 we formed a wholly-owned subsidiary, PSC Licensing Corp. to engage in technology licensing activities. We have no licensing revenues to date.

We are pursuing new customers for our HSS-3000 product line, focusing on larger volume applications for the digital signage, kiosk and point-of-sale terminal markets. We are also pursuing business development activities related to other commercial and consumer applications of our technology. We expect increased product sales during fiscal 2013 and new licensing and/or co-development arrangements pursuant to our licensing initiative but we are unable to predict the level of future product sales or the timing of future licensing revenues, if any.

We had no significant backlog at December 31, 2012.

Gross Profit

Gross profit for the three months ended December 31, 2012 was $54,618 (50% of revenues) compared to $39,865 (61% of revenues) for the three months ended December 31, 2011. The margin in each respective period was positively impacted from usage of parts valued at $9,766 and $3,059 respectively, that had inventory obsolescence and excess parts allowances recorded in prior periods. We continue to develop and implement volume pricing and production strategies, product updates and changes, including raw material and component changes that may impact margins. With such product updates and changes we have limited warranty cost experience and estimated future warranty costs can impact our gross margins. Due to our limited sales and manufacturing history, 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 three months ended December 31, 2012 were $916,597, including non-cash share based compensation expenses of $191,228. This compares to $338,959, including $152,291 of non-cash share based compensation expenses, during the comparable prior-year period ended December 31, 2011. The current year non-cash share based compensation expenses is attributable to vesting of prior awards of options to purchase shares of our common stock to employees and consultants and the effect that the increased price of our common stock during the year had on the quarterly revaluation of non-employee stock options for which service had not been completed. We expect to report significant amounts of non-cash share based compensation expense in future periods from vesting of existing option grants and the possibility of new grants.

Other major cost categories for the three months ended December 31, 2012 included compensation costs of $323,000 (excluding non-cash share based compensation expenses), consulting costs of $60,000, trade show and promotion expenses of $45,000, travel and related costs of $57,000, professional fees of $118,000, public company costs of $95,000 and occupancy costs of $21,000. Our staffing increased from five to fourteen employees between the two periods and we increased the use of outside consultants resulting in increases in compensation costs and related travel costs. Public company costs increased from $40,000 to $95,000 primarily as a result of the engagement of a corporate public relations firm, an increase in the number and compensation of directors and increased director and officer insurance costs. Professional fees increased from $62,000 to $118,000 primarily due to increases in legal costs related to forming our subsidiary HHI and other corporate transactions.

Research and Development Expenses

Research and development expenses for the three months ended December 31, 2012 were $391,853, compared to $230,705 for the comparable period ended December 31, 2011. These research and development expenses included non-cash share based compensation expenses of $62,435 and $44,011, respectively.

Major cost categories for the most recent quarter included personnel and consultancy costs of $287,000 (excluding non-cash share based compensation expenses), $16,000 of technical and testing costs associated with our new subsidiary HHI, $24,000 of occupancy costs and fixed asset amortization and depreciation costs of $51,000.

We added research and development personnel and personnel and consultancy costs increased $144,000 during the most recent quarter compared to the quarter ended December 31, 2011. Patent costs and patent, technology and fixed asset amortization and depreciation costs increased by $25,000 as a result of purchased technology amortization and increased patent filings and related research. Prototype and related testing and development costs decreased by $38,000 as a result of more internal development and less reliance on outside design and development resources.

The scope and magnitude of our future research and development expenses are difficult to predict as the amounts required for future product development costs are difficult to estimate but could be substantial.

Net Loss

The net loss for the three months ended December 31, 2012 and 2011 was $1,252,120 and $531,017, respectively. The most recent period loss included $253,663 of non-cash share-based compensation expenses compared to $196,302 for the prior year's first quarter. We expect to incur additional net losses until we are able to grow revenues to generate sufficient margins to cover operating costs.

Liquidity and Capital Resources

Overview

At December 31, 2012 we had cash of $4.6 million and our current assets exceeded our current liabilities by $4.8 million. Other than cash, accounts receivable and inventory, we have no unused sources of liquidity at this time.

Cash Flows

Operating Activities

During the three months ended December 31, 2012 cash used in operating activities was $856,136. The net loss of $1,252,120 for such period was reduced by net non-cash expenses of $301,873. Cash used in operating activities was also reduced by a $73,288 decrease in accounts receivable, prepaids and inventories and by a $23,439 increase in accounts payable and accrued liabilities.

For the prior year period ended December 31, 2011 cash used in operating activities was $304,960 resulting primarily from the net loss of $531,017 reduced by net non-cash expenses of $221,786.

Investing Activities

We used cash of $4,474 for property and equipment purchases and $18,347 for patent costs during the three months ended December 31, 2012. We have no material commitments for future capital expenditures but expect to continue to incur patent costs in the future.

Financing Activities

During the three months ended December 31, 2012 and 2011 we obtained $1,874 and $153,750, respectively, from the exercise of stock options.

Capital Requirements

Our future capital requirements, cash flows and results of operations could be affected by and will depend on many factors some of which are currently unknown to us, including:

· market acceptance of our products and our ability to grow revenues;

· the costs, timing and outcome of production and regulatory compliance of our products;

· the costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our issued patents and defending any future intellectual property-related claims;

· the costs and timing of additional product development and marketing efforts; and

· the costs, timing and outcome of any future warranty claims or litigation against us associated with any of our products.

We project that our current cash reserves will sustain our operations at least through the next twelve months. We are not aware of any trends or potential events that are likely to adversely impact our short-term liquidity through this term.

Contractual Obligations

Other than aggregate facility and office lease payments of approximately $11,000 per month, the equipment capital lease of $3,574 per month that began in February 2013 and our employment agreement with our Executive Chairman, we have no material contractual obligations.

Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the three-month period ended December 31, 2012, or subsequently thereto, that we believe are of potential significance to our financial statements.