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 March 31, 2005
or
¨	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: 000-24248  

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

Delaware	87-0361799
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
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.  x YES   o NO

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).   YES x  NO o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of April 28, 2005.

Common Stock, $0.00001 par value	21,317,239
(Class)	(Number of Shares)

AMERICAN TECHNOLOGY CORPORATION
INDEX

			Page
PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements:
		Balance Sheets as of March 31, 2005 and September 30, 2004 (unaudited)	3
		Statements of Operations for the three and six months ended March 31, 2005 and 2004 (unaudited)	4
		Statements of Cash Flows for the six months ended March 31, 2005 and 2004 (unaudited)	5
		Notes to Interim Financial Statements (unaudited)	6
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
	Item 3. Quantitative and Qualitative Disclosures about Market Risk		38
	Item 4. Controls and Procedures		39
PART II. OTHER INFORMATION			40
	Item 1. Legal Proceedings		40
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		40
	Item 3. Defaults upon Senior Securities		40
	Item 4. Submission of Matters to a Vote of Security Holders		40
	Item 5. Other Information		40
	Item 6. Exhibits		40
SIGNATURES			41

2

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.

American Technology Corporation
BALANCE SHEETS
Unaudited

	March 31, 2005			September 30, 2004 (a)
ASSETS
Current Assets:
Cash	$	6,162,409		$	4,178,968
Trade accounts receivable, less allowance for doubtful accounts of      $25,000 in each period		494,503			926,747
Inventories, net		904,710			651,095
Prepaid expenses and other		186,192			156,419
Prepaid transaction costs		1,036,184			—
Total current assets		8,783,998			5,913,229
Equipment, net		683,912			453,355
Patents, net		1,336,515			1,278,707
Total assets	$	10,804,425		$	7,645,291
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	1,617,191		$	1,300,075
Accrued liabilities:
Payroll and related		480,115			302,706
Deferred revenue		300,000			322,344
Warranty reserve		238,837			331,917
Legal settlements		291,466			150,000
Other		42,959			22,236
Capital lease short-term portion		11,631			10,967
Derivative instrument		1,111,036
Total current liabilities		4,093,235			2,440,245
Long-Term Liabilities:
8% Unsecured Subordinated Promissory Notes, net of $645,184   and $-0- debt discount		1,354,816			—
Capital lease long-term portion		5,203			12,131
Total liabilities		5,453,254			2,452,376
Commitments and contingencies
Stockholders’ equity
Preferred stock, $0.00001 par value; 5,000,000 shares authorized:
Series D Preferred stock 250,000 shares designated: 0 and 50,000     issued and outstanding, respectively. Liquidation     preference of $0 and $572,500, respectively.		—			—
Series E Preferred stock 350,000 shares designated: 0 and 233,250     issued and outstanding, respectively. Liquidation preference     of $0 and $2,556,000, respectively.		—			3
Common stock, $0.00001 par value; 50,000,000 shares authorized;   21,317,239 and 19,808,819 shares issued and outstanding respectively.		213			198
Additional paid-in capital		50,818,317			47,520,207
Accumulated deficit		(45,467,359	)		(42,327,493	)
Total stockholders’ equity		5,351,171			5,192,915
Total liabilities and stockholders’ equity	$	10,804,425		$	7,645,291

See accompanying notes to interim financial statements.
(a) Derived from the audited financial statements as of September 30, 2004.

3

American Technology Corporation
STATEMENTS OF OPERATIONS
(Unaudited)

	For the three months ended March 31,						For the six months ended March 31,
	2005			2004			2005			2004
Revenues:
Product sales	$	2,814,293		$	1,493,250		$	7,161,206		$	2,111,834
Contract and license		3,100			—			65,100			156,194
Total revenues		2,817,393			1,493,250			7,226,306			2,268,028
Cost of revenues		1,453,966			945,224			2,981,669			1,353,702
Gross profit		1,363,427			548,026			4,244,637			914,326
Operating expenses:
Selling, general and administrative		2,094,036			1,079,472			4,089,951			2,151,786
Research and development		1,452,393			644,248			2,913,008			1,093,219
Total operating expenses		3,546,429			1,723,720			7,002,959			3,245,005
Loss from operations		(2,183,002	)		(1,175,694	)		(2,758,322	)		(2,330,679	)
Other income (expense):
Interest income		18,407			11,491			29,348			30,865
Interest expense		(130,631	)		(993	)		(142,961	)		(1,809	)
Unrealized gain (loss) on derivative revaluation		682,210			—			(267,931	)		—
Total other income (expense)		569,986			10,498			(381,544	)		29,056
Net loss		(1,613,016	)		(1,165,196	)		(3,139,866	)		(2,301,623	)
Dividend requirements on convertible preferred stock		1,518,651			406,846			1,796,426			700,551
Net loss available to common stockholders	$	(3,131,667	)	$	(1,572,042	)	$	(4,936,292	)	$	(3,002,174	)
Net loss per share of common stock - basic and diluted	$	(0.15	)	$	(0.08	)	$	(0.24	)	$	(0.15	)
Average weighted number of common shares outstanding		20,665,004			19,508,387			20,234,075			19,442,192

See accompanying notes to interim financial statements.

4

American Technology Corporation
STATEMENTS OF CASH FLOWS
(Unaudited)

	For the six months ended March 31,
	2005			2004
Increase (Decrease) in Cash
Operating Activities:
Net loss	$	(3,139,866	)	$	(2,301,623	)
Adjustments to reconcile net loss to net cash    used in operations:
Depreciation and amortization		212,050			106,024
Warranty provision		(76,723	)		25,933
Options granted for compensation		270,043			—
Unrealized loss on derivative revaluation		267,931			—
Amortization of debt discount		98,793			—
Provision for obsolete inventory		239,986			—
Changes in assets and liabilities:
Trade accounts receivable		432,244			(1,221,810	)
Inventories		(493,601	)		(215,086	)
Prepaid expenses and other		(29,773	)		(48,835	)
Accounts payable		205,935			118,846
Warranty payments		(16,357	)		(20,433	)
Accrued liabilities		317,254			(101,768	)
Net cash used in operating activities		(1,712,084	)		(3,658,752	)
Investing Activities:
Purchase of equipment		(355,995	)		(104,765	)
Patent costs paid		(144,420	)		(204,819	)
Net cash used in investing activities		(500,415	)		(309,584	)
Financing Activities:
Offering Costs Paid		(102,875	)		—
Payments on capital lease		(6,264	)		(5,662	)
Proceeds from issuance of unsecured promissory notes		2,000,000			—
Proceeds from exercise of common stock warrants		1,661,277			50,000
Proceeds from exercise of stock options		643,802			653,202
Net cash provided by financing activities		4,195,940			697,540
Net increase (decrease) in cash		1,983,441			(3,270,796	)
Cash, beginning of period		4,178,968			9,850,358
Cash, end of period	$	6,162,409		$	6,579,562
Supplemental Disclosure of Cash Flow Information
Cash paid for interest	$	1,058		$	1,809
Cash paid for taxes	$	—		$	—
Non-cash financing activities:
Warrants issued for offering costs	$	843,105		$	—
Warrants issued for debt financing	$	723,000		$	—
Common stock issued for legal settlement accrual	$	—		$	248,000

See accompanying notes to interim financial statements.

5

1.  OPERATIONS

American Technology Corporation (the Company) is engaged in design, development and commercialization of sound, acoustic and other technologies. The Company produces products based on its HyperSonic® Sound (HSS®), Long Range Acoustic Device (LRAD™), NeoPlanar® and other sound technologies.

The Company’s operations are organized into two segments by the end-user markets they serve. The Commercial Products Group, (Commercial Group), formerly known as the Business Products and Licensing Group, markets and licenses HSS and NeoPlanar products to companies that employ audio in consumer, commercial and professional applications. The Government and Force Protection Systems Group (Government Group) markets LRAD, NeoPlanar, SoundCluster™ and HSS products to government and military customers and to the expanding force protection and commercial security markets.

The Company’s principal markets for its proprietary sound reproduction technologies and products are in North America, Europe and Asia.

The Company continues to be subject to certain risks, including history of net losses and expectation to continue to incur net losses; need for additional capital; potential dilutive impact on its stockholders of the Committed Equity Financing Facility (CEFF) described in Note 11 below; dependence on a limited number of customers; reliance on third party suppliers and manufacturers; competition; the uncertainty of the market for new sound products; limited manufacturing, marketing and sales experience; uncertainty regarding future warranty costs; and the substantial uncertainty of ability to achieve profitability and positive cash flow.

2.  STATEMENT OF PRESENTATION AND MANAGEMENT’S PLAN

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 six months 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, 2004 included in the Company’s annual report on Form 10-K.

Other than cash of $6,162,409 at March 31, 2005, accounts receivable collections and possible proceeds from the CEFF described in Note 11 below, the Company has no other material unused sources of liquidity at this time. The Company has financed its operations primarily through cash generated from product sales and from financing activities. Management expects to incur additional operating losses during the balance of fiscal 2005 as a result of expenditures for research and development and marketing costs for proprietary sound products. The timing and amounts of these expenditures and the extent of the Company’s operating losses will depend on future product sales levels and other factors, some of which are beyond management’s control. Based on the Company’s cash position and possible proceeds from the CEFF, and assuming currently planned expenditures and level of operations, management believes the Company will have sufficient capital resources for the next twelve months. Management believes increased product sales will provide additional operating funds. If required, management has significant flexibility to adjust the level of research and development and selling and administrative expenses based on the availability of resources.

6

3.  NET LOSS PER SHARE

Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common stockholders, after deduction for cumulative imputed and accreted dividends, by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution of securities that could share in the earnings of an entity. The Company’s losses for the periods presented cause the inclusion of potential common stock instruments outstanding to be antidilutive. Stock options and warrants exercisable into 4,437,545 shares of common stock were outstanding at March 31, 2005 and stock options, warrants and convertible preferred stock exercisable or convertible into 4,900,870 shares of common stock were outstanding at March 31, 2004. These securities were not included in the computation of diluted earnings (loss) per share because of the losses but could potentially dilute earnings (loss) per share in future periods.

The Company has allocated the proceeds from preferred stock issuances between the preferred stock and warrants and also calculated the beneficial conversion discount for each series of preferred stock. The value of the beneficial conversion discount and the value of the warrants were recorded as a deemed dividend and were accreted over the conversion period of the preferred stock. Net loss available to common stockholders was increased in each period presented in computing net loss per share by the accretion of the value of these imputed deemed dividends. Such imputed deemed dividends were not included in the Company’s stockholders’ equity as the Company has an accumulated deficit. Amounts were included in net loss available to common stockholders. The imputed deemed dividends were not contractual obligations of the Company to pay such imputed dividends. All of the Company’s outstanding shares of Series D and E Preferred Stock were converted to common stock during the quarter ending March 31, 2005.

The provisions of each of the Company’s series of preferred stock also provided for a 6% per annum accretion in the conversion value (similar to a dividend). These amounts also increased the net loss available to common stockholders. Net loss available to common stockholders is computed as follows:

	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Net loss	$	(1,613,016	)	$	(1,165,196	)	$	(3,139,866	)	$	(2,301,623	)
Imputed deemed dividends on Series D and E   warrants issued with preferrd stock		(490,857	)		(146,274	)		(592,137	)		(247,113	)
Imputed deemed dividends on Series D and E   preferred stock		(1,013,854	)		(214,112	)		(1,146,917	)		(359,990	)
Accretion on preferred stock at 6% stated rate:
Series D preferred stock		(1,500	)		(7,500	)		(9,167	)		(15,000	)
Series E preferred stock		(12,440	)		(38,960	)		(48,205	)		(78,448	)
Net loss available to common stockholders	$	(3,131,667	)	$	(1,572,042	)	$	(4,936,292	)	$	(3,002,174	)

On January 18, 2005, the Company gave notice to all holders of Series D and Series E Preferred Stock that it had elected to convert all of the outstanding shares of Series D and Series E Preferred Stock to common stock. The designations, rights and preferences of the Series D and Series E Preferred Stock permitted the Company to exercise this conversion option if the market price of its common stock exceeded $9.50 for ten consecutive trading days and certain other conditions were satisfied. The price condition was satisfied on January 6, 2005. The conversion of the Series D Preferred Stock was effective on January 18, 2005 and resulted in all 50,000 issued and outstanding shares of Series D Preferred Stock converting into an aggregate of 129,259 shares of common stock. The conversion of the Series E Preferred Stock was effective on February 1, 2005, and resulted in all 233,250 issued and outstanding shares of Series E Preferred Stock converting into an aggregate of 801,306 shares of common stock.

As all the Series D and Series E Preferred Stock was called for conversion as described above, $1,504,711 was accreted in the quarter ending March 31, 2005, in addition to the accretion of $13,940 at the stated rate of 6%, increasing the net loss available to common stockholders for that period.

7

4.  STOCK-BASED COMPENSATION

The Company accounts for employee stock-based compensation using the intrinsic value method. In most cases, the Company does not recognize compensation expense for its employee stock option grants, as they have been granted at the fair market value of the underlying Common Stock at the grant date. Had compensation expense for the Company’s employee stock option grants been determined based on the fair value at the grant date for awards through March 31, 2005 consistent with the provisions of Statement of Financial Accounting Standards No. 123, its after-tax net income and after-tax net income per share would have been reduced to the pro forma amounts indicated below:

	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Net loss available to common shareholders	$	(3,131,667	)	$	(1,572,042	)	$	(4,936,292	)	$	(3,002,174	)
Plus: Stock-based employee compensation         expense included in reported net loss		—			—			266,963			—
Less: Total stock-based employee compensation expense          determined using fair value based method		(326,524	)		(262,566	)		(884,226	)		(507,855	)
Pro forma net loss available to common stockholders	$	(3,458,191	)	$	(1,834,608	)	$	(5,553,555	)	$	(3,510,029	)
Net loss per common share - basic   and diluted - as reported	$	(0.15	)	$	(0.08	)	$	(0.24	)	$	(0.15	)
Net loss per common share - basic   and diluted - pro forma	$	(0.17	)	$	(0.09	)	$	(0.27	)	$	(0.18	)

The Company estimates the fair value of each stock award at the grant date by using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2005 and 2004, respectively: dividend yield of zero percent for each period; expected volatility of 53 to 56 percent in 2005 and 75 percent in 2004; risk-free interest rates of 3.82 to 1.84 percent; and expected lives of 2.5 years for each period. The estimated fair value of the options so determined is then amortized to expense over the options’ vesting periods.

5.  RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (FAS) 123(R), “Share Based Payment.” Although Statement 123(R) states that it is effective for public companies at the beginning of the first interim or annual period after June 15, 2005, the Securities and Exchange Commission has adopted a rule delaying the required compliance date to the first interim or annual reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. Therefore, the Company will first be required to comply with Statement 123(R) in the quarter ending December 31, 2005. This statement eliminates the ability to account for share-based compensation using the intrinsic value-based method under APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement 123(R) would require the Company to calculate equity-based compensation expense for stock options and employee stock purchase plan rights granted to employees based on the fair value of the equity instrument at the time of grant. Currently, the Company discloses the pro forma net income (loss) and the related pro forma income (loss) per share information in accordance with FAS 123 and FAS 148, “Accounting for Stock-Based Compensation Costs-Transition and Disclosure.” The Company has not evaluated the impact that Statement 123(R) will have on its financial position and results of operations.

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

6.  INVENTORIES AND CONTRACT MANUFACTURER

Inventory is stated at the lower of cost, which approximates actual costs on a first-in first-out (FIFO) basis, or market. At March 31, 2005 $597,560 of inventory value was located at the Company’s contract manufacturer in San Jose, California.

8

Inventories consisted of the following:

	March 31, 2005			September 30, 2004
Finished goods	$	719,057		$	342,647
Raw materials		535,639			418,448
		1,254,696			761,095
Reserve for obsolescence		(349,986	)		(110,000	)
	$	904,710		$	651,095

During the six months ended March 31, 2005, the Company shipped materials to it's contract manufacturer, booked an amount due from the contract manufacturer and reduced inventory by $387,889. The Company did not recognize any revenue on these transactions. At March 31, 2005, the remaining balance due from the contract manufacturer, for shipments made to it, was $160,050. The contract manufacturer used these materials to build products for the Company. The above due from the contract manufacturer of $160,050 has been netted against the payable due to the contract manufacturer.

7.  CUSTOMER CONCENTRATION

For the six months ended March 31, 2005, sales to one customer in the Government Group accounted for 82% of total revenues and sales to a second customer in the Government Group, including affiliates of the customer, accounted for 10% of total revenues. For the three months ended March 31, 2005, sales to one customer in the Government Group accounted for 93% of total revenues. At March 31, 2005,this customer accounted for 56% of accounts receivable, and two other customers accounted for 21% and 14% of accounts receivable. No other customer accounted for more than 10% of accounts receivable at March 31, 2005. For the six months ended March 31, 2004, sales to three customers in the Government Group accounted for 41%, 32% and 11% of total revenues respectively. For the three months ended March 31, 2004, sales to two customers in the Government Group accounted for 62% and 17% of total revenues. At March 31, 2004, the accounts receivable from these two customers accounted for 66% and 12% of accounts receivable respectively and no other customer accounted for more than 10% of accounts receivable. Management believes that the loss of any one of these significant customers would have a material adverse effect on the Company’s results of operations and financial condition.

8.  INTANGIBLES

Patents are carried at cost and, when granted, are amortized over their estimated useful lives. The carrying value of patents is periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than its carrying value. Patents consisted of the following:

	March 31, 2005			September 30, 2004
Cost	$	1,722,997		$	1,578,578
Accumulated amortization		(386,482	)		(299,871	)
Net patent	$	1,336,515		$	1,278,707

9

9.  PRODUCT WARRANTY COST

The Company establishes a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. Factors affecting warranty reserve levels include the number of units sold and anticipated cost of warranty repairs and anticipated rates of warranty claims. The Company evaluates the adequacy of the provision for warranty costs each reporting period.

Changes in the warranty reserve during the three and six months ended March 31, 2005 and 2004 were as follows:

	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Beginning balance	$	408,834		$	315,000		$	331,917		$	319,500
Warranty provision, net		(158,886	)		30,433			(76,723	)		25,933
Warranty deductions		(11,111	)		(20,433	)		(16,357	)		(20,433	)
Ending balance	$	238,837		$	325,000		$	238,837		$	325,000

10.  UNSECURED SUBORDINATED PROMISSORY NOTES

In December 2004, the Company sold an aggregate of $2,000,000 of 8% unsecured subordinated promissory notes due December 31, 2006. Interest on these notes accrues at the rate of 8% per year and is due and payable quarterly in arrears. For the three and six months ended March 31, 2005, we recorded interest on these notes of $39,452 and $42,959, respectively. The Company is required to use 40% of the net proceeds of any future equity financing to prepay these notes, including any amounts the Company raises pursuant to the CEFF described in Note 11 below. The Company may prepay the notes at its discretion at any time without penalty after June 30, 2005.

In connection with the issuance of these notes, the purchasers were granted warrants to purchase an aggregate of 150,000 shares of its common stock. The exercise price of the warrants was $9.28 per share for purchasers who were directors, officers, employees or consultants of the Company, or affiliates of such persons, and $8.60 per share for other purchasers. Warrants exercisable for 75,000 shares were issued at each such exercise price. The fair value of such warrants, which amounted to $723,000, and closing costs of $20,977 have been recorded as debt discount to be amortized over the term of the notes. The following variables were used to determine the fair value of the warrants under the Black-Scholes option pricing model: volatility of 56%, term of five years, risk free interest of 2.97% and underlying stock price equal to fair market value at the time of grant. For the three and six months ended March 31, 2005, $90,734 and $98,793,respectively, of debt discount was amortized.

A trust affiliated with an officer, director and significant stockholder of the Company purchased one of the aforementioned promissory notes in the principal amount of $500,000 and received a warrant exercisable for 37,500 shares with an exercise price of $9.28 per share.

10

11.  STOCKHOLDERS’ EQUITY

Summary

The following table summarizes changes in equity components from transactions during the six months ended March 31, 2005:

											Additional Paid-in Capital			Accumulated Deficit			Total Stockholders’ Equity (Deficit)
	Preferred Stock						Common Stock
	Shares			Amount			Shares		Amount
Balance, October 1, 2004		283,250		$	3			19,808,819	$	198	$	47,520,207		$	(42,327,493	)	$	5,192,915
Stock issued upon exercise of 369,568 warrants		—			—			369,568		4		1,661,273			—			1,661,277
Conversion of Series D Preferred Stock		(50,000	)		(1	)		129,259		1		—			—			—
Conversion of Series E Preferred Stock		(233,250	)		(2	)		801,306		8		(6	)		—			—
Cashless exercise of 25,000 Warrants		—			—			20,425		—		—			—			—
Stock issued upon exercise of stock options		—			—			187,862		2		643,800			—			643,802
Value assigned to extension of time to exercise 92,675 options		—			—			—		—		266,963			—			266,963
Debt discount for 150,000 warrants granted on 8% unsecured subordinated promissory notes		—			—			—		—		723,000			—			723,000
Issuance of stock options and warrants for services		—			—			—		—		3,080			—			3,080
Deemed dividends and accretion on convertible preferred stock of $1,796,426		—			—			—		—		—			—			—
Net loss for the period		—			—			—		—		—			(3,139,866	)		(3,139,866	)
Balance, March 31, 2005		—		$	—			21,317,239	$	213	$	50,818,317		$	(45,467,359	)	$	5,351,171

As of March 31, 2005, all previously outstanding shares of Series D and Series E Preferred Stock were converted into an aggregate of 930,565 shares of common stock.

Committed Equity Financing Facility

In December 2004, the Company entered into a $25 million Committed Equity Financing Facility (CEFF) with Kingsbridge Capital Limited, a firm specializing in financing small to medium sized technology-based companies. The CEFF allows the Company to sell to Kingsbridge, subject to certain significant limiting conditions, a maximum of 3,684,782 shares of its common stock at a price between 88% and 92% of the volume weighted average price during 15 day purchase periods.

As part of the arrangement, the Company issued a warrant to Kingsbridge to purchase 275,000 shares of its common stock at a price of $8.60 per share. The warrant is exercisable beginning six months after the date of issuance and for a period of five years thereafter. The Company also agreed to file a registration statement for the resale of shares acquired under the CEFF, or upon exercise of the warrant, within 45 days after entering into the agreement for the CEFF. In January 2005 the Company filed the required resale registration statement. The registration statement has not yet been declared effective. The 3,684,782 share maximum also includes any shares that the Company may issue in lieu of paying Kingsbridge liquidated damages in the event that registration statement is unavailable for the resale of the securities purchased by Kingsbridge under the CEFF once the registration statement has been declared effective. The Company has no obligation to draw down all or any portion of the commitment during its 24-month term.

The Company is obligated to use 40% of the proceeds it may receive from the CEFF or other equity financings to prepay any outstanding interest and principal on the notes described in Note 10 above. The Company may also be required to pay liquidated damages of up to $2,500,000 in the event that a registration statement is not available for the resale of securities purchased by Kingsbridge under the CEFF. The Company has also agreed to pay to a consultant, who is not an affiliate of the Company or Kingsbridge, a finder fee equal to 4% of the first $5 million raised under the CEFF, 3% for the second $5 million raised under the CEFF, 2% for the third $5 million raised under the CEFF, and 1.5% for any additional amounts raised.

11

The fair value of the warrant at the date of issuance, which amounted to $843,105, and legal, audit and associated fees of $193,079 were recorded as prepaid transaction costs. These costs will be reclassified to equity once the registration statement is declared effective or upon exercise of the warrant. The following variables were used to determine the fair value of the warrant under the Black-Scholes option pricing model: volatility of 56%, term of 5.5 years, risk free interest of 2.97% and underlying stock price equal to fair market value at the time of issuance. The warrant has been accounted for as a derivative instrument in accordance with Emerging Issues Task Force (EITF) 00-19 “Accounting for Derivative Financial Instruments, Indexed to, and Potentially Settled in a Company’s Own Stock.” As a derivative, the fair value of the warrant is recorded as a liability at its estimated fair value at each balance sheet date until the effective date of the related registration statement, or upon warrant exercise, when the warrant liability, as may be further revalued, will be reclassified to equity. Changes in the fair value of the warrant are recorded as other income or expense in the accompanying income statement. For the three months ended March 31, 2005, $682,210 was recorded as unrealized gain for the change in valuation of the fair value of the warrant. For the period measured from the issuance date of December 14, 2004 until March 31, 2005, $267,931 was recorded as an unrealized expense for the change in valuation of the fair value of the warrant.

Stock Options

During the six months ended March 31, 2005, the Company recorded non-cash compensation expense of $266,963 for the extension of time to exercise stock options for former employees relating to an aggregate of 92,675 shares of common stock. For the three and six months ended March 31, 2005, the Company also recognized $1,540 and $3,080 of non-cash compensation expense, respectively, for the value of options granted to non-employees. These options were valued in the same manner as described in Note 4 for employee options. There were no non-cash compensation expenses for the quarter ended March 31, 2004 or for the six months ended March 31, 2004.

The following table summarizes information about stock option activity during the six months ended March 31, 2005:

	Number of Options			Weighted Average exercise price
Outstanding October 1, 2004		1,839,498		$	4.68
Granted		597,500		$	8.28
Exercised		(187,862	)	$	(3.43	)
Canceled/expired		(119,825	)	$	(4.62	)
Outstanding March 31, 2005		2,129,311		$	5.80
Exercisable March 31, 2005		886,902		$	3.98

Options outstanding are exercisable at prices ranging from $2.50 to $10.06 and expire over the period from 2005 to 2010 with an average life of 3.1 years.

Stock Purchase Warrants

The following table summarizes information about warrant activity during the six months ended March 31, 2005:

	Number of Warrants			Weighted Average Exercise Price
Outstanding October 1, 2004		2,352,802		$	3.74
Issued		425,000		$	8.72
Exercised		(394,568	)	$	( 4.34	)
Canceled/expired		(75,000	)	$	(11.00	)
Outstanding March 31, 2005		2,308,234		$	4.31

At March 31, 2005, the following stock purchase warrants were outstanding arising from offerings and other transactions, each exercisable into one common share:

12

Number	Exercise Price		Expiration Date
655,000	$	2.00	September 30, 2006
451,880	$	3.01	March 31, 2007
272,729	$	6.75	July 10, 2007
100,000	$	4.25	September 30, 2007
353,625	$	3.25	December 31, 2007
50,000	$	3.63	April 8, 2008
75,000	$	8.60	December 31, 2009
75,000	$	9.28	December 31, 2009
275,000	$	8.60	June 14, 2010
2,308,234

12.  BUSINESS SEGMENT DATA

The Company is engaged in design, development and commercialization of sound, acoustic and other technologies. The Company’s operations are organized into two segments by the end-user markets they serve. The Company’s reportable segments are strategic business units that sell the Company’s products to distinct distribution channels. The Commercial Products Group (Commercial Group) markets and licenses HSS and NeoPlanar sound products to companies that employ audio in consumer, commercial and professional applications. The Government and Force Protection Systems Group (Government Group) markets LRAD, NeoPlanar, Sound Cluster and HSS sound products to government and military customers and to the expanding force protection and commercial security markets. The segments are managed separately because each segment requires different selling and marketing strategies as the class of customers within each segment is different.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company does not allocate operating expenses or assets between its two reportable segments. Accordingly the measure of profit for each reportable segment is gross profit.

	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Revenues:
Commercial Products Group	$	109,523	$	455,156	$	296,872	$	537,095
Government Group		2,707,870		1,038,094		6,929,434		1,730,933
	$	2,817,393	$	1,493,250	$	7,226,306	$	2,268,028

	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Gross Profit (Loss):
Commercial Products Group	$	(408,137	)	$	(73,180	)	$	(612,433	)	$	(76,792	)
Government Group		1,771,564			621,206			4,857,070			991,118
	$	1,363,427		$	548,026		$	4,244,637		$	914,326

13

13.  LEGAL PROCEEDINGS

In September 2003, the Company filed a complaint against eSoundIdeas, Inc., in the Superior Court of California, County of San Diego, alleging breach of contract and seeking a declaratory judgment to the effect that a License, Purchase and Marketing Agreement dated September 28, 2000 (the “ESI License Agreement”) with eSoundIdeas, a California partnership, was properly terminated in May 2003. The principals of eSoundIdeas are Greg O. Endsley and Douglas J. Paschall. The principals also founded a corporation, eSoundIdeas, Inc., which purported to assume the contractual obligations of eSoundIdeas. The Company amended the complaint in November 2003 to include eSoundIdeas (the general partnership), Mr. Endsley and Mr. Paschall as defendants. For convenience, the following discussion refers to eSoundIdeas and eSoundIdeas, Inc. collectively as “ESI.” In November 2003, the Company filed complaints in the Superior Court of California, County of San Diego, against Mr. Endsley and Paschall seeking declaratory judgments that options granted to each of Mr. Endsley and Mr. Paschall in April 2001 were terminated in October 2002.

The three cases were consolidated upon motion by the defendants and order of the court. The defendants filed a cross-action in the consolidated action alleging fraud, breach of contract in connection with the ESI License Agreement and the options, breach of the implied covenant of good faith and fair dealing, intentional interference with contract, negligent interference with contract, intentional interference with prospective economic advantage, negligent interference with prospective economic advantage, defamation, and violation of California Business and Professions Code §17200. The Company filed its answer to the second amended cross-complaint in August 2004.

In April 2005, the Company, ESI and its two principals entered into a Settlement Agreement and Mutual Release. As part of the settlement, the Company agreed to pay $150,000, which was previously recorded as a general and administrative expense, and to issue 17,500 shares of common stock to ESI, for which the fair market value as of April 27, 2005 was $140,175, which was recorded in the quarter ended March 31, 2005 as a general and administrative expense. In addition, Mr. Endsley and Mr. Paschall will be entitled to receive an aggregate commission equal to 1% of net sales from April 1, 2005 to September 28, 2007, of the Company’s HSS products specifically targeted for use in North America in the point of sale/purchase, kiosk, display, event, trade show and exhibit markets, subject to a maximum aggregate commission of $500,000. The Company also granted the recipients of the shares “piggyback” rights to have their shares included on future registration statements that the Company might file.

The Company may at times be involved in litigation in the ordinary course of business. The Company will also, from time to time, when appropriate in management’s estimation, record adequate reserves in the Company’s financial statements for pending litigation. Except as set forth above, there are no pending material legal proceedings to which the Company is a party or to which any of its property is subject.

14.  INCOME TAXES

At March 31, 2005, 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. At September 30, 2004 the Company had for federal income tax purposes net operating loss carryforwards of approximately $37,400,000, which expire through 2025 of which certain amounts are subject to significant limitations under the Internal Revenue Code of 1986, as amended.

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

The following discussion should be read in conjunction with the accompanying unaudited interim financial statements and the related notes included under Item 1 of this Quarterly Report on Form 10-Q, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2004.

The following discussion provides an overview of our results of operations for the three and six months ended March 31, 2005 and 2004. Significant period-to-period variances in the statements of operations are discussed under the caption “Results of Operations.” Our financial condition and cash flows are discussed under the caption “Liquidity and Capital Resources.”

14

Forward Looking Statements

This report contains certain statements of a forward-looking nature relating to future events or future performance. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the only means of identifying forward-looking statements. Prospective investors are cautioned that such statements are only predictions and that actual events or results may differ materially. In evaluating such statements, prospective investors should specifically consider various factors identified in this report, including the matters set forth below under the caption “Business Risks”, which could cause actual results to differ materially from those indicated by such forward-looking statements.

Overview

We are an innovator of proprietary sound reproduction technologies and products. We believe our innovative proprietary sound technologies provide us a significant competitive advantage in our principal markets. We believe we are the leader in developing and commercializing parametric loudspeakers, branded as HyperSonic® sound or HSS®. We believe we are also the leader in developing and commercializing high intensity directed acoustical devices, branded as our Long Range Acoustic Device or LRAD™. We have filed over 70 patent applications in the United States, and over 90 patent applications internationally covering our various sound technologies and products.

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

Our four major products from our technology portfolio are listed below.

• Our HyperSonic sound, or HSS, technology is a new parametric speaker technology that creates sound “in the air.” Sound is generated along an air column using ultrasonic frequencies, which are those above the normal range of hearing. The HSS sound beam is highly directional and maintains sound volume over longer distances than traditional loudspeakers. We believe our substantial intellectual property portfolio and pioneering HSS products support our leadership position in the field of parametric non-linear acoustics for sound reproduction, as we continue to improve and release higher reliability, lower distortion and higher output level models of our HSS products.

• Our Long Range Acoustic Device, or LRAD, technology produces variable intensity acoustical sound intended for use in long-range delivery of directional sound information, which is effectively a supercharged megaphone. LRAD products are designed and used as directed long-range hailing and warning systems by both government and commercial customers. We believe our LRAD product innovation, our growing engineering capabilities, and our manufacturing and marketing competencies have established us as the leader in this new marketplace. We are marketing LRAD throughout the U.S. Department of Defense as “The Sound of Force Protection™”, and our markets are expanding to include law enforcement and commercial customers with significant security concerns. In fiscal 2004, we developed a remote controlled pan/tilt version of LRAD for critical infrastructure force protection applications, and we demonstrated our competency to engineer additional new sound solutions for the U.S. Department of Defense. We plan to introduce in the summer of 2005 a new Medium Range Acoustic Device (MRAD^TM). MRAD will be about half the size and weight of LRAD, and provide effective hailing and warning at approximately half the range of LRAD. MRAD is expected to be particularly effective on armored vehicles for urban warfare, shorter-range checkpoints and access denial, plus multiple applications for local, national and international law enforcement.

• Our NeoPlanar® technology is a thin film magnetic speaker that produces sound of high quality, low distortion and high volume. NeoPlanar applications include high-end sound, emergency notification and public address systems. In fiscal 2004, we began marketing NeoPlanar for use in large indoor spaces and in outdoor environments for emergency notification. NeoPlanar offers customers a new capability by delivering remarkably intelligible communications in difficult spaces such as aircraft hangar bays and at distances up to one-half mile.

15

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

We believe we are uniquely equipped to provide our technologies and products in rapidly growing markets for new sound applications not currently served by conventional sound devices and as an alternative to conventional loudspeakers. We believe market factors such as the rapid growth of plasma and flat panel screens offer significant growth opportunities for our HSS focused sound solutions. We also believe that the growth in defense and homeland security and related protection spending by commercial customers provides a growing market for our sound products to be used for intelligible communication over long distances.

Our primary products sold to date have been LRAD and HSS products. These products are currently manufactured for us by Pemstar, Inc., an established contract manufacturer with multiple locations worldwide. Our sales have been highly dependent on large orders from a few customers. We target our products for sale worldwide, but expect the largest markets to be the U.S., Europe and Asia. To date, our sales have been made in U.S. Dollars and we do not expect currency fluctuations to have a material impact on our operations.

Overall Performance

Our second fiscal quarter, ended March 31, 2005, showed a substantial increase in revenues over the same period in the prior fiscal year. However, due to significant increases in operating expenses for the quarter, net loss for the fiscal quarter ended March 31, 2005 was higher than for the same period in the prior fiscal year. Our revenues for the three months ended March 31, 2005 were $2,817,393, compared to $1,493,250 for the three months ended March 31, 2004, an increase of 89%. Our gross profit for the three months ended March 31, 2005 was 48% of revenues, compared to 37% of revenues for the comparable period in the prior fiscal year. We recorded a gross profit of $1,363,427 for the three months ended March 31, 2005, which was higher than the gross profit of $548,026 for the three months ended March 31, 2004. Operating expenses increased from $1,723,720 for the three months ended March 31, 2004 to $3,546,429 for the three months ended March 31, 2005. In addition, for the three months ended March 31, 2005, there was a non-cash gain on derivative revaluation of $682,210 associated with the decrease in value of the warrant we issued to Kingsbridge Capital, and for the six months ended March 31, 2005 there was a non-cash expense of $267,931 associated with the increase in value of the same warrant. There were no corresponding entries for the same periods in the prior fiscal year. Our net loss increased from $1,165,196 for the three months ended March 31, 2004 to $1,613,016 for the three months ended March 31, 2005.

We are continuing to focus our efforts on near-term revenue and gross margin improvement from our existing, marketable products. We have filled key management and operations positions and increased personnel in our sales and marketing and engineering departments. While new hires have necessarily resulted in increased expenses, we believe these new hires are important to near-term revenue and gross margin improvements. We are currently focusing our resources primarily on sales, marketing, engineering and production of existing products. We are closely monitoring expenses for our Advanced Development department, charged with development of new products. Our policy is to establish a compelling business case for each Advanced Development initiative.

Our various technologies are high risk in nature. 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. Unanticipated technical or manufacturing obstacles can arise at any time and disrupt sales or licensing activities and result in lengthy and costly delays.  See “Business Risks” below.

16

Recent Developments

In April 2005, we entered into a Settlement Agreement and Mutual Release with eSoundIdeas, Inc., its two principals and a related partnership, which we refer to collectively as the ESI Parties. Pursuant to the Settlement Agreement, we and the ESI Parties settled litigation arising out of a dispute regarding a license and marketing agreement that we terminated in May 2003, and regarding stock options issued to each of the principals in April 2001 which expired unexercised following termination of consulting services provided to us by these principals. As part of the settlement, the Company agreed to pay $150,000, which was previously recorded as a general and administrative expense, and to issue 17,500 shares of common stock to the ESI Parties, for which the fair market value as of April 27, 2005 was $140,175, which was recorded in the quarter ended March 31, 2005 as a general and administrative expense. We granted the recipients of these shares “piggyback” rights to have their shares included on future registration statements that we might file. In addition, the ESI Parties will be entitled to receive an aggregate commission equal to 1% of net sales from April 1, 2005 to September 28, 2007, of our HSS products specifically targeted for use in North America in the point of sale/purchase, kiosk, display, event, trade show and exhibit markets, subject to a maximum aggregate commission of $500,000. We and the ESI Parties have executed a mutual release of claims, and have agreed to dismiss with prejudice the pending litigation among us.

In May 2005, Carl Gruenler, Vice President, Government and Force Protection Systems Group, left our company. Kalani Jones, President and Chief Operating Officer, will assume Mr. Gruenler's duties in the interim until we locate a replacement for Mr. Gruenler.

Critical Accounting Policies

We have identified the policies below as critical to our business operations and the understandings of our results of operations. Our accounting policies are more fully described in our financial statements located in Item 1 of Part I, “Financial Statements.”

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

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

Valuation of Intangible Assets.  Intangible assets include purchased technology and patents, which are amortized over their estimated useful lives. We must make judgments and estimates regarding the future utility and carrying value of intangible assets. The carrying values of such assets are periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than its carrying value. In fiscal 2004, we reviewed the carrying value of our intangible assets and reduced the carrying value of these assets by $37,798. Our judgments and estimates regarding carrying value and impairment of intangible assets have an impact on our financial statements.

17

Warranty Reserve.  We establish a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. These warranties require us to make estimates regarding the amount and costs of warranty repairs we expect to make over a period of time. Factors affecting warranty reserve levels include the number of units sold and anticipated cost of warranty repairs and anticipated rates of warranty claims. We evaluate the adequacy of the provision for warranty costs each reporting period. See Note 9 to our financial statements for additional information regarding warranties. The estimates we use have an impact on our financial statements. In the three and six months ended March 31, 2005, we recorded a net warranty reduction of $158,886 and $76,723, respectively, as a result of the following: 1) we reduced the warranty reserve that we had previously established in fiscal 2003 for HSS Generation 1 products, primarily as a result of the expiration of time to return failed HSS Generation 1 product to the company for replacement, and 2) we recorded a warranty provision for current sales of all products.

Derivative Instruments. We account for the warrant issued in December 2004 in conjunction with the Committed Equity Financing Facility with Kingsbridge Capital Limited as a derivative financial instrument. As a derivative, the fair value of the warrant is recorded as a liability in the balance sheet and changes in the fair value of the warrant are recognized as other income or expense during each period. The fair value of the warrant is expected to change primarily in response to changes in our stock price.

Significant increases in the fair value of our stock could give rise to significant expense in the period of the change. Likewise, a reduction in our stock price could give rise to significant income in the period of the change. The warrant liability will be reclassified to equity as of the effective date of the related registration statement, or upon the exercise of the warrant.

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

Deferred Tax Asset. We have provided a full valuation reserve related to our substantial deferred tax asset as management has not determined that it is more likely than not that the deferred tax asset will not be realized. In the future, if sufficient evidence of our ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, we may be required to reduce our valuation allowances, resulting in income tax benefits in our consolidated statement of operations. We evaluate the realizability of the deferred tax assets and assess the need for valuation allowance quarterly. The utilization of the net operating loss carryforwards could be substantially limited due to restrictions imposed under federal and state laws upon a change in ownership. Congress passed the American Jobs Creation Act of 2004 in October 2004. The new law contains numerous changes to existing tax laws, including both domestic and foreign tax incentives. We have not yet determined what impact, if any, this new law may have on our deferred tax asset, or our future results of operations and financial condition.

Legal Proceedings. We are currently involved in certain legal proceedings. We estimate the range of liability relating to pending litigation, where the amount and range of loss can be estimated. We record our best estimate of a loss when the loss is considered probable. Where a liability is probable and there is a range of estimated loss with no best estimate in the range, we record the minimum estimated liability related to the claim. As additional information becomes available, we assess the potential liability related to our pending litigation and revise our estimates.

Valuation of Inventory. Our inventory is comprised of raw materials, assemblies and finished products that we intend to sell to our customers. We must periodically make judgments and estimates regarding the future utility and carrying value of our inventory. The carrying value of our inventory is periodically reviewed and impairments, if any, are recognized when the expected future benefit from our inventory is less than its carrying value. In the quarter ended March 31, 2005, we reviewed the carrying value of our inventory and increased the reserve for obsolescence to $349,986, primarily for raw materials and finished goods that were used on our older HSS products for which there is anticipated to be reduced demand.

Results of Operations

Revenues

Revenues for the six months ended March 31, 2005 were $7,226,306, which was a 219% increase over the $2,268,028 in revenues for the six months ended March 31, 2004. Revenues for the six months ended March 31, 2005 and March 31, 2004 included $7,161,206 and $2,111,834 of product sales, and $65,100 and $156,194 of contract and license revenues, respectively. The increase in product sales was primarily due to increased sales of LRAD products by our Government Group.

Revenues for the three months ended March 31, 2005 were $2,817,393, which was an 89% increase over the $1,493,250 in revenues for the three months ended March 31, 2004. Revenues for the three months ended March 31, 2005 included $2,814,293 of product sales and $3,100 of contract and license revenues. Revenues for the three months ended March 31, 2004 consisted entirely of product sales. The increase in revenues was primarily due to increased sales of LRAD products by our Government Group.

18

At March 31, 2005, we had $300,000 in deferred revenue or deposits for existing contracts, agreements and licenses.

We have only a limited record of recurring sales, so we do not consider order backlog to be an important index of future performance at this time. Our backlog is affected by the timing of large orders and order deliveries, especially to government customers. Our order backlog was approximately $128,017 at March 31, 2005 and approximately $600,000 at March 31, 2004. Backlog orders are subject to modification, cancellation or rescheduling by our customers. Future shipments may also be delayed due to production delays, component shortages and other production and delivery related issues.

Our Commercial Products Group, or Commercial Group, markets and licenses HSS and NeoPlanar products to companies, which employ audio in consumer, commercial and professional applications. Our Government and Force Protection Systems Group, or Government Group, markets LRAD, NeoPlanar, SoundCluster and HSS products to government and military customers and to the expanding force protection and commercial security markets.

Presented below is a summary of revenues by business segment:

	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Revenues:
Commercial Products Group	$	109,523	$	455,156	$	296,872	$	537,095
Government Group		2,707,870		1,038,094		6,929,434		1,730,933
	$	2,817,393	$	1,493,250	$	7,226,306	$	2,268,028

Commercial Group revenues for all reported periods consisted primarily of HSS and Neoplanar product sales. The decrease in Commercial Group revenues for the three and six months ended March 31, 2005 compared to the comparable prior fiscal periods was due to a shift in marketing focus from multiple small volume sales to pursuit of high volume contracts which require much longer sales cycles.

Government Group revenues for all reported periods consisted primarily of sales of LRAD and, NeoPlanar products and engineering services such as installation design and support. These revenues are derived primarily from a limited number of large orders and the timing of follow-on orders, if any, is difficult to predict. Government Group revenues for the three and six months ended March 31, 2005 were $2,707,870 and $6,929,434 respectively, and consisted primarily of LRAD product sales and engineering services. Government Group sales for the three and six month periods ended March 31, 2004 were $1,038,094 and $1,730,933, respectively, and consisted primarily of LRAD and NeoPlanar product sales and engineering services.

For the six months ended March 31, 2005, sales to one customer in the Government Group accounted for 82% of total revenues and sales to a second customer in the Government Group, including affiliates of the customer, accounted for 10% of total revenues. For the three months ended March 31, 2005, sales to one customer in the Government Group accounted for 93% of total revenues. For the six months ended March 31, 2004 sales to two customers in the Government Group accounted for 41% and 32% of total revenues, respectively, and sales to one customer in the Commercial Group accounted for 11% of total revenues. For the three months ended March 31, 2004, sales to one customer in the Government Group accounted for 62% of total revenues, and sales to one customer in the Commercial Group accounted for 17% of total revenues. The loss of any one of these significant customers would have a material adverse effect on our results of operations and financial condition.

19

Gross Profit

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

	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Gross Profit (Loss):
Commercial Products Group	$	(408,137	)	$	(73,180	)	$	(612,433	)	$	(76,792	)
Government Group		1,771,564			621,206			4,857,070			991,118
	$	1,363,427		$	548,026		$	4,244,637		$	914,326

The overall gross profit for the six months ended March 31, 2005 was $4,244,637, or 59% of revenues, compared to gross profit of $914,326 or 40% of revenues for the comparable period of the prior fiscal year. The significant improvement in gross profit as a percentage of revenues reflected improved gross profit in our Government Group, offset in part by increased gross losses in our Commercial Group.

The overall gross profit for the three months ended March 31, 2005 was $1,363,427 or 48% of revenues, compared to gross profit of $548,026 or 37% of revenues for the comparable period of the prior fiscal year. Gross profit as a percentage of revenues improved over the comparable period of the prior fiscal year as a result of improved gross profit in our Government Group, offset in part by increased gross losses in our Commercial Group.

We experienced gross losses in our Commercial Group for the three and six months ended March 31, 2005 of $408,137 and $612,433 respectively, as limited sales were not sufficient to absorb fixed manufacturing overhead costs and substantial reserves were taken for obsolete and slow moving inventory particularly for our older HSS products. For the three and six months ended March 31, 2004, we had gross losses in our Commercial Group of $73,180 and $76,292 respectively, primarily as a result of limited sales compared to fixed overhead and warranty costs. During fiscal year 2003 and fiscal 2004 we changed our HSS Generation 1 emitter design to eliminate the requirement for a vacuum in the emitter, and we improved film quality. During fiscal 2004, we made further raw material improvements in the electronics and the manner in which the film and emitters are produced. We believe that future generations of our products will be more reliable. We expect that warranty costs will decrease in fiscal 2005, and that as the volume of HSS product sales grow, we will achieve positive gross margins in future periods.

Gross profit for our Government Group for the three and six months ended March 31, 2005, was $1,771,564 and $4,857,070 respectively compared to $621,206 and $991,118 for the three and six months ended March 31, 2004. Gross profit percentage continues to be highly dependent on sales prices, volumes, purchasing costs and overhead allocations. Our various sound products have different margins, so product sales mix will materially affect gross profits. In addition, we continue to make model updates and changes including raw material and component changes, which change product costs. We therefore 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 as a percentage of revenues were 57% for the six months ended March 31, 2005 compared to 95% for the six months ended March 31, 2004. These costs for the six months ended March 31, 2005 totaled $4,089,951, which represents an increase from selling general and administrative expenses of $2,151,786 for the six months ended March 31, 2004.

The overall increase for the six months ended March 31, 2005 included the following:

• $581,029 increase in personnel and related expenses due to increases in headcount and salaries.

• $213,180 increase in commission expenses resulting from increased sales in our Government Group.

• $539,399 increase in legal expense related to the litigation which settled in April 2005, and increased legal costs of public company compliance.

• $210,116 increase in travel and entertainment and marketing expenses as a result of increased sales efforts.

20

• $95,537 increase in insurance expenses.

• $69,724 increase in depreciation expenses due to an increase in depreciable capital assets.

Selling, general and administrative expenses as a percentage of sales were 74% for the three months ended March 31, 2005 compared to 72% for the three months ended March 31, 2004. These costs for the three months ended March 31, 2005 totaled $2,094,036, which represents an increase from selling, general and administrative expenses of $1,079,472 for the three months ended March 31, 2004.

The overall increase for the three months ended March 31, 2005 included the following:

• $192,213 increase in personnel and related expenses due to increases in headcount and salaries.

• $474,586 increase in legal expense related to the litigation which settled in April 2005, and increased costs of public company compliance.

• $106,841 increase in travel and entertainment and other marketing related expenses as a result of increased sales.

• $87,343 increase in insurance expenses.

• $44,225 of increased consulting expenses.

We expect selling, general and administrative expenses to increase in future periods as we increase our marketing efforts for our proprietary sound technologies. We will also incur substantial additional expense over the remainder of fiscal 2005 to improve and document our internal control over financial reporting in anticipation of management’s required assessment of the effectiveness of our internal control over financial reporting and the attestation of such assessment by our independent registered public accounting firm, required by Section 404 of the Sarbanes-Oxley Act of 2002 in connection with our report on Form 10-K for the fiscal year ending September 30, 2005.

Research and Development Expenses

Research and development expenses increased by $1,819,789 from $1,093,219 for the six months ended March 31, 2004 to $2,913,008 for the six months ended March 31, 2005. Research and development expenses as a percentage of sales were 40% for the six months ended March 31, 2005 compared to 48% for the six months ended March 31, 2004.

The overall increase for the six months ended March 31, 2005 included the following:

• $997,520 increase in personnel and related costs as we significantly increased our engineering design and development capability.

• $245,183 non-cash expense associated with the modification of stock options for departing employees.

• $538,239 increase for prototypes and other parts relating to our continuing effort to design and develop new and more reliable products.

Research and development expenses increased by $808,145 from $644,248 for the three months ended March 31, 2004 to $1,452,393 for the three months ended March 31, 2005. Research and development expenses as a percentage of sales were 52% for the three months ended March 31, 2005 compared to 43% for the three months ended March 31, 2004.

The overall increase for the three months ended March 31, 2005 included the following:

• $479,382 increase in personnel and related costs, as we significantly increased our engineering design and development capability.

• $59,712 decrease for consulting expenses.

21

• $320,555 increase for prototypes and other parts relating to our continuing effort to design and develop new and more reliable products.

Research and development expenses vary period to period due to the timing of projects, the availability of funds for research and development and the timing and extent of use of outside consulting, design and development firms. We expect research and development expenses for the remainder of fiscal 2005 to be higher than the corresponding periods of fiscal 2004.

Loss From Operations

Loss from operations was $2,758,322 for the six months ended March 31, 2005 compared to $2,330,679 for the six months ended March 31, 2004. The increase in loss from operations was due to a $3,757,954 increase in total operating expenses, offset in part by an increase of $3,330,311 in gross profit. Losses from operations are expected to continue in the current fiscal year.

Loss from operations was $2,183,002 for the three months ended March 31, 2005 compared to $1,175,694 for the three months ended March 31, 2004. The increase in loss from operations reflected a $1,822,709 increase in total operating expenses, offset in part by an increase of $815,401 in gross profit.

Other Income (Expense)

We recorded $569,986 of other income and $381,544 of other expense for the three and six months ended March 31, 2005, compared with $10,498 and $29,056 of other income for the three and six months ended March 31, 2004. Other income for the three months ended March 31, 2005 included $682,210 of non-cash derivative revaluation income related to the decrease in the fair value during the three months ended March 31, 2005 of the warrant issued to Kingsbridge Capital Limited. Other expense for the six months ended March 31, 2005 included $267,931 of non-cash derivative revaluation expense related to the increase in the fair value of such warrant measured from the issuance date of December 14, 2004 to March 31, 2005. We also incurred interest expense of $130,631 and $142,961 and recognized $18,407 and $29,348 of interest income from invested cash balances during the three and six months ended March 31, 2005. During the three and six months ended March 31, 2004, we recorded interest expense of $993 and $1,809, respectively, and $11,491 and $30,865, respectively, of interest income from invested cash balances.

Net Loss

Net loss for six months ended March 31, 2005 was $3,139,866 compared to net loss of $2,301,623 for the six months ended March 31, 2004. Net loss for the three months ended March 31, 2005 was $1,613,016 compared to net loss of $1,165,196 for the three months ended March 31, 2004. The increase in net loss during the 2005 periods resulted primarily from higher operating expenses, offset in part by increases in gross margins. The non-cash derivative revaluation expense recorded for the three and six months ended March 31, 2005 contributed to increased net loss for the six month period and reduced the net loss for the three month period.

Net Loss Available to Common Stockholders

Net loss available to common stockholders was increased in each period presented in computing net loss per share by the accretion of the value of imputed deemed dividends arising from the beneficial conversion discount and the value of warrants associated with convertible preferred stock outstanding during each period. The imputed deemed dividends were not contractual obligations to pay such imputed dividends. Net loss available to common stockholders is also increased by the 6% accretion (similar to a dividend) on outstanding preferred stock. These amounts aggregated $1,518,651 and $1,796,426 for the three and six months ended March 31, 2005, and $406,846 and $700,551 for the three and six months ended March 31, 2004. Accordingly, the net loss available to common stockholders was $3,131,667 and $4,936,292 for the three and six months ended March 31, 2005, and $1,572,042 and $3,002,174 for the three and six months ended March 31, 2004.

On January 18, 2005, we gave notice to all holders of Series D and Series E Preferred Stock that we had elected to convert the shares of Series D and Series E Preferred Stock to common stock. All 50,000 issued and outstanding shares of Series D Preferred Stock converted into an aggregate of 129,259 shares of common stock on the date of notice, and all 233,250 issued and outstanding shares of Series E Preferred Stock converted into an aggregate of 801,306 shares of common stock on February 1, 2005. As all the Series D and Series E Preferred Stock was called for conversion as described above, $1,504,711 was accreted in the second fiscal quarter, in addition to the accretion of $13,940 at the stated rate of 6%, and increased the net loss available to common stockholders.

22

Liquidity and Capital Resources

We have experienced significant negative cash flow from operating activities including developing and introducing our proprietary sound technologies. Our net cash used in operating activities was $1,712,084 for the six months ended March 31, 2005 compared to $3,658,752 for the six months ended March 31, 2004. For the six months ended March 31, 2005, the net loss of $3,139,866 included certain expenses not requiring the use of cash totaling $1,012,080. For the six months ended March 31, 2005, cash was used in operating activities through an increase of $493,601 in inventory, an increase of $29,773 in prepaid expenses and an increase of $16,357 in warranty payments. Cash was provided in operating activities through a decrease of $432,244 in accounts receivable, an increase of $523,189 in accounts payable and accrued liabilities.

At March 31, 2005, we had accounts receivable of $494,503 as compared to $926,747 at September 30, 2004. The balance at March 31, 2005 represented approximately 35 days of revenues. One customer accounted for 56% of accounts receivable and two other customers accounted for 21% and 14% of accounts receivable at March 31, 2005, No other customer accounted for more than 10% of accounts receivable at March 31, 2005. Terms with individual customers vary greatly. We typically require pre-payment or a maximum of thirty-day terms for our proprietary sound technology products. Our receivables can also vary substantially due to overall sales volumes and due to quarterly and seasonal variations in sales and timing of shipments to and receipts from large customers and the timing of contract payments.

For the six months ended March 31, 2005 and March 31, 2004 we used cash of $355,995 and $104,765, respectively for the purchase of equipment and software and made investments of $144,420 and $204,819, respectively in patents and new patent applications. We anticipate a continued investment in patents for the balance of fiscal 2005.

Cash from financing activities provided $4,195,940 and $697,540 for the six months ended March 31, 2005 and March 31, 2004. During the six months ended March 31, 2005, we received $2,000,000 from the sale of unsecured promissory notes, $1,661,277 from the exercise of common stock warrants and $643,802 from the exercise of stock options. During the six months ended March 31, 2004, we received $50,000 from the exercise of common stock warrants and $653,202 from the exercise of common stock options.

At March 31, 2005, we had working capital of $4,690,763 compared to working capital of $3,472,984 at September 30, 2004.

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

In December 2004, we entered into a Committed Equity Financing Facility (CEFF) with Kingsbridge Capital Limited, pursuant to which Kingsbridge committed, subject to certain significant limiting conditions, to purchase up to $25 million of our common stock to support future growth. As part of the arrangement, we issued a warrant to Kingsbridge to purchase 275,000 shares of our common stock at a price of $8.60 per share. The warrant is exercisable beginning six months after the date of grant and for a period of five years thereafter. Subject to certain conditions and limitations, from time to time under the CEFF, we may require Kingsbridge to purchase newly-issued shares of our common stock at a price that is between 88% and 92% of the volume weighted average price during a 15 day purchase period, and thereby raise capital as required, at the time, price and in the amounts deemed suitable to us. For each election to sell shares to Kingsbridge, we select the lowest threshold price at which our stock may be sold, but the threshold price cannot be lower than $3.00 per share. Our agreement with Kingsbridge permits Kingsbridge to terminate the CEFF if Kingsbridge determines that a material and adverse event has occurred affecting the business, operations, properties or financial condition of our company, or if any situation occurs that would interfere with our ability to perform any of our obligations under the agreement.

23

The CEFF requires us to have a resale registration statement filed within 45 days of entering into the CEFF, and to use commercially reasonable efforts to have such registration statement declared effective by the Securities and Exchange Commission (SEC) within 45 days or 120 days of filing, depending on whether the SEC elects to review the registration statement. The required registration statement was filed in January 2005. The resale statement has not yet been declared effective. We cannot elect to sell shares to Kingsbridge until the registration statement is effective.

In certain instances, we may be required to pay liquidated damages or other amounts resulting from the unavailability of a registration statement. For further details, see “Business Risks” below.

Based on such factors as market conditions, financing needs and the time required for the SEC to declare the resale registration statement effective, we currently expect that we may begin to utilize the CEFF during fiscal 2005 in order to fund working capital requirements. However, the timing and extent of our ability to utilize the CEFF is uncertain. We are obligated to use 40% of the proceeds we may receive from the CEFF to prepay any outstanding interest and principal on the notes sold in December 2004. Under the rules of the Nasdaq Stock Market, the maximum number of shares we may sell to Kingsbridge without approval of our stockholders is 3,684,782, which includes any shares we may issue in lieu of paying liquidated damages, but excludes the warrant shares. This limitation may further reduce the amount of proceeds we are able to obtain from the CEFF. We agreed to pay to a consultant a finder fee equal to 4% of the first $5 million raised under the CEFF, 3% for the second $5 million raised under the CEFF, 2% for the third $5 million raised under the CEFF, and 1.5% for any additional amounts raised under the CEFF. See “Business Risks” below for a discussion of other risks associated with the CEFF.

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

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

• government spending levels;

• introduction of competing technologies;

• failure of sales from our Government Group and Commercial Group to meet planned projections;

• product mix and effect on margins; and

• product acceptance in new markets.

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

• inability to have the registration statement required by the CEFF declared effective by the SEC;

• decrease in the market price of our common stock, which may render the CEFF unavailable (if the purchase price under the CEFF would be less than $3.00 per share), or which may make the CEFF a less attractive funding source.;

• our failure to satisfy other required conditions for use of the CEFF;

• the trading volume of public trading of our common stock; and

• overall market conditions.

Based on our cash position, and assuming currently planned expenditures and level of operations, we believe we will have sufficient cash for operations for the next twelve months. We believe increased sales of LRAD, HSS and, to a lesser extent, NeoPlanar products will continue to contribute cash in fiscal 2005. We believe that any investment capital we may require will be available to us, but there can be no guarantee that we will be able to raise funds on terms acceptable to us, or at all. We have flexibility to adjust the level of research and development and selling and administrative expenses based on the availability of resources. However, reductions in expenditures could delay development and adversely affect our ability to generate future revenues.

24

Contractual Commitments and Commercial Commitments

The following table summarizes our contractual obligations at March 31, 2005, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

	Less than 1							After 5
Contractual Obilgations	Total		Year		1-3 Years		4-5 Years	Years
Capital leases	$	21,344	$	12,806	$	8,538	—	—
Operating leases		355,827		245,033		110,794	—	—
Long Term Debt		2,000,000				2,000,000	—	—
Total contractual cash obligations	$	2,377,171	$	257,839	$	2,119,332	—	—

The Company had no material purchase obligations at March 31, 2005.

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 Note 5).

Business Risks

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

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

We have incurred significant operating losses and anticipate continued losses in the remainder of fiscal 2005. At March 31, 2005, we had an accumulated deficit of $45,467,359. We need to generate additional revenue to be profitable in future periods. Failure to achieve profitability, or maintain profitability if achieved, may cause our stock price to decline.

We may need additional capital for growth.  

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

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

• government spending levels;

• introduction of new competing technologies;

• failure of sales from our Government Group and Commercial Group to meet planned projections;

25

• product mix and effect on margins; and

• acceptance of our products in new markets.  

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.

If our stock price falls below $3.41 per share we will be unable to draw down on the CEFF unless the stock price increases. The potential unavailability of this facility would negatively affect our financing activities.  

We have entered into a Committed Equity Financing Facility, or CEFF, with Kingsbridge Capital Limited. Under the terms of our agreement with Kingsbridge, we may, at our sole discretion, sell to Kingsbridge, and Kingsbridge would be obligated to purchase, shares of our common stock for up to $25 million in proceeds to us. The price at which we may sell shares of common stock under the agreement is based on a discount to the volume weighted average market price of the common stock for fifteen trading days following each of our elections to sell shares. For each election to sell shares, we select the lowest threshold price at which our stock may be sold, but the threshold price cannot be lower than $3.00 per share. In the event the market price of our common stock falls below $3.41 per share, which after giving effect to the discount would result in a price per share lower that the $3.00 minimum threshold price, the CEFF will not be an available source of financing. Our stock has traded below $3.41 per share during many in the past, including most recently during May 2003. In addition, we are obligated to use 40% of the proceeds we may raise from the CEFF to prepay any outstanding interest and principal on promissory notes we sold in December 2004 with an aggregate principal amount of $2,000,000. Our agreement with Kingsbridge permits Kingsbridge to terminate the CEFF if Kingsbridge determines that a material and adverse event has occurred affecting the business, operations, properties or financial condition of our company, or if any situation occurs that would interfere with our ability to perform any of our obligations under the agreement.

If we are unable to draw down on the CEFF, and are otherwise unable to obtain capital from other sources on a timely basis or on terms favorable to us, we may be required to scale back our marketing and research and development efforts, sell or license some or all of our technology or assets or curtail or cease operations.

If Kingsbridge determines that a material and adverse event has occurred that affects our company, we will be unable to draw down on the CEFF. The potential unavailability of this facility would negatively affect our financing activities.

Our agreement with Kingsbridge permits Kingsbridge to terminate the CEFF if Kingsbridge determines that a material and adverse event has occurred affecting the business, operations, properties or financial condition of our company, or if any situation occurs that would interfere with our ability to perform any of our obligations under the agreement. If we are unable to draw down on the CEFF, and are otherwise unable to obtain capital from other sources on a timely basis or on terms favorable to us, we may be required to scale back our marketing and research and development efforts, sell or license some or all of our technology or assets or curtail or cease operations.

26

Each advance under the CEFF is limited. We may not draw down on the CEFF when Kingsbridge beneficially owns in excess of 9.9% of our outstanding shares. The potential unavailability of this facility would negatively affect our financing activities.

Each draw down election we make is limited to a maximum of 3% of our market capitalization at the time of the election, and cannot in any case exceed $10 million. We must also wait at least five trading days after the end of a fifteen trading day draw down period before we can commence the next draw down. In addition, the CEFF limits the beneficial ownership of Kingsbridge to 9.9% of our outstanding common stock, which percentage includes any shares of common stock purchased pursuant to the CEFF, that we may issue as liquidated damages, and issued upon exercise of the warrant. Depending on the market price of our common stock and Kingsbridge’s other holdings of our common stock, this restriction may limit the maximum amount we can draw down under the CEFF. If Kingsbridge’s beneficial ownership were to exceed 9.9% of our outstanding common stock, together with the total amount of our common stock that would be outstanding upon completion of a draw down, we would not be able to draw down on the Committee Equity Facility until such time as Kingsbridge sells enough shares of our common stock or our number of shares of common stock outstanding increases, which may not occur. Therefore, we may not be able to draw down on the full $25 million commitment.

Our sales of stock to Kingsbridge will be discounted to market price, so our stockholders will experience immediate dilution in the value of their shares if we sell shares to Kingsbridge under the CEFF.

The issuance of shares under the CEFF will have a dilutive impact on other stockholders, and the issuance or even potential issuance of such shares could have a negative effect on the market price of our common stock. In addition, if we draw down the CEFF, we will issue shares to Kingsbridge at a discount ranging from 8% to 12% of the daily volume weighted average prices of our common stock during the fifteen day trading period after initiation of each draw down. Issuing shares at such a discount will further dilute the interests of other stockholders. The 9.9% limitation on Kingsbridge’s beneficial ownership will not prevent Kingsbridge from selling some of its holdings and then receiving additional shares, such that the total number of shares that we may sell to Kingsbridge under the CEFF and it resells is greater than 9.9% of our outstanding stock.

There are a large number of shares underlying the CEFF that we are in the process of registering in a registration statement, and the sale of these shares may depress the price of our common stock.

To the extent that Kingsbridge sells shares of our common stock issued under the CEFF under an effective registration statement, our stock price may decrease due to the additional selling pressure in the market. The perceived risk of dilution from sales of stock to or by Kingsbridge may cause holders of our common stock to sell their shares, which could contribute to a decline in our stock price.

The sale of shares underlying the CEFF could encourage short sales by third parties, which could contribute to the future decline of our stock price.

A significant downward pressure on the price of our common stock caused by the sale of material amounts of common stock under the CEFF could encourage short sales by third parties. In a short sale, a prospective seller borrows stock from a stockholder or broker and sells the borrowed stock. The prospective seller hopes that the stock price will decline, at which time the seller can purchase shares at a lower price to repay the lender. The seller profits when the stock price declines because it is purchasing shares at a price lower than the sale price of the borrowed stock. Such sales could place downward pressure on the price of our common stock by increasing the number of shares being sold, which could contribute to the future decline of our stock price.

We cannot predict the actual number of shares that we will issue under the CEFF, in any particular draw down, or in total. The number of shares we will issue will fluctuate based on the market price of our stock over the fifteen trading days after we give a draw down notice for each draw down period.

The actual number of shares that we will issue under the CEFF in any particular draw down, and in total, is uncertain. Subject to the limitations in our agreement with Kingsbridge, we have the discretion to draw down funds at any time throughout the term of the CEFF, and we have not determined the amount of proceeds, if any, we will seek to raise through the CEFF. Also, the number of shares we must issue after giving a draw down notice will fluctuate based on the market price of our stock over the fifteen trading days after we give a draw down notice, and Kingsbridge will receive more shares if our stock price declines. Assuming the volume weighted average price of our common stock is $8.36 per share, which was the closing sale price reported on the NASDAQ SmallCap Market on April 15, 2005, and we elected to draw down a total of $10 million under the CEFF, we would issue 1,329,080 shares of common stock to Kingsbridge, representing 5.9% of our common stock outstanding as of April 15, 2005, after giving effect to the sale of such shares. Using the same assumptions and conditions but with elections by us to draw down the full $25 million under the CEFF, we would issue 3,322,700 shares of common stock to Kingsbridge, representing 13.5% of our common stock outstanding on April 15, 2005, after giving effect to the sale of such shares. During the one year period ended April 15, 2005, our stock price as reported on the NASDAQ SmallCap Market ranged from a high of $11.55 to a low of $4.38.

27

The above estimates of the number of shares to be sold assume that our stock price would remain constant during each fifteen trading day draw down period, and across all draw down periods. This assumption is not realistic, particularly since during each fifteen trading day draw down period, Kingsbridge is permitted to sell the shares to be issued with respect to each trading day once the discount purchase price for such day (and therefore the number of shares to be purchased for such day) is determined. These permitted sales during a draw down period may cause the volume weighted average price of our common stock to decline on immediately subsequent days, resulting in the sale of additional shares to Kingsbridge on immediately subsequent days for the same monetary proceeds to us. The further sale of shares priced on those immediately subsequent days could then cause further price declines on later days, resulting in the sale of increasing numbers of shares for the same monetary proceeds as the draw down period progresses.

Furthermore, Kingsbridge’s 9.9% beneficial ownership limitation is determined on, and based on the amount of our common stock outstanding on, each settlement date. As the number of shares outstanding on each settlement date increases, Kingsbridge may be required to purchase more shares of our common stock during a draw down period than would have been apparent on the date that we sent the draw down notice to Kingsbridge.

We may issue additional common stock in the future, including shares under our CEFF, and this stock may reduce the value of your common stock.  

As a result of the CEFF or other financings, we may issue additional shares of common stock without further action by our stockholders. Moreover, the economic and voting interests of each stockholder will be diluted as a result of such issuances. Although the number of shares of common stock that stockholders presently own will not decrease, such shares will represent a smaller percentage of our total shares that will be outstanding after such events. If we satisfy the conditions that allow us to draw down the entire $25 million available under the CEFF, and we choose to do so, then generally, as the market price of our common stock decreases, the number of shares we will have to issue upon each draw down on the CEFF increases, to a maximum of 3,684,782 shares we may issue without stockholder approval. Drawing down on the CEFF when the price of our common stock is decreasing will have an additional dilutive effect to your ownership percentage and may result in additional downward pressure on the price of our common stock.

Sales of common stock issuable on the exercise of outstanding options and warrants, including the warrant held by Kingsbridge, may depress the price of our common stock.

As of April 15, 2005, there were options granted to our employees, directors and consultants to purchase 2,129,311 shares of our common stock. As of April 15, 2005, there were warrants granted to investors to purchase 2,308,234 shares of our common stock, including the warrant issued to Kingsbridge exercisable for 275,000 shares. The exercise prices for the options and warrants range from $2.00 to $11.00 per share. In the future we may issue additional convertible securities, options and warrants. The issuance of shares of common stock issuable upon the exercise of convertible securities, options or warrants could cause substantial dilution to holders of common stock, and the sale of those shares in the market could cause the market price of our common stock to decline. The potential dilution from these shares could negatively affect the terms on which we could obtain equity financing.

Our CEFF imposes certain liquidated damages which may impair our liquidity and ability to raise capital.  

The terms of the CEFF require us to pay liquidated damages in the event that a registration statement is not available for the resale of securities purchased by Kingsbridge under the CEFF. These liquidated damages provisions generally require us to pay an amount based on the decline in value, if any, of shares held by Kingsbridge during the time a registration statement is unavailable. The liquidated damages could severely affect our liquidity, or to the extent we are permitted to and decide to pay such damages through the issuance of common stock, cause significant dilution to our common stockholders.

28

We may not issue convertible securities with a floating or adjustable discount to the price of our common stock during the two year term of the Common Equity Financing Facility without the prior written consent of Kingsbridge, which consent we may not be able to obtain. These restrictions may affect our ability to raise capital.

During the two-year term of the proposed CEFF, without the prior written consent of Kingsbridge, we are prohibited from issuing securities that are, or may become, convertible or exchangeable into shares of common stock where the purchase, conversion or exchange price for such common stock is determined using a floating or otherwise adjustable discount to the market price of the common stock (including pursuant to an equity line or other financing that is substantially similar to an equity line with an investor other than Kingsbridge). In the past, we met our capital needs through the sale of preferred stock and convertible notes which had floating price features. We may have difficulty raising capital if Kingsbridge does not consent to our use of such securities in the future. If we are unable to raise capital from Kingsbridge or from sources that do not demand a floating price feature, we may have to severely curtail our operations, which could cause a significant decrease in the price of our common stock.

Our ability to draw down on the CEFF may be limited under the rules of the NASDAQ Stock Market.

Under the rules of the NASDAQ Stock Market, the approval of our stockholders is required for the sale of shares to Kingsbridge totaling more than 20% of our issued and outstanding shares at the time we entered into the agreement with Kingsbridge. If our average sale price to Kingsbridge is below $6.78 per share (equivalent to a volume weighted average price of $7.54 per share, assuming a 10% discount for all sales) and we elect to draw the full $25 million commitment, it would require that we issue more than 20% of our issued and outstanding shares at the time we entered into the agreement with Kingsbridge and we would need to seek stockholder approval to do so. The $6.78 average sale price mentioned above assumes that we have not issued Kingsbridge any shares in lieu of paying liquidated damages that may be owed to Kingsbridge in the event that the availability of its registration statement is suspended. If we issue shares to Kingsbridge in lieu of payment of liquidated damages, the average sale price (and the volume weighted average price) would need to be higher in order to elect to draw the full $25 million commitment without stockholder approval. If we are unable to obtain such stockholder approval, our ability to raise capital under the CEFF will be impaired. If we are unable to obtain capital from other sources on a timely basis or on terms favorable to us, we may be required to scale back our marketing and research and development efforts, sell or license some or all of our technology or assets or curtail or cease operations.

One customer accounted for approximately 93% of our revenues for the three months ended March 31, 2005, two customers accounted for 92% of our revenues for the six months ended March 31, 2005, and we continue to be dependent on a few large customers.

ADS, Inc., a prime vendor to the U. S. military, accounted for 93% of net revenues for the three months ended March 31, 2005. For the six months ended March 31, 2005, ADS accounted for 82% of our revenues and a second customer and its affiliates accounted for 10% of our revenues. These customers have the right to cease doing business with us at any time. If this were to occur and we could not replace them, our net revenues could decline substantially. Any such decline could result in us incurring net losses, increasing our accumulated deficit and causing us to need to raise additional capital to fund our operations.

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

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

• our ability to manufacture reliable products that have the features that are required by our customers; 

29

• our ability to expand relationships with existing customers and to develop relationships with new customers that will lead to additional orders for our products; 

• our ability to develop and expand new markets for directed sound products; and 

• our ability to develop international product distribution directly or through strategic partners.

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

Although our LRAD products are designed for use by both government and commercial customers, our LRAD products have, to date, been predominantly sold for government use. Within the Government Group, our largest customer is a reseller of our products to end users in various branches of the military such as the U.S. Navy, U.S. Marine Corps, U.S. Army and the Department of Homeland Security. We have only recently achieved significant sales of LRAD products, and the product has not yet been widely accepted in the government market. Furthermore, the force protection and emergency response market is itself an emerging market, which is changing rapidly. If our LRAD product is not widely accepted by the government, military and the developing force protection and emergency response markets, we may not be able to identify other markets, and we may fail to achieve our sales projections.

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

Potential customers for our LRAD products, including government, military and force protection and emergency response agencies may be influenced by claims or perceptions that long range hailing devices are unsafe or may be used in an abusive manner. These claims or perceptions could cause our product sales to decline. In addition, if these agencies have these perceptions, it will be difficult for us to grow our customer base beyond these markets. These factors could reduce future revenues, adversely affecting our financial condition and results of operations.

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

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

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

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

30

At March 31, 2005, we had a warranty reserve of $238,837. We recorded substantial warranty reserves for early versions of our HSS products and have little history to predict future warranty costs. Future warranty costs could further adversely affect our financial position, results of operations and business prospects.

We could incur charges for excess and obsolete inventory.

Due to rapidly changing technology and uneven customer demand, product cycles tend to be short and the value of our inventory may be adversely affected by changes in technology that affect our ability to sell the products in our inventory. Therefore, periodically, it may be necessary to write off inventory as excess or obsolete.

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

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

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

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

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

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

• unpredictable volume and timing of customer orders;

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

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

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

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

• unpredictable warranty costs associated with new product models;

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

• seasonal fluctuations in sales;

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

31

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

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

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

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

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

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

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

• the value of our stock price, which impacts the income or expense we record each quarter for the warrant issued to Kingsbridge; 

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

• investments and costs of maintaining or protecting our intellectual property;

• the extent of marketing and sales efforts to promote our products and technologies; and

• the timing of personnel and consultant hiring.

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

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

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

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

32

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

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

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

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

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

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

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

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

33

• obtain a license from the holder of the infringed intellectual property right, which license may not be available on reasonable terms, if at all; and

• redesign products or services that incorporate the disputed technology.

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

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

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

Our 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 customer or we may be required to comply with FDA requirements to remedy the defect and/or notify consumers of the problem. This could lead to unanticipated expense, and possible product liability litigation against a customer or us. Any regulatory impediment to full commercialization of our HSS technology, or any of our other technologies, could adversely affect our results of operations.

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

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

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

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

In the case of certain agreements involving equipment or services controlled under the International Traffic in Arms Regulations (ITAR) and sold at specified dollar volumes, the U.S. Department of State must notify Congress at least 15 to 30 days, depending on the intended overseas destination, prior to authorizing these sales. During that time, Congress may take action to block the proposed sale. Based on our current product lines, we do not anticipate the congressional notification requirement to have an immediate impact; however, as our product lines expand, this notification requirement could impact our ability to sell certain controlled products or services in the international market.

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

34

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

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

• changes in tariff regulations;

• political instability, war, terrorism and other political risks;

• foreign currency exchange rate fluctuations;

• establishing and maintaining relationships with local distributors and dealers;

• lengthy shipping times and accounts receivable payment cycles;

• import and export licensing requirements;

• compliance with a variety of foreign laws and regulations, including unexpected changes in taxation and regulatory requirements;

• greater difficulty in safeguarding intellectual property than in the U.S.; and

• difficulty in staffing and managing geographically diverse operations.

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

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

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

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 are dependent on third party manufacturers.  

We do not have the capacity to manufacture all of our products internally and we are therefore dependent on third party manufacturers. At present, we manufacture NeoPlanar and SoundCluster internally only in small quantities and would need to outsource our manufacturing if sales of these products were to increase significantly. In addition, we established a manufacturing relationship with Pemstar, Inc. in fiscal 2004 to manufacture our LRAD and HSS products. We do not have a formal written agreement with Pemstar. Pemstar, or any other contract manufacturing partner, may not be able or willing to manufacture products for us in the quantities and at the level of quality that we require. If we need to seek additional third party manufacturers for our products, we may not be able to obtain acceptable replacement manufacturing sources on a timely basis. An extended interruption in the supply of our products could result in a substantial loss of sales. In addition, any actual or perceived degradation of product quality as a result of our reliance on third party manufacturers may have an adverse effect on sales or result in increased product returns and buybacks. Failure to maintain quality contract manufacturing could reduce future revenues, adversely affecting financial condition and results of operations.

35

 We rely on outside suppliers to provide a large number of components incorporated in our products.

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

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

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

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

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

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

• be subject to purchasing decisions of agencies that are subject to political influence; 

• contain onerous procurement procedures; and  

• be subject to cancellation if government funding becomes unavailable.

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

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, including Elwood G. Norris, our Chairman, and Kalani Jones, our President and Chief Operating Officer. We are dependent on our ability to retain and motivate high quality personnel, especially highly skilled technical personnel. Our future success and growth also depends on our continuing ability to identify, hire, train and retain other highly qualified technical, managerial and sales personnel. Competition for such personnel is intense, and we may not be able to attract, 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 cause our business, operating results or financial condition to suffer.

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

36

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

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

• problems maintaining uniform standards, procedures, controls and policies; 

• unanticipated costs associated with the acquisition;

• diversion of management’s attention from our core business;

• adverse effects on existing business relationships with suppliers and customers;

• risks associated with entering new markets in which we have no or limited prior experience;

• potential loss of key employees of acquired businesses; and

• increased legal and accounting costs as a result of the newly adopted rules and regulations related to the Sarbanes-Oxley Act of 2002.

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

We are subject to increased costs as a result of newly adopted accounting and SEC regulations.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management will be required by the end of fiscal 2005 to perform an evaluation of our internal control over financial reporting and have our independent auditor attest to that evaluation. Compliance with these requirements is expected to be expensive and time consuming. If we fail to timely complete this evaluation, or if our independent registered public accounting firm cannot timely attest to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal control over financial reporting.

In designing and evaluating our internal control over financial reporting, we recognize that any internal control or procedure, no matter how well designed and operated, can provide only reasonable assurance of achieving desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. No system of internal control can be designed to provide absolute assurance of effectiveness and any material failure of internal control over financial reporting could materially impact our reported financial results and the market price of our stock could significantly decline. In addition, adverse publicity related to a material failure of internal control over financial reporting would have a negative impact on our reputation and business.

Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace.

Technology companies in general and our company in particular have a history of depending upon and using broad based employee stock option programs to hire, incentivize and retain employees in a competitive marketplace. Currently, we do not recognize compensation expense for stock options issued to employees or directors, except in limited cases involving modifications of stock options, and we instead disclose in the notes to our financial statements information about what such charges would be if they were expensed. An accounting standard setting body has recently adopted a new accounting standard that will require us to record equity-based compensation expense for stock options and employee stock purchase plan rights granted to employees based on the fair value of the equity instrument at the time of grant. We will be required to record these expenses beginning with our first quarter of fiscal 2006, which ends December 31, 2005. The change in accounting rules will lead to increased reported net loss or, should we become profitable, a decrease in reported earnings. This may negatively impact our future stock price. In addition, this change in accounting rules could impact our ability to utilize broad based employee stock plans to reward employees and could result in a competitive disadvantage to us in the employee marketplace.

37

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

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

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

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

• our anticipated or actual operating results;

• developments concerning our sound reproduction technologies;

• technological innovations or setbacks by us or our competitors;

• conditions in the consumer electronics market;

• announcements of merger or acquisition transactions;

• changes in personnel within our company; and

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

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

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 flows due to adverse changes in market prices, including interest rate risk and other relevant market rate or price risks. We do not use derivative financial instruments in our investment portfolio.

We are exposed to market risk associated with our issuance of a warrant to Kingsbridge Capital Limited for 275,000 shares. Because this warrant is classified as a liability on our balance sheet, we must calculate the fair value of the warrant at the end of each quarter and record the change in fair value over the quarter to other income or expense until the related registration statement is effective, until the warrant is fully exercised, or until the expiration of the warrant in June 2010. Accordingly, we are incurring risk associated with increases or decreases in the market price of our stock, which will directly impact the fair value calculation and the non-cash charge or credit recorded to our statement of operations for future quarters. For example, if our stock price increases by 20% during the quarter ending June 30, 2005 from its March 31, 2005 value, the registration statement is not effective and all other inputs into the Black-Scholes valuation model remain unchanged from March 31, 2005, we would record approximately $353,516 of other expense for the period ended June 30, 2005. If our stock price decreased by 20% during the quarter ending June 30, 2005 from its March 31, 2005 value, and all other inputs into the Black-Scholes valuation model remain unchanged from March 31, 2005, we would record approximately $330,763 as other income.

We are also exposed to some market risk through interest rates, related to our investment of current cash and cash equivalents of approximately $6.2 million. Based on this balance, a change of one percent in interest rate would cause a change in interest income of $62,000. The risk is not considered material and we manage such risk by continuing to evaluate the best investment rates available for short-term high quality investments.

38

Item 4. Controls and Procedures.

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

(a)

As of the end of the period covered by this report, we carried out an evaluation under the supervision and with the participation of management, including our co-principal executive officers and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our co-principal executive officers and principal financial officer concluded, as of the date of such evaluation, that the design and operation of such disclosure controls and procedures were effective, as of March 31, 2005.

(b)

Except as set forth below, no significant changes were made in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. As a result of a notification from our independent registered accounting firm to our Audit Committee that we had not followed all appropriate period close down procedures for our quarter ended December 31, 2004, referencing deficient procedures for evaluation of the accrual for bonuses for which executives were eligible, we have rectified this significant deficiency by accelerating the timing of the Compensation Committee's assessment for executive bonuses earned in the period.

Limitations. Our management, including our co-principal executive officers and principal financial officer, does not expect that our disclosure control or internal controls over financial reporting will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of control is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitation of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

39

PART II. OTHER INFORMATION

Item 1.  Legal Proceedings.

Reference is made to Note 13 of our Notes to Interim Financial Statements included in Part I, Item 1 of this report for information regarding Legal Proceedings.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3.  Defaults Upon Senior Securities.

Not applicable.

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

Not applicable.

Item 5.  Other Information.

On May 9, 2005, Carl Gruenler, Vice President, Government and Force Protection Systems Group, left our company. Mr. Gruenler had been employed under the terms of a letter agreement amended on July 30, 2003. The letter agreement provided for an annual base salary of $110,000, and an annual performance bonus of up to 10% of base salary to be determined by the Compensation Committee and the Board of Directors. Mr. Gruenler's annual base salary at the time of separation was $250,000, and he participated in our broad-based commission plan in lieu of the annual performance bonus contemplated by his letter agreement. Mr. Gruenler's employment was terminable at-will by us or by Mr. Gruenler for any reason, with or without notice. Our employment arrangement with Mr. Gruenler was terminated in conjunction with his departure.

The foregoing disclosure is made in lieu of disclosure under Item 1.02 on Form 8-K.

Item 6. Exhibits

10.1	Table of Inducement Grants.
10.2	Offer Letter for Bruce Gray. +
10.3	Inducement Stock Option Grant Notice and Inducement Stock Option Agreement for Bruce Gray dated March 22, 2005. +
10.4	Summary Sheet of Director and Executive Officer Compensation. +
31.1	Certification of Elwood G. Norris, Co-Principal Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Kalani Jones, Co-Principal Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.3	Certification of Michael A. Russell, Principal Financial Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Elwood G. Norris and Kalani Jones, Co-Principal Executive Officers, and Michael A. Russell, Principal Financial Officer.
+ Management contract or compensatory plan or arrangement.

40

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
	By:	/S/ MICHAEL A. RUSSELL
Date: May 10, 2005		Michael A. Russell, Chief Financial Officer (Principal Financial and Accounting Officer and duly authorized to sign on behalf of the Registrant)

41

Exhibit Index  

10.1	Table of Inducement Grants.
10.2	Offer Letter for Bruce Gray. +
10.3	Inducement Stock Option Grant Notice and Inducement Stock Option Agreement for Bruce Gray dated March 22, 2005. +
10.4	Summary Sheet of Director and Executive Officer Compensation. +
31.1	Certification of Elwood G. Norris, Co-Principal Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Kalani Jones, Co-Principal Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.3	Certification of Michael A. Russell, Principal Financial Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Elwood G. Norris and Kalani Jones, Co-Principal Executive Officers, and Michael A. Russell, Principal Financial Officer.
+ Management contract or compensatory plan or arrangement.

42

EX-10.1

EXHIBIT 10.1

Table of Inducement Stock Option Grants

          From time to time, as an inducement to employment, the registrant has granted to certain of its employees that are not executive officers non-qualified stock options in accordance with individual compensation arrangements that have not been approved by the registrant’s security holders (collectively, the “Inducement Options”). All Inducement Options are documented pursuant to the form of Inducement Grant Notice and Inducement Stock Option Agreement filed as Exhibit 4.1 to the registrant’s Form 8-K filed on September 28, 2004.

          The table set forth below lists the Inducement Options granted by the registrant to certain of its employees that are not executive officers, and the principal terms thereof. Each of the following options is a non-statutory option, has a five year term and vests 25% on the first anniversary of the grant date and then quarterly thereafter for the next 12 quarters, subject to continued employment and other conditions.

Date of Grant	Shares Underlying Option	Exercise Price
9/21/04	3,500	$6.14
9/21/04	15,000	$6.14
9/21/04	1,000	$6.14
9/21/04	10,000	$6.14
9/21/04	17,500	$6.14
10/26/04	2,500	$6.21
10/26/04	12,500	$6.21
10/26/04	5,000	$6.21
11/16/04	1,500	$6.70
11/16/04	2,500	$6.70
12/22/04	6,000	$10.06
12/22/04	18,000	$10.06
12/22/04	20,000	$10.06
12/22/04	5,000	$10.06
12/22/04	2,500	$10.06
12/22/04	25,000	$10.06
1/25/05	20,000	$9.48
1/25/05	2,000	$9.48
1/25/05	8,000	$9.48
1/25/05	15,000	$9.48
1/25/05	12,000	$9.48
3/16/05	12,000	$8.40
3/16/05	12,000	$8.40

EX-10.2

EXHIBIT 10.2

March 15, 2005

Bruce Gray
11477 Winding Ridge
San Diego, CA 92131

Dear Bruce,

American Technology Corporation (“Company”) is very pleased to confirm our offer of employment. This offer is contingent upon satisfactory results of all reference, education, and background checks and is based on the following terms and conditions:

Title: Vice President of the Business Group.

Start Date: We have an anticipated your start date as Monday, March 21, 2005

Salary: Your starting salary as an exempt employee will be $7,692.31 gross bi-weekly which is an annual wage of $200,000.00.

Sales Bonus: You will be eligible for an annual sales bonus up to $100,000.00. The bonus will be based on the Business Group  attaining quarterly and annual goals. The detailed quarterly and annual goals will be created jointly by you and Kalani Jones by April 30, 2005. This bonus is payable on a quarterly basis and will be paid on the second pay period of the month following the end of the commission quarter

Stock Options: Management will recommend to the Board of Directors, that, as an inducement material to you entering into employment with the Company, you be granted stock options to purchase 100,000 shares of common stock.  The grant will occur at the first meeting of the Board of Directors held after your start date, or by unanimous written consent. The recommended options will have an exercise price equal to the fair market value of our common stock on the date the Board of Directors approves the grant.  The recommended options will be exercisable for five (5) years after grant, subject to earlier termination upon termination of your continuous service.  The recommended options will vest over four (4) years, with one fourth (1/4) of the shares vesting twelve (12) months after grant date, and the balance vesting in equal quarterly installments through and including the fourth anniversary of the grant date.  These recommended options will be issued outside of the 2002 Stock Option Plan, and accordingly will be non-statutory stock options and will not qualify for incentive stock option (ISO) treatment under the Internal Revenue Code.

-1-

Health Benefits: The Company offers a comprehensive benefits plan that includes medical, dental, vision, short-term disability, long-term disability and life insurances. The company pays for 100% of all health benefit premiums, including dependents and you can elect HMO or PPO medical coverage. You may pay for any qualified out-of-pocket expense on a pre-tax basis through a Section 125 plan. Benefits begin the first day of the month following your hire date.

Paid Time Off & Holidays: You will receive 15 days of accrued Paid Time Off (PTO) annually, in use for vacation or for personal time off. PTO hours are accrued per pay period. Any hours in excess of 200 will be paid out in the first pay period of December. In the event of short-term illness, you will be provided time to convalesce at home and will be paid your regular salary for this time. Sick time is not accrued but rather is taken as needed.

The Company offers 9-paid holidays each calendar year. You must be on active status the day before and the day after the holiday to receive holiday pay.

Retirement: A 401k package is available with multiple investment options and the company matches 25% of the employee’s deferral up to 6% of your annual earnings. (Note: Some IRS limitations may apply.)

Arbitration: As a contingency of this offer, you will be required to sign the attached Mutual Agreement to Arbitrate (“Arbitration Agreement”).

Due to the enactment of the Immigration Reform and Control Act of 1986, this offer is contingent on your ability to produce acceptable documentation verifying your eligibility to work in the United States. You will be required to present the necessary documents on the day you begin work at American Technology Corp.

Additionally, as a condition of this offer and of your employment with American Technology Corp., you will be required to preserve the Company’s proprietary and confidential information and you must comply with the Company’s policies and procedures. Accordingly, you will be required to execute the Company’s Non-Disclosure Agreement on your first date of employment.

If accepted, your employment will be at-will with no specified period or term of employment. This means that either you or the Company may terminate employment at anytime, with or without reason. The Company may also transfer, promote, demote or otherwise alter your position and/or status at any time and for any reason. An employment agreement for a specified period of time, which contradicts this at-will agreement, may only be entered into in writing, signed by the President of the Corporation.

-2-

We sincerely hope that you decide to join American Technology Corp. Please acknowledge your acceptance of our offer by signing below and returning a copy of this letter to us not later than close of business Friday, March 18, 2005. If we do not receive your response by close of business March 18, 2005 this offer will be withdrawn.

If there are any questions, please do not hesitate to call me.

Sincerely,

/s/ Kalani Jones

Kalani Jones
President/COO

I understand and agree to the terms and conditions set forth in this letter. I further understand that any misrepresentations that I have made on my employment application or resume can result in termination. I acknowledge that no statement contradicting this letter, oral or written, has been made to me, that I am not relying on any statement or term not contained in this letter, and that no agreements exist which are contrary to the terms and conditions set forth in this letter.

Accepted by: /s/ Bruce Gray Date: March 18, 2005

-3-

EX-10.3

EXHIBIT 10.3

AMERICAN TECHNOLOGY CORPORATION
INDUCEMENT STOCK OPTION GRANT NOTICE

          AMERICAN TECHNOLOGY CORPORATION (the “Company”) hereby grants to the Optionee named below, an employee of the Company, as an inducement material to the Optionee’s entering into employment with the Company, a stock option to purchase the number of shares of the Company’s common stock set forth below. This option is subject to all of the terms and conditions as set forth herein and the Stock Option Agreement (attached hereto), which is incorporated herein in its entirety.

Optionee:	Bruce Gray
Grant No:	I-
Date of Grant:	03/22/05
Shares Subject to Option:	100,000
Exercise Price Per Share:	$8.90
Expiration Date:	03/22/2010
Intended to be Incentive Stock Option:	No

VESTING SCHEDULE:
Vesting Start Date
03/22/05
Vesting Schedule
Subject to continuing Service (as defined in the Stock Option Agreement) this option becomes exercisable with respect to 1/4^th of the Shares Subject to Option on the one-year anniversary of the Vesting Start Date, which is defined as the date on which the option is granted. Thereafter, subject to continuing Service, this option becomes exercisable with respect to an additional 1/16^th of the Shares Subject to Option on each subsequent three-month anniversary of the Vesting Start Date, for a total of 4 years when this option is fully vested.

ADDITIONAL TERMS/ACKNOWLEDGMENTS: The undersigned Optionee acknowledges receipt of, and represents that the Optionee has read, understands, accepts and agrees to the terms of this Grant Notice and the Stock Option Agreement. Optionee hereby accepts the Option subject to all of its terms and conditions and further acknowledges that as of the Date of Grant, this Grant Notice and the Stock Option Agreement set forth the entire understanding between Optionee and the Company regarding the acquisition of stock in the Company and supersede all prior oral and written agreements pertaining to this particular option.

NOTE: THE OPTIONEE IS SOLELY RESPONSIBLE FOR ANY ELECTION TO EXERCISE THE OPTION, AND THE COMPANY SHALL HAVE NO OBLIGATION WHATSOEVER TO PROVIDE NOTICE TO THE OPTIONEE OF ANY MATTER, INCLUDING, BUT NOT LIMITED TO, THE DATE THE OPTION TERMINATES.

AMERICAN TECHNOLOGY CORPORATION:


By:   /s/ Kalani Jones  
      Name: Kalani Jones, President/COO
      Dated: April 1, 2005 OPTIONEE:


By:   /s/ Bruce Gray  

Date:   April 1, 2005  

-1-

AMERICAN TECHNOLOGY CORPORATION
INDUCEMENT STOCK OPTION AGREEMENT

Pursuant to the Grant Notice and this Stock Option Agreement (“Agreement”), American Technology Corporation (the “Company”) has granted to the Optionee named in the Grant Notice (“you” or the “Optionee”) an Option to purchase the number of shares of the Company’s common stock (“Stock”) indicated in the Grant Notice at the exercise price indicated in the Grant Notice.

          The details of this Option are as follows:

          1.    Definitions And Construction.

                   1.1   Definitions. Whenever used herein, the following terms shall have their respective meanings set forth below:

                             (a)    “Affiliate” means (i) an entity, other than a Parent Corporation, that directly, or indirectly through one or more intermediary entities, controls the Company or (ii) an entity, other than a Subsidiary Corporation, that is controlled by the Company directly, or indirectly through one or more intermediary entities, or (iii) an entity which the Board designates as an Affiliate. For this purpose, the term “control” (including the term “controlled by”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of the relevant entity, whether through the ownership of voting securities, by contract or otherwise; or shall have such other meaning assigned such term for the purposes of registration on Form S-8 under the Securities Act.

                             (b)    “Board” means the Board of Directors of the Company. If one or more Committees have been appointed by the Board to administer outstanding stock options, “Board” also means such Committee(s).

                             (c)    A “Change In Control” shall mean an Ownership Change Event or a series of related Ownership Change Events (collectively, a “Transaction”) wherein the stockholders of the Company immediately before the Transaction do not retain immediately after the Transaction, in substantially the same proportions as their ownership of shares of the Company’s voting stock immediately before the Transaction, direct or indirect beneficial ownership of more than fifty percent (50%) of the total combined voting power of the outstanding voting securities of the Company or, in the case of a Transaction described in Section 1.1(q)(iii), the corporation or other business entity to which the assets of the Company were transferred (the “Transferee”), as the case may be. The Board shall determine in its discretion whether multiple sales or exchanges of the voting securities of the Company or multiple Ownership Change Events are related. Notwithstanding the preceding sentence, a Change in Control shall not include a Spinoff Transaction.

                             (d)    “Code” means the Internal Revenue Code of 1986, as amended, and any applicable regulations promulgated thereunder.

                             (e)    “Committee” means the Compensation Committee or other committee of the Board duly appointed to administer this Agreement and having such powers as shall be specified by the Board. Unless the powers of the Committee have been specifically limited, the Committee shall have all of the powers of the Board granted herein.

-2-

                             (f)    “Company” means American Technology Corporation, a Delaware corporation, or any Successor.

                             (g)    “Consultant” means a person engaged to provide consulting or advisory services (other than as an Employee or a Director) to a Participating Company.

                             (h)    “Director” means a member of the Board or of the board of directors of any other Participating Company.

                             (i)    “Disability” means the Optionee has been determined by the long-term disability insurer of the Participating Company Group as eligible for disability benefits under the long-term disability plan of the Participating Company Group or the Optionee has been determined eligible for Supplemental Security Income benefits by the Social Security Administration of the United States of America.

                             (j)    “Employee” means any person treated as an employee (including an Officer or a Director who is also treated as an employee) in the records of a Participating Company. The Company shall determine in good faith and in the exercise of its discretion whether the Optionee has become or has ceased to be an Employee and the effective date of the Optionee’s employment or termination of employment, as the case may be.

                             (k)    “Exchange Act” means the Securities Exchange Act of 1934, as amended.

                             (l)    “Fair Market Value” means, as of any date, the value of the Stock determined as follows:

                                       (i)    If the Stock is listed on any established stock exchange or traded on the Nasdaq Stock Market or the Nasdaq SmallCap Market, the Fair Market Value of a share of Stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or market (or if the stock is traded on more than one exchange or market, the exchange or market with the greatest volume of trading in the Stock) on the last market trading day prior to the day of determination, as reported in The Wall Street Journal or such other source as the Board deems reliable.

                                       (ii)    If the common stock is quoted by a recognized securities dealer but selling prices are not reported, the Fair Market Value of a share of common stock shall be the mean between the bid and asked prices for the common stock on the last market trading day prior to the day of determination, as reported in the Wall Street Journal or such other source as the Board deems reliable.

                                       (iii)    In the absence of such markets for the Stock, the Fair Market Value shall be determined in good faith by the Board.

-3-

                             (m)    “Incentive Stock Option” means an Option intended to be (as set forth in the Option Agreement) and which qualifies as an incentive stock option within the meaning of Section 422(b) of the Code.

                             (n)    “Insider” means an Officer, a Director of the Company or other person whose transactions in Stock are subject to Section 16 of the Exchange Act.

                             (o)    “Non-Control Affiliate” means any entity in which any Participating Company has an ownership interest and which the Board shall designate as a Non-Control Affiliate.

                             (p)    “Officer” means any person designated by the Board as an officer of the Company.

                             (q)    An “Ownership Change Event” shall be deemed to have occurred if any of the following occurs with respect to the Company: (i) the direct or indirect sale or exchange in a single or series of related transactions by the stockholders of the Company of more than fifty percent (50%) of the voting stock of the Company; (ii) a merger or consolidation in which the Company is a party; (iii) the sale, exchange, or transfer of all or substantially all, as determined by the Board in its discretion, of the assets of the Company; or (iv) a liquidation or dissolution of the Company.

                             (r)    “Parent Corporation” means any present or future “parent corporation” of the Company, as defined in Section 424(e) of the Code.

                             (s)    “Participating Company” means the Company or any Parent Corporation or Subsidiary Corporation or Affiliate.

                             (t)    “Participating Company Group” means, at any point in time, all entities collectively which are then Participating Companies.

                             (u)    “Rule 16b-3” means Rule 16b-3 under the Exchange Act, as amended from time to time, or any successor rule or regulation.

                             (v)    “Securities Act” means the Securities Act of 1933, as amended.

                             (w)    “Service” means

                                       (i)    the Optionee’s employment or service with the Participating Company Group, whether in the capacity of an Employee, a Director or a Consultant. The Optionee’s Service shall not be deemed to have terminated merely because of a change in the capacity in which the Optionee renders Service to the Participating Company Group or a change in the Participating Company for which the Optionee renders such Service, provided that there is no interruption or termination of the Optionee’s Service. Furthermore, only to such extent as may be provided by the Company’s leave policy, the Optionee’s Service with the Participating Company Group shall not be deemed to have terminated if the Optionee takes any military leave, sick leave, or other leave of absence approved by the Company. Notwithstanding the foregoing, a leave of absence shall be treated as Service for purposes of vesting only to such extent as may be provided by the Company’s leave policy. The Optionee’s Service shall be deemed to have terminated either upon an actual termination of Service or upon the entity for which the Optionee performs Service ceasing to be a Participating Company; except that if the entity for which Optionee performs Service is a Subsidiary Corporation and ceases to be a Participating Company as a result of the distribution of the voting stock of such Subsidiary Corporation to the stockholders of the Company, Service shall not be deemed to have terminated as a result of such distribution. Subject to the foregoing, the Company, in its discretion, shall determine whether the Optionee’s Service has terminated and the effective date of such termination.

-4-

                                       (ii)    Notwithstanding any other provision of this Section, an Optionee’s Service shall not be deemed to have terminated merely because the Participating Company for which the Optionee renders Service ceases to be a member of the Participating Company Group by reason of a Spinoff Transaction, nor shall Service be deemed to have terminated upon resumption of Service from the Spinoff Company to a Participating Company. For all purposes under this Agreement, the Optionee’s Service shall include Service, whether in the capacity of an Employee, Director or a Consultant, for the Spinoff Company provided the Optionee was employed by the Participating Company Group immediately prior to the Spinoff Transaction. Notwithstanding the foregoing, if the Company’s auditors determine that the provisions or operation of the preceding two sentences would cause the Company to incur a compensation expense and provided further that in the absence of the preceding two sentences no such compensation expense would be incurred, then the two preceding sentences shall be without force or effect, and the vesting and exercisability of each outstanding Option and any shares acquired upon the exercise thereof shall be determined under any other applicable provision of this Agreement.

                             (x)    “Spinoff Company” means a Participating Company which ceases to be such as a result of a Spinoff Transaction.

                             (y)    “Spinoff Transaction” means a transaction in which the voting stock of an entity in the Participating Company Group is distributed to the shareholders of a parent corporation as defined by Section 424(e) of the Code, of such entity.

                             (z)    “Stock” means the common stock of the Company, as adjusted from time to time in accordance with Section 4.2.

                             (aa)    “Subsidiary Corporation” means any present or future “subsidiary corporation” of the Company, as defined in Section 424(f) of the Code.

                             (bb)    “Successor” means a corporation into or with which the Company is merged or consolidated or which acquires all or substantially all of the assets of the Company and which is designated by the Board as a Successor for purposes of this Agreement.

                   1.2    Construction. Captions and titles contained herein are for convenience only and shall not affect the meaning or interpretation of any provision of this Agreement. Except when otherwise indicated by the context, the singular shall include the plural and the plural shall include the singular. Use of the term “or” is not intended to be exclusive, unless the context clearly requires otherwise.

-5-

          2.    VESTING. Except as otherwise provided in this Agreement, this option will vest as provided in the Grant Notice.

          3.    Exercise Of The Option.

                   3.1    Method Of Exercise. You may exercise the vested portion of this Option at any time prior to the expiration of the Option by delivering a notice of exercise in such form as may be designated by the Company from time to time together with the exercise price to the Secretary of the Company, or to such other person as the Company may designate, during regular business hours and prior to the expiration of the Option, together with such additional documents as the Company may then require.

                   3.2    Method Of Payment. Payment of the exercise price may be by cash (or check), or pursuant to a program developed under Regulation T as promulgated by the Federal Reserve Board which, prior to the issuance of Stock, results in either the receipt of cash (or check) by the Company or the receipt of irrevocable instructions to a broker which provides for the payment of the aggregate exercise price to the Company, or a combination of the above methods, as the Company may designate from time to time. The Company reserves, at any and all times, the right, in the Company’s sole and absolute discretion, to establish, decline to approve or terminate any program or procedures for the exercise of Options by means of a Cashless Exercise.

                   3.3    Tax Withholding. By exercising this Option you agree that as a condition to any exercise of this Option, the Company may withhold from your pay and any other amounts payable to you, or require you to enter an arrangement providing for the payment by you to the Company of any tax withholding obligation of the Company arising by reason of (1) the exercise of this Option; or (2) the disposition of Stock acquired upon such exercise.

                   3.4    Responsibility For Exercise. You are responsible for taking any and all actions as may be required to exercise this Option in a timely manner and for properly executing any such documents as may be required for exercise in accordance with such rules and procedures as may be established from time to time. By signing this Agreement you acknowledge that information regarding the procedures and requirements for this exercise of the Option is available to you on request. The Company shall have no duty or obligation to notify you of the expiration date of this Option.

          4.    Securities Law Compliance. Notwithstanding anything to the contrary contained herein, this Option may not be exercised unless the Stock issuable upon exercise of this Option is then registered under the Securities Act or, if such Stock is not then so registered, the Company has determined that such exercise and issuance would be exempt from the registration requirements of the Securities Act.

          5.    Termination Of The Option. The term of this Option commences on the Date of Grant (as specified in the Grant Notice) and expires and shall no longer be exercisable upon the earliest of:

                   5.1    the Expiration Date indicated in the Grant Notice;

-6-

                   5.2    the last day for exercising the Option following termination of your Service as described in Section 6 below; or

                   5.3    a Change of Control, to the extent provided in Section 7 below.

          6.    Effect Of Termination Of Service.

                   6.1    Option Exercisability. Subject to earlier termination of the Option as otherwise provided herein, the Option shall be exercisable after the Optionee’s termination of Service only during the applicable time period determined in accordance with this Section 6 and thereafter shall terminate.

                             (a)    Disability. If the Optionee’s Service terminates because of the Disability of the Optionee, the Option shall continue for the period of such Disability and may be exercised by the Optionee at any time during the period of Disability but in any event no later than the Expiration Date.

                             (b)    Death. If the Optionee’s Service terminates because of the death or because of the Disability of the Optionee and such termination is subsequently followed by the death of the Optionee, (A) the exercisability and vesting of the Option shall be accelerated effective upon the Optionee’s death, and (B) the Option, to the extent unexercised and exercisable on the date of the Optionee’s death, may be exercised by the Optionee’s legal representative or other person who acquired the right to exercise the Option by reason of the Optionee’s death at any time prior to the expiration of twelve (12) months after the date of the Optionee’s death, but in any event no later than the Expiration Date.

                             (c)    Termination Upon Transfer To Non-Control Affiliate. If at the request of the Company, the Optionee transfers Service to a Non-Control Affiliate and the Optionee’s Service ceases as a result, then, subject to the Optionee’s execution of a general release of claims form reasonably satisfactory to the Company, the Option, to the extent unexercised and exercisable on the date on which the Optionee’s Service terminated, may be exercised by the Optionee (or the Optionee’s guardian or legal representative) at any time prior to the expiration of twelve (12) months after the date on which the Optionee’s Service terminated, but in any event no later than the Expiration Date.

                             (d)    Termination After Change In Control. If the Optionee’s Service ceases as a result of Termination After Change in Control (as defined below), then (A) the exercisability and vesting of the Option shall be accelerated effective as of the date on which the Optionee’s Service terminated, and (B) the Option, to the extent unexercised and exercisable on the date on which the Optionee’s Service terminated, may be exercised by the Optionee (or the Optionee’s guardian or legal representative) at any time prior to the expiration of six (6) months after the date on which the Optionee’s Service terminated, but in any event no later than the Expiration Date.

                             (e)    Other Termination Of Service. If the Optionee’s Service with the Participating Company Group terminates for any reason except Disability, death, Transfer to a Non-Control Affiliate, or Termination after Change in Control, the Option, to the extent unexercised and exercisable by the Optionee on the date on which the Optionee’s Service terminates, may be exercised by the Optionee at any time prior to the expiration of thirty (30) days after the date on which the Optionee’s Service terminates, but in any event no later than the Expiration Date.

-7-

                   6.2    Extension If Exercise Prevented By Law. Notwithstanding the foregoing, other than termination for Cause, if the exercise of an Option within the applicable time periods set forth in Section 6.1 is prevented by the provisions of Section 4 above, the Option shall remain exercisable until three (3) months after the date the Optionee is notified by the Company that the Option is exercisable, but in any event no later than the Expiration Date.

                   6.3    Extension If Optionee Subject To Section 16(b). Notwithstanding the foregoing, other than termination for Cause, if a sale within the applicable time periods set forth in Section 6.1 of shares acquired upon the exercise of the Option would subject the Optionee to suit under Section 16(b) of the Exchange Act, the Option shall remain exercisable until the earliest to occur of (i) the tenth (10th) day following the date on which a sale of such shares by the Optionee would no longer be subject to such suit, (ii) the one hundred and ninetieth (190th) day after the Optionee’s termination of Service, or (iii) the Expiration Date.

                   6.4    Certain Definitions.

                             (a)    “Cause” shall mean any of the following: (1) the Optionee’s theft, dishonesty, or falsification of any Participating Company documents or records; (2) the Optionee’s improper use or disclosure of a Participating Company’s confidential or proprietary information; (3) any action by the Optionee which has a detrimental effect on a Participating Company’s reputation or business; (4) the Optionee’s failure or inability to perform any reasonable assigned duties after written notice from a Participating Company of, and a reasonable opportunity to cure, such failure or inability; (5) any material breach by the Optionee of any employment or service agreement between the Optionee and a Participating Company, which breach is not cured pursuant to the terms of such agreement; (6) the Optionee’s conviction (including any plea of guilty or nolo contendere) of any criminal act which impairs the Optionee’s ability to perform his duties with a Participating Company; or (7) violation of a material Company policy.

                             (b)    “Good Reason” shall mean any one or more of the following:

                                       (i)    without the Optionee’s express written consent, the assignment to the Optionee of any duties, or any limitation of the Optionee’s responsibilities, substantially inconsistent with the Optionee’s positions, duties, responsibilities and status with the Participating Company Group immediately prior to the date of the Change in Control;

                                       (ii)    without the Optionee’s express written consent, the relocation of the principal place of the Optionee’s employment or service to a location that is more than fifty (50) miles from the Optionee’s principal place of employment or service immediately prior to the date of the Change in Control, or the imposition of travel requirements substantially more demanding of the Optionee than such travel requirements existing immediately prior to the date of the Change in Control;

-8-

                                       (iii)    any failure by the Participating Company Group to pay, or any material reduction by the Participating Company Group of, (A) the Optionee’s base salary in effect immediately prior to the date of the Change in Control (unless reductions comparable in amount and duration are concurrently made for all other employees of the Participating Company Group with responsibilities, organizational level and title comparable to the Optionee’s), or (B) the Optionee’s bonus compensation, if any, in effect immediately prior to the date of the Change in Control (subject to applicable performance requirements with respect to the actual amount of bonus compensation earned by the Optionee);

                                       (iv)    any failure by the Participating Company Group to (A) continue to provide the Optionee with the opportunity to participate, on terms no less favorable than those in effect for the benefit of any employee or service provider group which customarily includes a person holding the employment or service provider position or a comparable position with the Participating Company Group then held by the Optionee, in any benefit or compensation plans and programs, including, but not limited to, the Participating Company Group’s life, disability, health, dental, medical, savings, profit sharing, stock purchase and retirement plans, if any, in which the Optionee was participating immediately prior to the date of the Change in Control, or their equivalent, or (B) provide the Optionee with all other fringe benefits (or their equivalent) from time to time in effect for the benefit of any employee group which customarily includes a person holding the employment or service provider position or a comparable position with the Participating Company Group then held by the Optionee;

                                       (v)    any breach by the Participating Company Group of any material agreement between the Optionee and a Participating Company concerning Optionee’s employment; or

                                       (vi)    any failure by the Company to obtain the assumption of any material agreement between the Optionee and the Company concerning the Optionee’s employment by a successor or assign of the Company.

                             (c)    “Termination After Change In Control” shall mean either of the following events occurring within twenty-four (24) months after a Change in Control:

                                       (i)    termination by the Participating Company Group of the Optionee’s Service with the Participating Company Group for any reason other than for Cause; or

                                       (ii)    the Optionee’s resignation for Good Reason from all capacities in which the Optionee is then rendering Service to the Participating Company Group within a reasonable period of time following the event constituting Good Reason.

Notwithstanding any provision herein to the contrary, Termination After Change in Control shall not include any termination of the Optionee’s Service with the Participating Company Group which (1) is for Cause; (2) is a result of the Optionee’s death or Disability; (3) is a result of the Optionee’s voluntary termination of Service other than for Good Reason; or (4) occurs prior to the effectiveness of a Change in Control.

-9-

          7.    Change In Control. In the event of a Change in Control, the surviving, continuing, successor, or purchasing corporation or other business entity or parent thereof, as the case may be (the “Acquiring Corporation”), may, without the consent of the Optionee, either assume the Company’s rights and obligations the Option or substitute for the Option substantially equivalent options for the Acquiring Corporation’s stock. In the event the Acquiring Corporation elects not to assume or substitute for the Option in connection with a Change in Control, the exercisability and vesting of the Option shall be accelerated, effective as of the date ten (10) days prior to the date of the Change in Control. The exercise or vesting of this Option that was permissible solely by reason of this Section shall be conditioned upon the consummation of the Change in Control. To the extent this Option is neither assumed or substituted for by the Acquiring Corporation in connection with the Change in Control nor exercised as of the date of the Change in Control, it shall terminate and cease to be outstanding effective as of the date of the Change in Control. Notwithstanding the foregoing, shares acquired upon exercise of the Option prior to the Change in Control and any consideration received pursuant to the Change in Control with respect to such shares shall continue to be subject to all applicable provisions of the Agreement. Furthermore, notwithstanding the foregoing, if the corporation the stock of which is subject to the Option immediately prior to an Ownership Change Event described in Section 1.1(q)(i) constituting a Change in Control is the surviving or continuing corporation and immediately after such Ownership Change Event less than fifty percent (50%) of the total combined voting power of its voting stock is held by another corporation or by other corporations that are members of an affiliated group within the meaning of Section 1504(a) of the Code without regard to the provisions of Section 1504(b) of the Code, the Option shall not terminate unless the Board otherwise provides in its discretion.

          8.    Option Not A Service Contract. This Option is not an employment or service contract and nothing in this Agreement or the Grant Notice shall be deemed to create in any way whatsoever any obligation on your part to continue in the service of the Company, or of the Company to continue your service with the Company. In addition, nothing in your Option shall obligate the Company, its stockholders, Board, Officers or Employees to continue any relationship which you might have as a Director or Consultant for the Company.

          9.    Adjustments For Changes In Capital Structure. In the event of any stock dividend, stock split, reverse stock split, recapitalization, combination, reclassification or similar change in the capital structure of the Company, appropriate adjustments shall be made in the number and class of shares subject to the Option and in the exercise price per share of the Option. If a majority of the shares of Stock are exchanged for, converted into, or otherwise become (whether or not pursuant to an Ownership Change Event) shares of another corporation (the “New Shares”), the Board may unilaterally amend this Agreement to provide that the Option is exercisable for New Shares. In the event of any such amendment, the number of shares subject to, and the exercise price per share of, the Option shall be adjusted in a fair and equitable manner as determined by the Board, in its discretion. Notwithstanding the foregoing, any fractional share resulting from an adjustment pursuant to this Section shall be rounded down to the nearest whole number, and in no event may the exercise price of the Option be decreased to an amount less than the par value, if any, of the Stock subject to the Option.

-10-

          10.    Representations. By executing this Agreement, you hereby warrant and represent that you are acquiring this Option for your own account and that you have no intention of distributing, transferring or selling all or any part of this Option except in accordance with the terms of this Agreement and Section 25102(f) of the California Corporations Code. You also hereby warrant and represent that you have either (i) preexisting personal or business relationships with the Company or any of its officers, directors or controlling persons, or (ii) the capacity to protect your own interests in connection with the grant of this Option by virtue of the business or financial expertise of you or any of your professional advisors who are unaffiliated with and who are not compensated by the Company or any of its affiliates, directly or indirectly.

          11.    Notices. Any notices provided for in this Agreement or the Grant Notice shall be given in writing and shall be deemed effectively given upon receipt or, in the case of notices delivered by the Company to you, five (5) days after deposit in the United States mail, postage prepaid, addressed to you at the last address you provided to the Company.

          12.    Transferability. This Option shall not be transferable in any manner (including without limitation, sale, alienation, anticipation, pledge, encumbrance, or assignment) other than, (i) by will or by the laws of descent and distribution, (ii) by written designation of a beneficiary, in a form acceptable to the Company, with such designation taking effect upon the death of the Optionee, (iii) by delivering written notice to the Company, in a form acceptable to the Company (including such representations, warranties and indemnifications as the Company shall require the Optionee to make to protect the Company’s interests and ensure that this Option has been transferred under the circumstances approved by the Company), by gift to the Optionee’s spouse, former spouse, children, stepchildren, grandchildren, parent, stepparent, grandparent, sibling, niece, nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law, persons having one of the foregoing types of relationship with the Optionee due to adoption, any person sharing the Optionee’s household (other than a tenant or employee), a foundation in which these persons or the Optionee control the management of assets, and any other entity in which these persons (or the Optionee) own more than fifty percent of the voting interests. A transfer to an entity in which more than fifty percent of the voting interests are owned by these persons (or the Optionee) in exchange for an interest in that entity is specifically included as a permissible type of transfer. In addition, a transfer to a trust created solely for the benefit (i.e., the Optionee and/or any or all of the foregoing persons hold more than 50 percent of the beneficial interest in the trust) of the Optionee and/or any or all of the foregoing persons is also a permissible transferee, or (iv) such other transferees as may be authorized by the Board in its sole and absolute discretion. During the Optionee’s life this Option is exercisable only by the Optionee or a transferee satisfying the above conditions. Except in the event of the Optionee’s death, upon transfer of this Option to any or all of the foregoing persons, the Optionee is liable for any and all taxes due upon exercise of this transferred Option. At no time will a transferee who is considered an affiliate under Rule 144(a)(1) be able to sell any or all such Stock without complying with Rule 144. The right of a transferee to exercise the transferred portion of this Option shall terminate in accordance with the Optionee’s right of exercise under this Option and is further subject to such representations, warranties and indemnifications from the transferee that the Company requires the transferee to make to protect the Company’s interests and ensure that this Option has been transferred under the circumstances approved by the Company. Once a portion of this Option is transferred, no further transfer may be made of that portion of this Option.

-11-

          13.    Arbitration. Any dispute or claim concerning the Option, the Grant Notice or this Agreement shall be fully, finally and exclusively resolved by binding arbitration conducted by the American Arbitration Association pursuant to the commercial arbitration rules in San Diego, California. By accepting the Option, the Optionee and the Company waive their respective rights to have any such disputes or claims tried by a judge or jury.

          14.    Amendment. The Board may amend your Option at any time, provided no such amendment may adversely affect the Option or any unexercised portion of your Option, without your consent unless such amendment is necessary to comply with any applicable law or government regulation. No amendment or addition to this Agreement shall be effective unless in writing or, in such electronic form as may be designated by the Company.

-12-

EX-10.4

EXHIBIT 10.4

AMERICAN TECHNOLOGY CORPORATION
SUMMARY SHEET
OF
DIRECTOR AND EXECUTIVE OFFICER COMPENSATION

Compensation of Directors

We currently have no standard arrangements pursuant to which our directors are compensated for services provided as a director or committee member, other than in the form of reimbursement of expenses of attending directors’ or committee meetings. Our directors have received in the past, and may receive in the future, stock option grants. During fiscal 2005, the Compensation Committee will be reevaluating our director compensation program.

Compensation of Executive Officers

The executive officers of the Company serve at the discretion of the Board of Directors. From time to time, the Compensation Committee of the Board of Directors reviews and determines the salaries that are paid to the Company’s executive officers. The following table sets forth the annual salary rates for the Company’s current executive officers as of the date of this report on Form 10-Q:

Elwood G. Norris, Chairman	$200,000
Kalani Jones, President and Chief Operating Officer	$220,000
Michael A. Russell, Chief Financial Officer and Secretary	$185,000
Bruce Gray, Vice President of the Commercial Products Group	$200,000

Employment Arrangements with Current Executive Officers

The following discussion summarizes the employment arrangements between us and our current executive officers as of the date of this report on Form 10-Q:

Mr. Elwood G. Norris - Effective September 1, 1997, we entered into a three year employment contract with Mr. Norris, for his services as Chief Technology Officer. The three-year term expired on August 31, 2000, but the agreement remains in effect until one party gives thirty days advance notice of termination to the other. Mr. Norris now serves as Chairman under the term of this agreement. The agreement, as amended by the Compensation Committee, provides for a base salary of $16,667 per month. The agreement provides that Mr. Norris will participate in bonus, benefit and other incentives at the discretion of the Board of Directors. Mr. Norris has agreed not to disclose trade secrets and has agreed to assign certain inventions to us during employment. We are also obligated to pay Mr. Norris certain royalties. See “Certain Relationships and Related Transactions” in our Form 10-K/A filed March 18, 2005.

Mr. Kalani Jones - We entered into a letter agreement dated as of August 28, 2003, as amended on October 20, 2003, under which Mr. Jones was employed as our Senior Vice President of Operations. Mr. Jones has since been promoted to President and Chief Operating Officer. Mr. Jones has also assumed the duties of Vice President of the Government and Force Protection Systems Group until we locate a replacement. The letter agreement provides for an annual base salary of $140,000, and an annual performance bonus of up to 30% of base salary to be determined by the Compensation Committee and the Board of Directors. Mr. Jones’ base salary was $200,000 per year at September 30, 2004.

-1-

On January 27, 2005, our Compensation Committee increased Mr. Jones’ current annual base salary to $220,000.  For fiscal 2005, the Compensation Committee determined that Mr. Jones’ bonus should be based upon a target bonus of 50% of base salary given his increased responsibilities as President and Chief Operating Officer. We expect future bonus determinations for Mr. Jones to be made based upon a target bonus of 50% of base salary. Mr. Jones’ employment is terminable at-will by us or by Mr. Jones for any reason, with or without notice.

Mr. Michael Russell - We entered into a letter agreement dated June 15, 2004, under which Mr. Russell was employed as our Chief Financial Officer. Mr. Russell has also been appointed as our Secretary. The letter agreement provides for an annual base salary of $185,000, and an annual performance bonus of up to 25% of base salary to be determined by the Compensation Committee and the Board of Directors. Mr. Russell’s employment is terminable at-will by us or by Mr. Russell for any reason, with or without notice.

Mr. Bruce Gray - We entered into a letter agreement with Mr. Bruce Gray, under which Mr. Gray was employed as our Vice President of the Commercial Products Group effective March 21, 2005. The letter agreement provides for an annual base salary of $200,000, and an annual sales bonus of up to $100,000, payable on a quarterly basis, based on attaining quarterly and annual goals to be established. Mr. Gray’s employment is terminable at-will by us or by Mr. Gray for any reason, with or without notice.

Executive officers in charge of revenue producing business segments also participate in a broad-based commission arrangement. Under our existing commission arrangement, commissions are awarded for each of our business segments based on achievement of operating plan revenue within the segment, with commissions increasing in percentage if operating plan is exceeded. Executive officers in charge of each business unit recommend an allocation of such commissions amongst sales personnel and themselves, which recommendation is reviewed and approved by the Chairman and the President. All commissions payable to executive officers are then reviewed and approved by the Compensation Committee.

-2-

EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Elwood G. Norris, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of American Technology Corporation;

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.   The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)   [paragraph omitted pursuant to SEC Release Nos. 33-2838 and 34-47986];

c)   Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)   Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrant's internal control over financial reporting; and

5.   The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's independent registered public accounting firm and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting.

Date: May 10, 2005

/s/ ELWOOD G. NORRIS  

Elwood G. Norris, Chairman of the Board
(Co-Principal Executive Officer)

EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

I, Kalani Jones, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of American Technology Corporation;

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.   The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)   [paragraph omitted pursuant to SEC Release Nos. 33-2838 and 34-47986];

c)   Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)   Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrant's internal control over financial reporting; and

5.   The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's independent registered public accounting firm and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting.

Date: May 10, 2005

/s/ KALANI JONES    

Kalani Jones, President and Chief Operating Officer
(Co-Principal Executive Officer)

EX-31.3

EXHIBIT 31.3

CERTIFICATIONS

I, Michael A. Russell, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of American Technology Corporation;

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.   The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)   [paragraph omitted pursuant to SEC Release Nos. 33-2838 and 34-47986];

c)   Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)   Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrant's internal control over financial reporting; and

5.   The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's independent registered public accounting firm and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting.

Date: May 10, 2005

/s/ MICHAEL A. RUSSELL   

Michael A. Russell, Chief Financial Officer

(Principal Financial Officer)

EX-32.1

EXHIBIT 32.1

CERTIFICATION OF CO-PRINCIPAL EXECUTIVE OFFICERS AND PRINCIPAL FINANCIAL OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Each of the undersigned hereby certifies, in accordance with 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in his capacity as an officer of American Technology Corporation (the "Company"), that, to his knowledge, the quarterly report of the Company on Form 10-Q for the quarter ended March 31, 2005 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in such report fairly presents, in all material respects, the financial condition and results of operation of the Company as of the dates and for the periods presented in the financial statements included in such report.

Dated: May 10, 2005

/s/ ELWOOD G. NORRIS   

Elwood G. Norris, Chairman of the Board

(Co-Principal Executive Officer)

/s/ KALANI JONES    

Kalani Jones, President and Chief Operating Officer

(Co-Principal Executive Officer)

/s/ MICHAEL A. RUSSELL   

Michael A. Russell, Chief Financial Officer

(Principal Financial Officer)