10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2002

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________to __________.

Commission File Number 0-24248

AMERICAN TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)

Delaware	87-03261799
(State or other jurisdiction of incorporation or organization)	(I.R.S. Empl. Ident. No.)
13114 Evening Creek Drive South, San Diego, California	92128
(Address of principal executive offices)	(Zip Code)
(858) 679-2114
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.        YES  x  NO  o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock, $0.00001 par value	14,345,226
(Class)	(Outstanding at August 2, 2002)

AMERICAN TECHNOLOGY CORPORATION
INDEX

PART I		FINANCIAL INFORMATION			Page
	Item 1.			Financial Statements:
				Balance Sheets as of June 30, 2002 (unaudited) and September 30, 2001	3
				Statements of Operations for the three and nine months ended June 30, 2002 and 2001 (unaudited)	4
				Statements of Cash Flows for the nine months ended June 30, 2002 and 2001 (unaudited)	5
				Notes to Interim Financial Statements	6
	Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
	Item 3.			Quantitative and Qualitative Disclosures about Market Risk	19
PART II		OTHER INFORMATION			20
	Item 1.		Legal Proceedings		20
	Item 2.		Changes in Securities and Use of Proceeds		20
	Item 3.		Defaults upon Senior Securities		20
	Item 4.		Submission of Matters to a Vote of Security Holders		20
	Item 5.		Other Information		21
	Item 6.		Exhibits and Reports on Form 8-K		21
SIGNATURES					22

2

American Technology Corporation
BALANCE SHEETS

		June 30, 2001			September 30, 2002
		(unaudited)
ASSETS
Current Assets:
	Cash	$	1,359,272		$	1,354,072
	Trade accounts receivable, less allowance of $20,191 for doubtful accounts for each period		133,538			117,584
	Inventories [note 5]		201,604			197,013
	Prepaid expenses and other		28,260			67,160
Total current assets			1,722,674			1,735,829
Equipment, net			361,771			516,208
Patents, net of accumulated amortization of $123,170 and $74,584			952,020			848,783
Purchased technology, net of accumulated amortization of of $841,657 and $526,036 [note 6]			420,843			736,464
Total assets		$	3,457,308		$	3,837,284
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable		$	488,350		$	321,775
Accrued liabilities and other:
	Payroll and related		142,336			159,311
	Deferred revenue		367,492			248,611
	Interest		180,058			—
	Other		28,011			114,092
12% Convertible Promissory Note, net of $810,000 and $800,000 for for debt discount [note 7]			1,215,000			—
Total current liabilities			2,421,247			843,789
Commitments and contingencies [notes 6 and 8]
Stockholders' equity [note 8]:
Preferred stock, $0.00001 par value; 5,000,000 shares authorized Series B Preferred stock 250,000 shares designated: 0 and 168,860 issued and outstanding, respectively.			—			2
Series C Preferred stock 300,000 shares designated: 10,000 issued and outstanding each period. Liquidation preference of $227,484 and $218,510, respectively			—			—
Series D Preferred stock 250,000 shares designated: 235,400 and 0 issued and outstanding, respectively. Liquidation preference of $2,376,442 and $0, respectively.			2			—
Common stock, $0.00001 par value; 20,000,000 shares authorized 14,295,226 and 13,704,139 shares issued and outstanding			143			137
Additional paid-in capital			26,792,520			22,913,268
Accumulated deficit			(25,756,604	)		(19,919,912	)
Total stockholders' equity			1,036,061			2,993,495
Total liabilities and stockholders' equity		$	3,457,308		$	3,837,284

See accompanying notes to the interim financial statements.

3

American Technology Corporation
STATEMENTS OF OPERATIONS
(Unaudited)

		For the three months ended June 30						For the nine months ended June 30
		2002			2001			2002			2001
Revenues:
	Product sales	$	165,365		$	128,688		$	489,475		$	423,438
	Related party sales		32,323			—			32,323			—
	Contract and license		38,003			21,630			169,947			259,936
Total revenues			235,691			150,318			691,745			683,374
Cost of revenues			158,998			109,516			397,843			477,489
Gross profit			76,693			40,802			293,902			205,885
Operating expenses:
	Selling, general and administrative		760,967			545,272			1,864,087			1,694,185
	Research and development		1,002,980			770,848			2,883,977			2,366,262
Total operating expenses			1,763,947			1,316,120			4,748,064			4,060,447
Loss from operations			(1,687,254	)		(1,275,318	)		(4,454,162	)		(3,854,562	)
Other income (expense):
	Interest income		772			18,770			13,328			122,862
	Interest expense		(465,584	)		—			(1,395,058	)		—
	Gain on sale of asset		—			—			—			3,000
	Other		—			—			(800	)		(800	)
Total other income (expense)			(464,812	)		18,770			(1,382,530	)		125,062
Net loss		$	(2,152,066	)	$	(1,256,548	)	$	(5,836,692	)	$	(3,729,500	)
Net loss available to common stockholders [note 3]		$	(2,253,264	)	$	(1,285,293	)	$	(5,960,805	)	$	(3,821,660	)
Net loss per share of common stock — basic and diluted		$	(0.16	)	$	(0.09	)	$	(0.42	)	$	(0.28	)
Average weighted number of common shares outstanding			14,291,087			13,677,390			14,147,027			13,515,667

See accompanying notes to the interim financial statements.

4

American Technology Corporation
STATEMENTS OF CASH FLOWS
(Unaudited)

			Nine Months Ended June 30,
			2002			2001
Decrease in Cash
Operating Activities:
Net loss			$	(5,836,692	)	$	(3,729,500	)
Adjustments to reconcile net loss to net cash used in operations:
	Depreciation and amortization			545,292			451,272
	Allowance for doubtful accounts			—			191
	Gain on sale of asset			—			(3,000	)
	Stock issued for services			106,469			—
	Options issued for services			272,539			153,344
	Amortization of debt discount			1,215,000			—
Changes in assets and liabilities:
		Trade accounts receivable		(15,954	)		100,510
		Inventories		(4,591	)		(347	)
		Prepaid expenses and other		38,900			(26,042	)
		Accounts payable		166,575			(25,814	)
		Accrued liabilities		195,883			80,724
Net cash used in operating activities				(3,316,579	)		(2,998,662	)
Investing Activities:
Purchase of equipment				(31,647	)		(211,340	)
Patent costs paid				(146,824	)		(158,113	)
Proceeds loaned on notes receivable — officer				—			(40,000	)
Proceeds on sale of asset				—			3,000
Net cash used in investing activities				(178,471	)		(406,453	)
Financing Activities:
Offering costs on Series D preferred stock				(78,750	)		—
Proceeds from exercise of stock options				—			225,000
Proceeds from issuance of series D preferred stock				2,354,000			—
Proceeds from issuance of convertible promissory notes				1,225,000			—
Net cash provided by financing activities				3,500,250			225,000
Net increase (decrease) in cash				5,200			(3,180,115	)
Cash, beginning of year				1,354,072			4,645,615
Cash, end of year			$	1,359,272		$	1,465,500
Supplemental Disclosure of Cash Flow Information:
Supplemental disclosure of noncash investing and financing activities:
Issuance of stock warrants in connection with convertible debt			$	624,750		$	—
Common stock issued on conversion of Series B Preferred Stock				2,102,412			234,000
Dividends on conversion of Series B Preferred Stock				—			32,076

See accompanying notes to the interim financial statements.

5

AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)

1. OPERATIONS

American Technology Corporation (the “Company”), a Delaware corporation, is engaged in design, development and commercialization of sound, acoustics and other technologies and the sales and marketing of portable consumer products.

2. STATEMENT PRESENTATION

The accompanying unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. In the opinion of management, the interim financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the results for interim periods. Operating results for the three and nine month periods are not necessarily indicative of the results that may be expected for the year. The interim financial statements and notes thereto should be read in conjunction with the Company’s audited financial statements and notes thereto for the year ended September 30, 2001.

3. NET LOSS PER SHARE

The Company applies Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.” SFAS No. 128 provides for the calculation of “Basic” and “Diluted” earnings per share (“EPS”). Basic EPS includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of an entity. The Company’s net losses for the periods presented cause the inclusion of potential common stock instruments outstanding to be antidilutive and, therefore, in accordance with SFAS No. 128, the Company is not required to present a diluted EPS. Convertible preferred stock, convertible promissory notes, stock options and warrants convertible or exercisable into approximately 5,127,879 and 2,563,875 shares of common stock were outstanding at June 30, 2002 and 2001, respectively. These securities were not included in the computation of diluted EPS because of the net losses but could potentially dilute EPS in future periods.

Net loss available to common stockholders for the three and nine months ended June 30, 2002, includes imputed deemed dividends based on the value of warrants issued and a discount at issuance in connection with Series D Preferred Stock (see Note 8). The Company has recorded deemed dividends for the warrants and discount at issuance at $35,377 and $40,385, respectively. Such imputed deemed dividends are not included in the Company’s stockholders’ equity as the Company has an accumulated deficit. The imputed deemed dividends are not contractual obligations of the Company to pay such imputed dividends.

The provisions of the Company’s Series B Preferred Stock provided for an accretion in the conversion value (similar to a dividend) of 6% or $0.60 per share per annum. The Series C Preferred Stock provides for an accretion in the conversion value of 6% or $1.20 per share per annum. The Series D Preferred Stock provides for an accretion in the conversion value of 6% or $0.60 per share per annum. The accrued accretion of the Series B, C and D Preferred Stock for the nine months ended June 30, 2002 and 2001 was $48,351 and $92,160, respectively, which increases the net loss available to common stockholders. Net loss available to common stockholders is computed as follows:

	Three months ended June 30,						Nine months ended June 30,
	2002			2001			2002			2001
Net Loss	$	(2,152,066	)	$	(1,256,548	)	$	(5,836,692	)	$	(3,729,500	)
Imputed deemed dividends based on warrants issued with Series D Preferred Stock		(35,377	)		—			(35,377	)		—
Series D Preferred Stock imputed deemed
dividends based on discount at issuance		(40,385	)		—			(40,385	)		—
Accretion on Series B, C and D Preferred
Stock at stated rate		(25,436	)		(28,745	)		(48,351	)		(92,160	)
Net loss available to common stockholders	$	(2,253,264	)	$	(1,285,293	)	$	(5,960,805	)	$	(3,821,660	)

4. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board finalized FASB Statements No. 141 “Business Combinations” (SFAS 141) and No. 142; “Goodwill and Other Intangible Assets” (SFAS 142). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interest method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business

6

AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)

combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS 142 that the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141.

SFAS 142 requires among other things, that companies no longer amortize goodwill but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date regardless of when those assets were initially recognized. SFAS 142 requires the Company to complete a transitional goodwill impairment test nine months from the date of adoption. The Company is also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. The Company has not entered into any business combinations and has no recorded goodwill. The Company is assessing, but has not yet determined how the adoption of SFAS 142 will impact its financial position and results of operations.

In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for the Company, for the fiscal year ending September 30, 2003. The Company believes the adoption of this statement will have no material impact on its financial statements.

In October 2001, the SFAS issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lives Assets”. SFAS 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value, less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, is to be applied prospectively. The Company has not yet determined what effect, if any, SFAS 144 will have on its financial statements once implemented.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB No. 4, 44 and 64, Amendment of FASB No. 13, and Technical Corrections.”  SFAS rescinds FASB No. 4 “Reporting Gains and Losses from Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.”  This statement also rescinds SFAS No. 44 “Accounting for Intangible Assets of Motor Carriers” and amends SFAS No. 13, “Accounting for Leases”, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions.  This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions.  This statement is effective for fiscal years beginning after May 15, 2002.  The Company does not expect the adoption of this statement to have a material effect on the Company’s financial statements.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 addresses accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).”  SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred.  SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged.   The Company does not expect the adoption of this statement to have a material effect on the Company’s financial statements.

5. INVENTORIES

Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. Inventories consist of the following:

7

AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)

	June 30, 2002			September 30, 2001
Finished goods	$	168,680		$	137,890
Raw materials		52,924			79,123
Reserve for obsolete inventory		(20,000	)		(20,000	)
	$	201,604		$	197,013

6. PURCHASED TECHNOLOGY

In April 2000, the Company acquired all rights to certain loudspeaker technology owned by David Graebener (“Graebener”), Stephen M. Williams (“Williams”) and Hucon Limited, a Washington corporation (“Hucon”).  The purchase price consisted of $300,000 cash plus 200,000 shares of common stock.  The 200,000 shares of common stock were issued in June 2000 and were valued at $962,500. The Company will pay up to an additional 159,843 shares of common stock to Williams and Graebener contingent upon the achievement of certain performance milestones relating to gross revenues received by the Company from the purchased technology. These contingent shares will be recorded as compensation expense when earned and issued. The Company agreed to employ Mr. Williams and Mr. Graebener for a term of three years subject to certain terms and conditions.

7. CONVERTIBLE PROMISSORY NOTES

In September and October, 2001 the Company sold for cash in a private offering $800,000 and $1,225,000, respectively of unsecured 12% Convertible Subordinated Promissory Notes due December 31, 2002 (“Notes”) to accredited investors. The principal and interest amount of each Note may at the election of the Note holder be converted one or more times into fully paid and nonassessable shares of common stock, at a price of $2.00 per share. The Notes may be called by the Company for conversion if the market price exceeds $5.00 per share for five days and certain conditions are met. The purchasers were granted warrants to purchase 1,012,500 common shares of the Company at $2.00 per share until September 30, 2006 (“Warrants”). As of June 30, 2002 the Notes and accrued interest would have been convertible into 1,102,530 shares of common stock.

The Notes and Warrants have antidilution rights reducing the conversion and exercise price for certain issuances of equity securities by the Company at an effective price below the applicable conversion or exercise price. In connection with the Notes and Warrants, the Company recorded $2,025,000 as the value of the beneficial conversion feature of the Notes and the value of the Warrants. The Warrants were valued using the Black-Scholes model and the value was reflected as a discount to the debt. This debt discount is being amortized as non-cash interest expense over the term of the Notes. As of June 30, 2002, $1,215,000 was amortized as non-cash interest expense.

8. STOCKHOLDERS’ EQUITY

The Company has 10,000 shares of Series C Preferred Stock outstanding convertible into 39,562 shares of Common Stock as of June 30, 2002. The dollar amount of Series C Preferred Stock, increased by $1.20 per share accretion per annum and other adjustments, is convertible one or more times into fully paid shares of common stock at a conversion price which is the lower of (i) $8.00 per share or (ii) 92% of the average of the five days closing bid market price prior to conversion, but in no event less than $5.75 per share. The shares of Series C Preferred Stock may be called by the Company for conversion if the market price of the common stock exceeds $20.00 per share for ten days and certain conditions are met. The Series C Preferred Stock is subject to automatic conversion on March 31, 2003.

In May 2002, the Company sold 235,400 shares of Series D Convertible Preferred Stock (“Series D Stock”), par value $.00001 per share, at $10.00 per share for gross cash proceeds of $2,354,000. A total of 250,000 shares of Series D Stock have been authorized. The dollar amount of Series D Stock, increases by $0.60 per share accretion per annum and other adjustments, is convertible one or more times into fully paid shares of common stock at a conversion price which is the lower of (i) $4.50 per share or (ii) 90% of the volume weighted average market price for the five days prior to conversion, but in no event less than $2.00 per share, subject to adjustment. Provided however, that no such conversion may be made prior to January 1, 2003 at a conversion price of less then $4.50 per share. The Company is required to file a registration statement by December 31, 2002, if the registration statement is not filed, the conversion value of the Series D Stock is subject to adjustment. The shares of Series D Stock may be called by the Company for conversion if the market price of the common stock exceeds $9.50 per share for ten days and certain conditions are met. The Series D Stock is subject to automatic conversion on March 31, 2006. The purchasers of the Series D Stock were granted warrants to purchase an aggregate of 517,880 common shares of the Company at $4.50 per share until March 31, 2007 (“D Warrants”). The Series D Stock and the D Warrants have antidilution rights reducing the floor conversion and warrant exercise price for certain issuances of equity securities by the Company at an effective price below the applicable floor conversion or warrant exercise price.  In connection with the Series D Stock financing, the Company incurred closing costs of $78,750. As of June 30, 2002 the Series D Stock

8

AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)

(based on 360-day year) would have been convertible into 528,161 shares of common stock.

In connection with the Series D Stock and D Warrants, the Company recorded $994,310 and $871,000 as the value of the discount at issuance of the Series D Stock and the value of the warrants, respectively.  The warrants were valued using the Black-Scholes model.  The value of the warrants and the discount at issuance are being amortized as a deemed dividend over the period to automatic conversion of the Series D stock (“March 31, 2007”).

As of June 30, 2002, $35,377 and $40,385 was amortized as a deemed dividend.

The following table summarizes changes in equity components from transactions during the nine months ended June 30, 2002:

	Preferred Stock						Common Stock				Additional			Accumulated
	Shares			Amount			Shares		Amount		Paid-in-Capital			Deficit
Balance as of October 1, 2001		168,860		$	2			13,704,139	$	137	$	22,913,268		$	(19,919,912	)
Issuance of Common Stock for compensation and services		—			—			24,129		—		106,469			—
Issuance of Series D Preferred Stock net of offering costs of $78,750		235,400			2			—		—		2,275,248			—
Options issued for services		—			—			—		—		272,539			—
Debt discount on promissory notes		—			—			—		—		1,225,000			—
Accretion of deemed dividends ($75,762)		—			—			—		—		—			—
Conversion of Series B preferred stock and cumulative dividends		(168,860	)		(2	)		566,958		6		(4	)		—
Net Loss		—			—			—		—		—			(5,836,692	)
Balance as of June 30, 2002		235,400		$	2			14,295,226	$	143	$	26,792,520		$	(25,756,604	)

8. STOCKHOLDERS’ EQUITY (cont’d)

The following table summarizes information about stock option activity during the nine months ended June 30, 2002:

	Shares			Weighted Average Exercise Price
Outstanding October 1, 2001		1,338,200		$	5.17
Granted		340,000		$	3.70
Canceled/expired		(296,775	)	$	8.87
Outstanding June 30, 2002		1,381,425		$	4.01
Exercisable at June 30, 2002		1,051,100		$	4.10

Options outstanding are exercisable at prices ranging from $2.50 to $9.03 and expire over the period from 2002 to 2007 with an average life of three years.

At June 30, 2002, the Company had warrants outstanding, exercisable into the following number of common shares:

Number		Exercise Price		Expiration Date
	50,000	$	16.00		May 12, 2003
	50,000	$	10.00		January 5, 2004
	375,000	$	11.00		March 31, 2005
	1,012,500	$	2.00		September 30, 2006
	517,880	$	4.50		March 31, 2007
	2,005,380

In October 2001, the Company granted a total of 110,000 stock options to a consultant in conjunction with related development and manufacturing agreements.  Options to purchase 65,000 shares of common stock vest depending on the consultant’s completion of various project milestones as well as the Company’s acceptance of the specified work. The Company estimates the period required to complete the specified milestones each reporting period and records consulting expense based on the current market price of the Company’s stock and the estimated percentage of the work completed. Consulting expense is adjusted each reporting period until vesting occurs. The Company has recorded consulting expense of $29,797 for the Black Scholes value of 10,000 milestone options vested at March 31, 2002 and

9

AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)

consulting expense of $30,889 for the Black Scholes value of 10,000 milestone options vested at April 30, 2002. Options to purchase 45,000 shares of common stock vest based on the consultant meeting certain performance criteria. The Company records consulting expense at each vesting date. The Company has recorded consulting expense of $96,655 for the Black Scholes value of 45,000 performance options vested during the nine month period ended June 30, 2002.

9. INCOME TAXES

At June 30, 2002, a valuation allowance has been provided to offset the net deferred tax asset as management has determined that it is more likely than not that the deferred tax asset will not be realized. As of September 30, 2001, the Company has for federal income tax purposes net operating loss carryforwards of approximately $17,600,000, which expire through 2021 of which certain amounts are subject to limitations under the Internal Revenue Code of 1986, as amended.

10. RELATED PARTY SALES

On April 19, 2002, We offered to our shareholders and employees the opportunity to purchase limited edition NeoPlanar Speaker Systems with Purebass Subwoofers. The offer was limited to a first come first serve basis.  We offered 100 complete sets at a price of $979.50 per set. As of June 30, 2002 we sold 33 units for cash receipts of $32,323.

10

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

THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, “BUSINESS RISKS.” ALSO SEE OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED SEPTEMBER 30, 2001.

Overview

We are focused on commercializing our proprietary HyperSonic, NeoPlanar, PureBass and Stratified Field sound technologies. Our HyperSonic Sound (HSS) technology employs a laser-like beam to project sound to any listening environment. Our NeoPlanar technology is a thin film magnetic speaker that uses unique films and materials, which we believe results in superior sound quality and volume for any given size with low distortion. PureBass is an extended range woofer designed to complement our high performance Stratified Field and NeoPlanar technologies. PureBass employs unique cabinet construction and vent configurations along with multiple acoustic filters, which we believe produces improved performance. Our Stratified Field technology features a thin form factor, in a variety of shapes and sizes, producing high-fidelity, low distortion sound reproduction. Our strategy is to commercialize these technologies through OEMs primarily through licensing or supply agreements.

We believe our NeoPlanar, PureBass and Stratified Field technologies currently meet OEM commercial requirements. These technologies have been licensed to OEMs (including Harman International and Amtech Manufacturing Inc.) and are being transferred to commercial production. We expect product royalties to commence in fiscal 2002 from these technologies. We are also completing second generation HSS electronic packages and ultrasonic emitters that can be supplied to OEMs to be incorporated into end-user products. We expect that these components will be supplied to HSS licensees in fiscal 2002 for use in HSS products. We are however in the early stage of licensing of our sound technologies and have not generated significant revenues from such technologies to date.

When we license an audio technology, we typically receive a flat fee up-front, with the balance of payments based upon a percentage of net revenues of the products in which our technology is incorporated. Revenues from up-front license fees are recognized ratably over the specified term of the particular license. Contract fees are recorded as services are performed.

We have developed a strategic manufacturing relationship with HST, Inc., providing for sub-contract manufacturing of our sound technologies. HST has commenced production of HyperSonic sound systems and is currently developing volume manufacturing for magnetic NeoPlanar components for military contracts and other OEM customers. Production of the NeoPlaner transducers is expected in the fourth quarter of fiscal 2002. HST also provides us with additional developmental manufacturing support for ongoing research and future technologies. On April 18, 2002 we announced a letter of intent for the acquisition of HST, Inc., in a stock transaction. No formal merger agreement was executed and the parties announced the mutual termination of acquisition discussions on June 24, 2002.

Our various technologies are high risk in nature. Unanticipated technical obstacles can arise at any time and disrupt licensing activities or OEM product sales or result in lengthy and costly delays. There can be no assurance commercially viable sound products being developed by OEMs will meet with market acceptance or that such products will perform on a cost-effective basis.

Our future is largely dependent upon the success of our sound technologies. We invest significant funds in research and development and on patent applications related to our proprietary technologies. There can be no assurance our technologies will achieve market acceptance sufficient to sustain operations or achieve future profits. See “Business Risks” below.

In past years substantially all of our revenues have been derived from the sale of portable consumer products. We have sourced a total of 16 products targeted for niche markets at retail prices ranging from $11.99 to $29.99. Sourcing is on both an exclusive and nonexclusive basis and for different market territories on a product by product basis. Our market focus is in North America. We inventory finished goods as well as provide direct factory shipment to certain customers. There can be no assurance that our line of products can be marketed successfully. We have also produced high-end NeoPlanar speakers for sale to the marine market and expect to target other high-end sales to selected niche markets.

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Critical Accounting Policies

We have identified the policies below as critical to our business operations and the understandings of our results of operations.  The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations when such policies affect our reported and expected financial results.

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America.  Actual results could differ significantly from those estimates under different assumptions and conditions.  We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

We do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).

Revenue Recognition

We derive our revenue primarily from two sources: (i) product revenue and (ii) contract and license fee revenue. We recognize revenue on product sales in the periods that products are shipped. Revenue from on going per unit license fees are based on units shipped incorporating the Company’s patented proprietary technologies and are recognized in the period when the manufacturers’ units shipped information is available to the Company and collectibility is reasonably assured. We recognize revenue from up-front license and other fees and annual license fees ratably over the specified term of the particular license or agreement.

Research and Development Expenses

Research and development expenses are salaries and related expenses associated with the development of our proprietary sound technologies and include compensation paid to engineering personnel and fees to outside contractors and consultants.

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 assesses the need for valuation allowance quarterly.

Results of Operations

Total revenues for the nine months ended June 30, 2002 were $691,745, a 1% increase from the comparable nine months of the prior year. Revenue for the three month period ended June 30, 2002 and 2001 were $235,691 and $150,318, respectively. Product revenue including related party sales for the nine months ended June 30, 2002 was $521,798 a 23% increase from the comparable nine months of the prior year. Contract and license revenues for the nine months ended June 30, 2002 and 2001 were $169,947 and $259,936, respectively. Consumer product sales are subject to significant month to month and quarter to quarter variability based on the timing of orders, new accounts, lost accounts and other factors. At June 30, 2002 and 2001 we had $367,492 and $126,279, respectively, collected and recorded as deferred revenue for existing contracts and licenses. We recognize upfront fees and advance revenues over the term of the respective license agreements.

At June 30, 2002, we had open purchase orders for approximately $316,000 of  backordered products and services to be billed for future work under development contracts. The product is expected to be shipped by December 2002. The contracts are expected to be completed during the fourth quarter ending September 30, 2002. There was no material backlog at June 30, 2001. Anticipated shipments are subject to change due to a variety of factors, many outside our control. Our customers may modify or cancel orders and delay or change schedules. Shipments may also be delayed due to production delay, component shortages and other production related issues.

Cost of sales for the nine months ended June 30, 2002 was $397,843 resulting in a gross profit of $293,902 or 42%. This compares to a gross profit of $205,885 or 30% for the comparable period of the prior year. Cost of sales for the three months ended June 30, 2002 and 2001 were $158,998 and $109,516, representing gross profit percentages of 33% and 27%, respectively. The fiscal 2002 second quarter gross profit is due to the increase in margins for new products introduced in the retail radio division and higher margins for our acoustic technologies. Product cost of sales for the nine months ended June 30, 2002 and 2001 were $329,275 and $344,164, respectively, representing a gross profit of 37%

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and 19% on product sales.  Gross profit percentage is highly dependent on sales prices, volumes, purchasing costs and overhead allocations.

Selling, general and administrative expenses for the nine months ended June 30, 2002 and 2001 were $1,864,087 and $1,694,185, respectively. The $169,902 increase resulted primarily from an increase of $35,136 for depreciation and amortization, an increase of $116,611 for professional services and consulting, and an increase of $10,842 for legal and related costs related to the proposed acquisition of HST, Inc.  Selling, general and administrative expenses for the three month period ended June 30, 2002 and 2001 were $760,967 and $545,272, respectively. The $215,695 increase resulted from an increase of $90,160 for professional services and consulting, a $16,629 increase in legal and related costs, an $11,100 increase for annual meeting costs and an increase of $84,912 for personnel and related costs. We may expend additional resources on marketing HSS, NeoPlanar and other technologies in future quarters, which may increase selling, general and administrative expenses.

Research and development costs for the nine months ended June 30, 2002 were $2,883,977 compared to $2,366,262 for the comparable nine months of the prior year. The $517,715 increase resulted from an increase of $374,030 for consulting and professional services and an increase of $151,679 for materials, film and other related costs used in developing our technologies. Research and development costs for the three months ended June 30, 2002 and 2001 were $1,002,980 and $770,848, respectively. The $232,131 increase resulted from an increase of $125,169 for consulting services, an increase of $52,847 for materials, film and other related costs for the development of our sound technologies and an increase of $91,961 for personnel and related costs offset by a decrease of $25,570 for prepaid PMT royalties.

Research and development costs vary quarter by quarter due to the timing of projects, the availability of funds for research and development and the timing and extent of use of outside consulting, design and development firms. We expect fiscal 2002 research and development costs to remain at levels higher than the prior year due to increased staffing and the use of outside designers and consultants.

We recorded in selling, general and administrative expenses non-cash compensation expenses of $106,469 and $153,344 for the nine month periods ended June 30, 2002 and 2001. The non-cash compensation expense was for services paid through the issuance of 24,129 and 35,250 shares of common stock, respectively.  Non-cash compensation costs vary depending on elections regarding the use of common stock to pay services and other factors related to warrant and option valuations.

We experienced a loss from operations of $4,454,162 during the nine months ended June 30, 2002, compared to a loss from operations of $3,854,562 for the comparable nine months ended June 30, 2001. The $599,600 increase is primarily due to the increase in research and development expenses.

The net loss available to common stockholders for the nine months ended June 30, 2002 and 2001 of $5,960,805 and $3,821,660 respectively included $48,351 and $92,160 of accretion on the Series B, C and Series D Preferred Stock, respectively.

At September 30, 2001, we have federal net loss carryforwards of approximately $17,600,000 for federal tax purposes expiring through 2021. The amount and timing of the utilization of our net loss carryforwards may be limited under Section 382 of the Internal Revenue Code. A valuation allowance has been recorded to offset the related net deferred tax asset as management was unable to determine that it is more likely than not that the deferred tax asset will be realized.

Liquidity and Capital Resources

Since we recommenced operations in January 1992, we have had significant negative cash flow from operating activities.  During the nine months ended June 30, 2002, operating activities used cash of $3,316,579. This amount consisted primarily of a net loss of $5,836,692 and a $15,954 increase in accounts receivable and $4,591 in inventories, offset by $545,292 of depreciation and amortization, $1,215,000 of debt discount amortization, $379,008 of compensation paid in options and common stock, an increase of $38,900 in prepaid expenses and other, an increase of $166,575 in accounts payable and an increase of $195,883 in accrued liabilities.

At June 30, 2002, we had gross accounts receivable of $153,729 as compared to $137,775 at September 30, 2001. This represented approximately 72 days of sales. Receivables can vary substantially due to quarterly and seasonal variations in sales and timing of shipments to and receipts from large customers, many of which demand extended terms of 90-120 days.

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For the nine months ended June 30, 2002, net cash used in investing activities was $178,471, consisting primarily of  $31,647 for the purchase of computer equipment, website development costs and leasehold improvements, and $146,824 in patents and new patent applications. We anticipate significant investments in patents in fiscal 2002. We cannot currently estimate the dollar amounts of these patent investments.

At June 30, 2002, we had working capital deficit of $698,573 compared to working capital of $892,040 at September 30, 2001. In May 2002, the Company issued 235,400 shares of Series D Convertible Preferred Stock for gross cash proceeds of $2,354,000 (see Page 8, Note 8).

We have financed our operations primarily through the sale of preferred stock, exercise of stock options, issuances of convertible notes, proceeds from the sale of investment securities and margins from consumer product sales. At June 30, 2002, we had cash of $1,359,272. As a result of the cash used in operations offset by proceeds from convertible notes, our cash position increased by approximately $5,200 from September 30, 2001. Based on our current cash position and projections for future revenues and currently planned expenditures, we will need to raise additional capital of approximately $2.3 million to continue operations at planned levels during the next twelve months. While we believe that investment capital in sufficient amounts will be available to us, there can be no guarantee that we will be able to raise funds on terms acceptable to us, or at all.  In addition, we may be required to repay up to $2,025,000 borrowed under convertible promissory notes, which mature December 31, 2002.  We have the right to require the holders of these notes to convert the entire principal balance of the notes into common shares at a conversion price of $2.00 per share if the closing bid price of our common shares is at least $5.00 per share for five consecutive days of regular trading, and if at such time there is an effective registration statement for resale of such conversion shares on file with the SEC.  We intend to file a registration statement for those shares promptly after the date of this report.  If the conditions for mandatory conversion are not satisfied before December 31, 2002, we anticipate that most or all of the note holders will elect to convert the notes to common shares if the market price of our shares is in excess of $2.00 per share.  On August 7, 2002, our stock closed at $4.39 on the Nasdaq SmallCap Market.  However, there can be no guarantee that our share value will not decrease or that such conversion will occur.  If such conversion does not occur we will attempt to renegotiate the terms of the notes with non-converting note holders or to raise capital from other sources to repay the notes.  If we are not successful with either of those alternatives, we will be obligated to pay the remaining balance due, which would further increase our need for additional capital to maintain operations at planned levels.

Any equity based source of additional funds could be dilutive to existing equity holders and the dilution could be material. The lack of sufficient funds from operations or additional capital could force us to curtail or scale back operations and would therefore have an adverse effect on our business. Other than cash and cash equivalents, we have no unused sources of liquidity at this time. We expect to incur additional operating losses as a result of expenditures for research and development and marketing costs for our sound and other products and technologies. The timing and amounts of these expenditures and the extent of our operating losses will depend on many factors, some of which are beyond our control. We anticipate that the commercialization of our technologies may require increased operating costs, however we cannot currently estimate the amounts of these costs.

Contractual Commitments and Commercial Commitments

The following table summarizes our contractual obligations, including purchase commitments at June 30, 2002, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

	Payments Due by Period
Contractual Obligations	Less than 1 Year		1-3 years		4-5 years		After 5 Years
Operating leases	$	50,050	$	164,800	$	—	$	—
Employment agreements	$	143,250	$	124,200		—		—
Convertible promissory notes due December 31, 2002 (1)	$	2,025,000		—		—		—
Total contractual cash obligations	$	2,218,300	$	289,000	$		$	—

(1) Assumes notes are not sooner converted to common shares at $2.00 per share.

Employment Agreements

The Company has entered into six employment agreements with executive officers and key employees. These agreements are each for one to three-year terms expiring from September 2002 to February 2003.  Certain of the

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agreements provide for up to twelve months severance for certain terminations and payments for the term of the agreement (or in one case twelve months, if longer) on certain changes in control.

New Accounting Pronouncements

A number of new pronouncements have been issued for future implementation as discussed in the footnotes to our interim financial statements (see page 6, Note 4). As discussed in the notes to the interim financial statements, the implementation of these new pronouncements is not expected to have a material effect on our financial position or results of operations.

Business Risks

You should consider each of the following factors as well as the other information in this Quarterly Report in evaluating our business and our prospects. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business and financial results could be harmed. In that case the trading price of our common stock could decline. You should also refer to the other information set forth in this Quarterly Report and in our Annual Report of Form 10-K for the fiscal year ended September 30, 2001, including our financial statements and the related notes.

We have a history of net losses. We expect to continue to incur net losses and we may not achieve or maintain profitability.  We have incurred significant operating losses and anticipate continued losses in fiscal 2002. At June 30, 2002 we had an accumulated deficit of $25,756,604. We need to generate additional revenue to be profitable in future periods. Failure to achieve profitability, or maintain profitability if achieved may have a material adverse effect on our stock price.
We will need additional capital to support our operations during the next twelve months.  If additional capital is not available, we may have to curtail or cease operations.
Our current plans indicate we will need to raise significant additional capital to support our planned level of operations for the next twelve months.  The actual amount of funds that we will need will be determined by many factors, some of which are beyond our control, and we may need funds sooner than currently anticipated.  These factors include:
•	the extent to which we receive royalties from existing license agreements for our sound technologies;
•	our success in entering into new licensing arrangements for our sound technologies;
•	our progress with research and development; and
•	the costs and timing of obtaining new patent rights.
When we require additional funds, general market conditions or the then-current market price of our common stock may not support capital raising transactions.  If we require additional funds and we are unable to obtain them on a timely basis or on terms favorable to us, we may be required to scale back our research and development efforts, sell or license some or all of our technology or assets or curtail or cease operations.  If we raise additional funds by selling additional shares of our capital stock or securities convertible into common stock, the ownership interest of our stockholders will be diluted.
We may not have sufficient funds to pay the outstanding principal on convertible notes due December 31, 2002 if those notes are not converted prior to the due date.
We may be obligated to pay $2,025,000 in outstanding principal for unsecured convertible notes which mature on December 31, 2002.  While we have a right to force conversion of the amounts due under these notes to common shares, we can exercise that right only if our stock price exceeds $5.00 per share for five trading days in a row, and we have on file with the SEC an effective registration statement for the resale of such shares.  We have not yet filed a registration statement for this purpose.  The note holders may voluntary convert the notes to common shares at a conversion price of $2.00 per share any time before payment, but they are not obligated to do so unless the conditions for mandatory conversion are met.  If our stock price is below $2.00 per share at December 31, 2002, it is unlikely any remaining holders will elect to convert, and the notes will be due and payable unless they are renegotiated.  Even if our stock price exceeds $2.00 per share on that date or before, some or all of the holders may not elect to convert their notes.

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We may not have sufficient funds available to make payments of notes which do not convert before December 31, 2002.  Even if we do have sufficient funds, such payments could impair our ability to meet other critical operating expenses, and could require us to scale back our research and development efforts, sell or license some or all of our technology or assets or curtail or cease operations.  If we do not pay any amounts due and any note holders declare us in default, our financial position and business prospects could be materially impaired.
We are an early stage company introducing new technologies. If commercially successful products do not result from our efforts, we may be unprofitable or forced to cease operations.  Our HSS, NeoPlanar, PureBass and SFT technologies have only recently been introduced to market and are still being improved. Commercially viable sound technology systems may not be successfully and timely produced by OEMs due to the inherent risks of technology development, new product introduction, limitations on financing, competition, obsolescence, loss of key technical personnel and other factors. We have not generated significant revenues from our sound technology to date, and we cannot guarantee significant revenues in the future. The development and introduction of our sound technology has taken longer than anticipated by management and could be subject to additional delays. Even if products employing our sound technology are introduced, they may not achieve market acceptance. Our various sound projects are high risk in nature, and unanticipated technical obstacles can arise at any time and result in lengthy and costly delays or result in a determination that further exploitation is unfeasible. If we do not successfully exploit our technology, our financial condition and results of operations and business prospects would be adversely affected.
Our quarterly and annual revenues are subject to fluctuations caused by many factors, any of which could result in our failure to achieve our revenue expectations. Our quarterly and annual revenues from portable consumer products have varied significantly in the past and are likely to continue to vary in the future due to a number of factors. Our revenues from licensing our sound reproduction technologies are also expected to vary significantly due to a number of factors. Many of these factors are beyond our control. Any one or more of the factors listed below or other factors could cause us to fail to achieve our revenue expectations. These factors include:
	•	our ability to develop, introduce, produce in volume quantities and market successfully new or enhanced portable consumer products;
	•	our ability to develop and license to OEMs our sound reproduction technologies or our ability to supply components to OEMs or customers;
	•	changes in the relative volume of sales of various products or components with sometimes significantly different margins or royalties;
	•	market acceptance of and changes in demand for our portable consumer products and products of our licensees;
	•	gains or losses of significant customers, distributors or strategic relationships;
	•	unpredictable volume and timing of customer orders;
	•	the availability, pricing and timeliness of delivery of components for our products and OEM products;
	•	fluctuations in the availability of manufacturing capacity or manufacturing yields and related manufacturing costs;
	•	the timing of new technological advances, product announcements or introductions by us, by our licensees and by our competitors;
	•	product obsolescence and the management of product transitions and inventory;
	•	production delays by OEMs or by us or our suppliers;
	•	decreases in the average selling prices of products;
	•	seasonal fluctuations in sales;
	•	general consumer electronics industry conditions, including changes in demand and associated effects on inventory and inventory practices;
	•	the conditions of other industries, such as military and commercial industries, into which our technologies may be licensed; and
	•	general economic conditions that could affect the timing of customer orders and capital spending and result in order cancellations or rescheduling.

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Some or all of these factors could adversely affect demand for our portable consumer products and for OEM products incorporating our sound reproduction technologies, and therefore adversely affect our future operating results.
Most of our operating expenses are relatively fixed in the short term. We may be unable to rapidly adjust spending to compensate for any unexpected sales or license revenue shortfalls, which could harm our quarterly operating results. Because the lead times of firm orders are typically short in the consumer electronics industry, we do not have the ability to predict future operating results with any certainty.
Because of the above factors, you should not rely on period-to-period comparisons of results of operations as an indication of future performance.
Our expenses may vary from period to period, which could affect quarterly results and our stock price.  If we incur additional expenses in a quarter in which we do not experience increased revenue, our results of operations would be adversely affected and we may incur larger losses than anticipated for that quarter. Factors that could cause our expenses to fluctuate from period to period include:
	•	the timing and extent of our research and development efforts;
	•	the extent of marketing and sales efforts to promote our technologies; and
	•	the timing of personnel and consultant hiring.
The demand for our portable consumer products has historically been weaker in certain quarters, which makes it difficult to compare our quarterly results.  Due to industry seasonality, demand for consumer electronic products is strongest during the fourth quarter of each year and is generally slower in the period from March through July. Because the consumer products market experiences substantial seasonal fluctuations, with more sales occurring toward the end of the year, our quarterly results will be difficult to compare so long as portable consumer products remains our principal revenue source.
Sound reproduction markets are subject to rapid technological change, so our success will depend on our ability to develop and introduce new technologies. Technology and standards in the sound reproduction markets evolve rapidly, making timely and cost-effective product innovation essential to success in the marketplace. The introduction of products with improved technologies or features may render our technologies obsolete and unmarketable. If we cannot develop products in a timely manner in response to industry changes, or if our technologies do not perform well, our business and financial condition will be adversely affected. The life cycles of our technologies are difficult to estimate, particularly those such as HyperSonic sound for which there is no established market. As a result, our technologies, even if successful, may become obsolete before we recoup our investment.
Our HSS technology is subject to government regulation, which could lead to unanticipated expense or litigation.  Our HyperSonic Sound technology emits ultrasonic vibrations, and as such is regulated by the Food and Drug Administration. In the event of certain unanticipated defects in an HSS product, a licensee or we may be required to comply with FDA requirements to remedy the defect and/or notify consumers of the problem. This could lead to unanticipated expense, and possible product liability litigation against a licensee or us. Any regulatory impediment to full commercialization of our HSS technology, or any of our other technologies, could adversely affect our results of operation. For a further discussion of the regulation of our HSS technology, see Part I, Item 1 of our Annual Report on Form 10-K, under the heading “Government Regulation.”
Many potential competitors who have greater resources and experience than we do may develop products and technologies that make ours obsolete.  Technological competition from other and longer established electronic and loudspeaker manufacturers are significant and expected to increase. Most of the companies with which we expect to compete have substantially greater capital resources, research and development staffs, marketing and distribution program and facilities and many of them have substantially greater experience in the production and marketing of products. In addition, one or more of our competitors may have developed or may succeed in developing technologies and products that are more effective than any of ours, rendering our technology and products obsolete or noncompetitive.

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Commercialization of our sound technologies depends on collaborations with HST, Inc. and other companies. If we are not able to maintain or find collaborators and strategic alliance relationships in the future, we may not be able to develop our sound technologies and products. As we do not have the production, marketing and selling resources to commercialize our products on our own our strategy is to establish business relationships with leading participants in various segments of the electronics and sound reproduction markets to assist us in producing, marketing and selling consumer electronic components and products that include our sound technologies.

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

We have developed a strategic manufacturing relationship with HST, Inc. providing for sub-contract manufacturing of our sound technologies. The loss or disruption of HST, Inc. as a supplier could have a material adverse effect on our financial condition and results of operations.

Any inability to adequately protect our proprietary technologies could harm our competitive position.  We are heavily dependent on patent protection to secure the economic value of our technologies. We have both issued and pending patents on our sound reproduction technologies and we are considering additional patent applications. Patents may not be issued from some or all of our pending applications. Claims allowed from existing or pending patents may not be of sufficient scope or strength to protect the economic value of our technologies. Issued patents may be challenged or invalidated. Further, we may not receive patents in all countries where our products can be sold or licensed. Our competitors may also be able to design around our patents. The electronics industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, which have resulted in significant and often protracted and expensive litigation. There is currently no pending intellectual property litigation against us. Third parties may charge that our technologies or products infringe their patents or proprietary rights. Problems with patents or other rights could potentially increase the cost of our products, or delay or preclude our new product development and commercialization. If infringement claims against us are deemed valid, we may be forced to obtain licenses, which might not be available on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our future patent and/or technology license positions, or to defend against infringement claims. A successful challenge to our sound technology could have a material adverse effect on our business prospects.

Our retail products and sound component production are dependent on outside contractors and suppliers. Disruptions in supply could adversely affect us.  We are dependent on contract suppliers for our finished consumer electronics products. We source products from a variety of suppliers. The loss of a supply of a high selling product could have a material adverse effect on our operations. Disruption of our supply could cause additional costs and delays and could also have an adverse impact on our operations. The manufacturers of our consumer electronic products are also dependent upon the availability of electronic components. Any significant delays in obtaining components could have a material adverse effect on our financial condition and results of operations.

We have developed component supply arrangements for film and components for our Neoplanar and HSS sound technologies. These are generally sole supplier arrangements and the loss or a disruption of supply could have a material adverse effect on our ability to introduce these technologies, or once introduced in volume, could disrupt future revenues adversely affecting financial condition and results of operations.

Two customers represented a significant amount of our business in the last fiscal year. We do not know if we will receive further orders from them.  ASI and Vulcan Northwest Inc. accounted for 23% and 11% of total revenues for the fiscal year ended September 30, 2001. Neither ASI nor Vulcan have committed to purchase any further products or technology from us. During the quarter ended June 30, 2002, neither company made significant purchases from us. We cannot provide any assurances that any of our current customers will continue at current or historical levels or that we will be able to obtain orders from new customers.

If our key employees do not continue to work for us, our business will be harmed because competition for replacements is intense.  Our performance is substantially dependent on the performance of our executive officers and key technical employees. We are dependent on our ability to retain and motivate high quality personnel, especially highly skilled technical personnel. Our future success and growth also depend on our continuing ability to identify, hire, train and retain other highly qualified technical, managerial and sales personnel. Competition for such personnel is intense, there can be no assurance that we will be able to attract,

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assimilate or retain other highly qualified technical, managerial or sales personnel in the future. The inability to attract and retain the necessary technical, managerial or sales personnel could have a material adverse effect upon our business, operating results or financial condition.

Terrorist acts and acts of war may seriously harm our business and results of operations.  Terrorist acts or acts of war (wherever located around the world) may cause damage or disruption to our employees, facilities, OEM partners, suppliers, distributors and resellers, and customers, which could significantly impact our results of operations. The terrorist attacks that took place in the United States on September 11, 2001 were unprecedented events that have created many economic and political uncertainties, some of which may materially harm our business and results of operations. The long-term effects of the September 11, 2001 attacks on our business and results of operations are unknown. The potential for future terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility have created many economic and political uncertainties, which could adversely affect our business and results of operations in ways that cannot presently be predicted.  We are predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war.

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

Our certificate of incorporation, bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and, consequently, decrease the market value of your investment.  Some provisions of our amended certificate of incorporation and bylaws and Delaware law could delay or prevent a change in control or changes in our management that a stockholder might consider favorable. If a change of control or change in management is delayed or prevented, the market price of our common stock could decline.

Conversion of all of or part of our outstanding convertible preferred stock and debt or the exercise of outstanding warrants will cause immediate and possibly significant dilution in the net tangible book value of your shares.  If the holders of our outstanding convertible preferred stock, convertible debt or warrants decide to convert or exercise all or part of their securities, you will experience immediate and possibly significant dilution in the net tangible book value of your shares. The market price of our common stock could also decline upon the resale of the common stock obtained upon conversion of our preferred stock or convertible debt or upon exercise of warrants.

Our stock price is volatile and may continue to be volatile in the future.  Our common stock trades on the NASDAQ Small Cap Market. The market price of our common stock has fluctuated significantly to date. In the future, the market price of our common stock could be subject to significant fluctuations due to general market conditions and in response to quarter-to-quarter variations in (i) our anticipated or actual operating results; (ii) developments concerning our sound reproduction technologies; (iii) technological innovations or setbacks by us or our competitors; (iv) conditions in the consumer electronics market; (v) announcements of merger or acquisition transactions; and (vi) other events or factors and general economic and market conditions. The stock market in recent years has experienced extreme price and volume fluctuations that have affected the market price of many technology companies, and that have often been unrelated or disproportionate to the operating performance of companies.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk represents the risk of loss that may impact our financial position, results of operations or cash due to adverse changes in market prices, including interest rate risk and other relevant market rate or price risks.

We are exposed to some market risk through interest rates, related to our investment of our current cash of $1,359,272 We do not consider this risk to be material, and we manage the risk by continuing to evaluate the best investment rates available for short-term high quality investments.

We have no activities in long-term indebtedness and our other investments are insignificant. At the present time we do not have any significant foreign sales or foreign currency transactions.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time we are involved in routine litigation incidental to the conduct of our business. There are currently no material pending legal proceedings to which we are a party or to which any of our property is subject.

Item 2. Changes in Securities

(a) Not applicable

(b) Not applicable

(c) In May 2002 we sold in a private offering for cash at $10.00 per share a total of 235,400 shares of Series D Preferred Stock to a limited number of accredited or foreign investors for aggregate gross proceeds of $2,354,000. The dollar amount of the Series D stock, increased by $0.60 per share per annum and other adjustments, may be converted one or more times at the election of the Preferred holder, into common stock at a conversion price which is the lower of (i) $4.50 per share or (ii) 90% of the volume weighted average market price of our common stock for the five trading days prior to conversion, but no less than $2.00 per share, subject to certain adjustments. The Series D Preferred Stock may not be converted at less than $4.50 per share prior to December 31, 2002. We may call the shares of Series D Preferred Stock for conversion if the market price of the common stock exceeds $9.50 per share for ten consecutive trading days and certain conditions are met. The Series D Preferred Stock will be subject to automatic conversion on March 31, 2006.

Each purchaser was also granted a warrant to purchase 2.2 common shares at $4.50 per share, subject to certain future adjustments, until March 31, 2007 for each share of preferred stock purchased (aggregate warrants exercisable into 517,880 shares).

The Series D Preferred Stock and the related warrants have antidilution rights reducing the floor price for conversion of the Series D stock and the warrant exercise price for certain issuances of equity securities at an effective price below the applicable floor conversion or warrant exercise price.

We sold these securities without an underwriter. We paid finders fees of $78,750 for the introduction of purchasers. These securities were offered and sold without registration under the Securities Act in reliance upon the exemption provided by Regulation D or Regulation S thereunder, and an appropriate legend was placed on the Series D Preferred Stock and the warrants and will be placed on the shares issuable upon conversion of the Series D Preferred Stock or exercise of the warrants unless registered under the Securities Act prior to issuance. We have agreed to file, not later than December 31, 2002, a registration statement for the resale of the common stock issuable on conversion of the Series D Preferred Stock and exercise of the warrants.

Net proceeds from the sale of the Series D stock of approximately $2,275, 000 will be used for working capital.

(d)    Not applicable

Item 3. Defaults Upon Senior Securities

         Not applicable

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

             At the Company’s fiscal 2002 Annual Meeting of Stockholders held on May 20, 2002, the following individuals, constituting all of the members of the Board of Director were elected: Elwood G. Norris, Terry Conrad, Richard M. Wagner, David J. Carter, O’Connell J. Benjamin and Daniel Hunter. For each elected director, the results of the voting were:

	Affirmative Votes	Negative Votes	Votes Withheld
Elwood G. Norris	11,742,360	-0-	38,682
Terry Conrad	11,744,895	-0-	36,147
Richard M. Wagner	11,744,895	-0-	36,147
David J. Carter	11,749,595	-0-	31,447
O’Connell J. Benjamin	11,749,595	-0-	31,447
Daniel Hunter	11,744,895	-0-	36,147

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Our stockholders also voted to ratify the selection of BDO Seidman, LLP as our independent auditors for the fiscal year ended September 30, 2002. The results of the voting on this proposal were:

Affirmative Votes	Negative Votes	Votes Withheld
11,762,843	12,070	6,129

      The foregoing proposal was approved and accordingly ratified.

Item 5. Other Information

         Not applicable

Item 6. Exhibits and Reports on Form 8-K

(a)	Exhibits:
	3.1	Certificate of Designations of Series D Preferred Stock filed with Delaware on May 3, 2002, incorporated by reference to exhibit 3.1 to Form 10-Q filed May 15, 2002.
	10.1	Stock and Warrant Purchase Agreement dated May 3, 2002, incorporated by reference to exhibit 10.1 to Form 10-Q filed May 15, 2002.
	10.2	Form of Stock Purchase Warrant exercisable until March 31, 2007 granted to investors for an aggregate of 517,880 common shares (individual warrants differ as to holder, number of shares and issuance date), incorporated by reference to exhibit 10.2 to Form 10-Q filed May 15, 2002.
	10.3	Amendment No. 1 To Series D Preferred Stock And Warrant Purchase Agreement dated July 3, 2002.
	99.1	Certifications.
(b)	Reports on Form 8-K

We filed a report on Form 8-K on April 23, 2002 disclosing in Item 5 of a press release concerning our letter of intent to acquire HST, Inc.

We filed a report on Form 8-K on June 24, 2002 disclosing in Item 5 of a press release concerning the termination by mutual agreement of the letter of intent to acquire HST, Inc.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	AMERICAN TECHNOLOGY CORPORATION
Date:  August 14, 2002	By:	/s/ RENEE´ WARDEN
		Renee¢ Warden, Chief Accounting
		Officer, Treasurer and Corporate Secretary
		(Principal Financial and Accounting Officer and duly authorized to sign on behalf of the Registrant)

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EX-10.3

Exhibit 10.3

AMERICAN TECHNOLOGY CORPORATION

AMENDMENT NO. 1 TO SERIES D PREFERRED STOCK AND WARRANT
PURCHASE AGREEMENT

                 THIS AMENDMENT No. 1 TO SERIES D PREFERRED STOCK AND WARRANT PURCHASE AGREEMENT  (the “Amendment”) is entered into effective as of July 3, 2002, by and among American Technology Corporation, a Delaware corporation (the “Company”), and each of those persons and entities, severally and not jointly, whose names are set forth on the Schedule of Purchasers attached hereto as Exhibit A (which persons and entities are hereinafter collectively referred to as “Purchasers” and each individually as a “Purchaser”).

RECITALS

               A.     The parties have previously entered into a Series D Preferred Stock Purchase Agreement dated as of May 3, 2002 (the “Purchase Agreement”);

               B.     The Company desires to amend the Purchase Agreement and its Certificate of Incorporation so as to ensure compliance by it with the rules and interpretive policies of the Nasdaq Stock Market, where the Company’s common shares are currently listed for trading;

               C.     Section 7.6 of the Purchase Agreement requires the consent of the Company and the holders of at least fifty percent (50%) of the Shares (treated as if converted and including any Conversion Shares into which the Shares or Warrants have been converted or exercised that have not been sold to the public) to amend or modify the Purchase Agreement; and

               D.     The designations, rights and preferences of the Shares may be amended by amendment of the Charter, which amendment requires the approval of the holders of a majority of the outstanding stock of the Corporation entitled to vote thereon, together with approval of the holders of a majority of the outstanding Shares voting separately as a class; and

               E.     The undersigned, constituting the Company and at least fifty percent (50%) of the Shares (treated as if converted and including any Conversion Shares into which the Shares or Warrants have been converted or exercised that have not been sold to the public), wish to amend the Purchase Agreement to correct certain errors and to agree to not to vote their Shares in excess of the number of votes permitted by Nasdaq policies applicable to voting rights for convertible securities; and

               F.     The undersigned, constituting the holders of at least a majority of the outstanding Shares,  wish to consent to the amendment to the Charter as approved by the Company’s board of directors.

               NOW, THEREFORE, in consideration of the mutual promises set forth in this Amendment, and for other valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties, intending to be legally bound, hereby agree as follows:

1

               1.     Defined terms.  Except as otherwise defined herein, all capitalized terms used herein shall have the respective meanings ascribed to them in the Purchase Agreement.

               2.     Correction of Drafting Error Concerning Adjustment of Conversion Terms.  Section 6.2(b) of the Purchase Agreement is hereby deleted and replaced with the following:

(b)     Adjustment of Conversion Terms.  If the Registration Statement covering the Registrable Securities which is required to be filed by the Company pursuant to the first sentence of Section 6.2(a) hereof is not filed by December 31, 2002, the terms of conversion of the Shares shall be adjusted as provided in the Certificate of Designation.

               3.     Voting Agreement.  Purchasers’ agree that until such time as the Charter is amended in accordance with the resolution to amend the Charter attached hereto as Exhibit B, for each matter upon which the Shares are entitled to vote pursuant to Section 4(a) of the Certificate of Designation (a “Stockholder Matter”), no Purchaser shall cast votes in excess of the number of votes obtained by multiplying the number of such Purchaser’s Shares held at the time of such vote by a fraction obtained by dividing the purchase price per share paid by such Purchaser for such Shares, by $4.03 (as adjusted for any stock splits, reorganizations, dividends, recapitalizations and the like).  Purchasers further agree that any proxy delivered in connection with a Stockholder Matter shall be deemed a proxy to vote only the number of shares permitted to be voted in accordance with this Section 3.  The Company shall treat as abstentions any Shares which, in accordance with the agreement in this Section 3, are not voted to the full extent otherwise permitted by Section 4(a) of the Certificate of Designation. The provisions of this Section 3 shall be binding upon the successors in interest to any of the Shares.  The Company shall not permit the transfer of any of the Shares on its books or issue a new certificate representing any of the Shares unless and until the person to whom such security is to be transferred shall have executed a written agreement, substantially in the form of this Amendment, pursuant to which such person agrees to the provisions of this Section 3. The agreement in this Section 3 shall terminate upon the filing with the Delaware Secretary of State of a certificate certifying that the Charter has been amended in the manner contemplated by the resolutions in Exhibit B.

               4.     Ownership.  Each Purchaser represents and warrants that (a) such Purchaser now owns its Shares, free and clear of liens or encumbrances, and has not, prior to or on the date of this Amendment, executed or delivered any proxy or entered into any other voting agreement or similar arrangement other than one which has expired or terminated prior to the date hereof, and (b) such Purchaser has full power and capacity to execute, deliver and perform this Amendment, which has been duly executed and delivered by, and evidences the valid and binding obligation of, such Purchaser enforceable in accordance with its terms.

               5.     Specific Performance.  The parties hereto hereby declare that it is impossible to measure in money the damages which will accrue to a party hereto or to its heirs, personal representatives, or assigns by reason of a failure to perform any of the obligations under this Amendment and agree that the terms of this Amendment shall be specifically enforceable.  If any party hereto or its heirs, personal representatives, or assigns institutes any action or proceeding to

2

specifically enforce the provisions hereof, any person against whom such action or proceeding is brought hereby waives the claim or defense therein that such party or such personal representative has an adequate remedy at law, and such person shall not offer in any such action or proceeding the claim or defense that such remedy at law exists.

               6.     Consent to Amendment of Certificate of Incorporation.  The undersigned hereby consents to the amendments to the Charter in substantially the form set forth in the resolutions to amend the Charter attached as Exhibit B hereto, and the filing of a certificate evidencing such amendment with the Delaware Secretary of State.

               7.     Ratification.  The Purchase Agreement, as hereby amended, is ratified and confirmed as being in full force and effect.

               8.     Governing Law.  This Amendment shall be interpreted and enforced under the laws of the State of California as such laws are applied to agreements between California residents entered into and performed entirely in California.

               9.     Counterparts; Facsimile Signatures.  This Amendment may be executed in counterparts, all of which together shall constitute a single original.  Facsimile signatures shall be deemed originals for all purposes.

3

               IN WITNESS WHEREOF, the parties hereto have executed the SERIES D PREFERRED STOCK AND WARRANT PURCHASE AGREEMENTas of the date set forth in the first paragraph hereof.

COMPANY:		PURCHASER:
AMERICAN TECHNOLOGY CORPORATION
13114 Evening Creek Drive South		[Print Name of Purchaser]
San Diego, California  92128
By:		By:
	Name:
	Title:
		Title (if any):

AMERICAN TECHNOLOGY CORPORATION
SIGNATURE PAGE
TO SERIES D PREFERRED STOCK AND WARRANT PURCHASE AGREEMENT

4

SERIES D PREFERRED STOCK AND WARRANT PURCHASE AGREEMENT

EXHIBIT A
SCHEDULE OF PURCHASERS

Michael E. Spencer

Leonard M. Teninbaum Keogh Account,

Leonard M. Teninbaum, Trustee

Veech Trust,

Bryant I.  Pickering,

Trustee

Jerry E. Polis Family

Trust,

Jerry E. Polis, Trustee

Canusa Trading Ltd.

W.A. Manuel,

President

Palermo Trust

James A. Barnes,

Trustee

Sunrise Management, Inc. Profit Sharing Plan

James A. Barnes,

Trustee

Clifford E. Koerner and Kathy L. Koerner,

JTWROS

James C. Zolin and Josephine M. Zolin,

JTWROS

Wayne Opperman

Horacek Family Trust,

Anthony J. Horacek,

Trustee

NGHK Holdings, LLC

Gerald L. and Wilma S. Ehrens Family Trust

5

Stifel, Nicolaus Custodian for Jonathan Berg

IRA

R. Kirk Avery

John C. Roemer

Allan F. Gossman

Jaron Summers and Kathleen Dahlberg,

JTWROS

Granite Capital LP

c/o Walter F. Harrison,

III

Managing Member, Granite Capital LLC, G.P.

Granite Capital II LP

c/o Walter F. Harrison,

III

Managing Member, Granite Capital LLC, G.P.

6

EXHIBIT B

RESOLUTIONS TO AMEND
CERTIFICATE OF INCORPORATION
OF
AMERICAN TECHNOLOGY CORPORATION

                   WHEREAS, American Technology Corporation, a corporation organized under the laws of Delaware (the “Corporation”), filed a Certificate of Designations of Series D Preferred Stock with the Delaware Secretary of State on May 3, 2002 (the “Series D Certificate of Designations”), and in accordance with Section 151 of the Delaware Corporation Code, the Series D Certificate of Designations had the effect of amending Corporation’s Certificate of Incorporation;

                   WHEREAS, the Corporation has proposed to make certain amendments to the Series D Certificate of Designations to conform the same to policies of the Nasdaq Stock Market concerning voting and conversion rights of securities issued by a listed company which are convertible to common shares; and

                   WHEREAS, the Board of Directors has approved the following resolutions, and directed that the same be submitted to the stockholders of the Corporation for approval in accordance with Delaware law and Section 4(b) of the Series D Certificate of Designation.

                   NOW THEREFORE, BE IT:

                   Resolved, that the Corporation’s Certificate of Incorporation be amended to modify the voting powers, preferences and relative, participating, optional and other special rights, and qualifications, limitations and restrictions of the Series D Preferred Stock, as set forth in the Series D Certificate of Designation, as follows:

               1.     Section 4(a) of the Series D Certificate of Designation be amended by adding the following immediately prior to the period at the end of the first sentence thereof:  “provided, however, that the number of such votes for each holder of Series D Preferred Stock shall in no event exceed the number of votes obtained by multiplying the number of shares of Series D Preferred Stock held by the fraction obtained by dividing the Original Issue Price by $4.03 (as adjusted for any stock splits, reorganizations, dividends, recapitalizations and the like)”.

               2.     Section 5(l) of the Series D Certificate of Designation be amended by replacing the phrase “Common Stock equal to” in the first sentence thereof with: “Common Stock, which when added to the maximum number of shares of Common Stock issuable upon exercise of all warrants issued by the Corporation in connection with the sale of the Series D Preferred Stock, is equal to”.

7

EX-99.1

Exhibit 99.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

               I, Elwood G. Norris, Chief Executive Officer of American Technology Corporation (the  “Company”), do hereby certify as of August 14, 2002, in accordance with 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

               (1)     The foregoing Quarterly Report on Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and,

               (2)     The information contained in the foregoing Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Elwood G. Norris

Elwood G. Norris

Chief Executive Officer

CERTIFICATION OF CHIEF FINANCIAL OFFICER

               I, Renee Warden, Chief Accounting Officer of American Technology Corporation (the  “Company”), do hereby certify as of August 6, 2002, in accordance with 18 U.S.C.  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

               (1)     The foregoing Quarterly Report on Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and,

               (2)     The information contained in the foregoing Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Renee Warden

Renee Warden

Chief Accounting Officer