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 September 30, 2004
------------------
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: 0-18267
NCT Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware 59-2501025
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
20 Ketchum Street, Westport, Connecticut 06880
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(203) 226-4447
- --------------------------------------------------------------------------------
(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 / / No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). / / Yes /X/ No
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of November 12, 2004 was 641,970,392.
Table of Contents
Page
Part I Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets at December 31, 2003 and September 30, 2004
(unaudited)) 3
Condensed Consolidated Statements of Operations (Unaudited) and Condensed Consolidated
Statements of Comprehensive Loss (Unaudited) for the Three and Nine Months
Ended September 30, 2003 and 2004 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months
Ended September 30, 2003 and 2004 5
Notes to the Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 35
Item 4. Controls and Procedures 35
Part II Other Information
Item 1. Legal Proceedings 36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 36
Item 6. Exhibits 37
Signatures 42
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NCT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Notes 1 and 6)
(in thousands, except share data)
December 31, September 30,
2003 2004
-------------- --------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 988 $ 795
Investment in available-for-sale marketable securities 49 32
Accounts receivable, net 255 743
Inventories, net 509 519
Other current assets (includes $138 and $28, respectively, due from officers) 310 136
-------------- --------------
Total current assets 2,111 2,225
Property and equipment, net 641 526
Goodwill, net 7,184 7,184
Patent rights and other intangibles, net 1,223 1,121
Other assets 1,616 129
-------------- --------------
$ 12,775 $ 11,185
============== ==============
LIABILITIES AND CAPITAL DEFICIT
Current liabilities:
Accounts payable $ 2,905 $ 1,720
Accrued expenses (includes $1,128 and $4,075, respectively, related parties) 13,799 17,644
Notes payable 3,403 621
Related party convertible notes (due to a stockholder) 28,650 33,697
Current maturities of convertible notes 3,438 4,416
Deferred revenue 2,763 1,430
Shares of subsidiary subject to exchange into a variable number of shares 742 704
Other current liabilities 7,227 6,987
-------------- --------------
Total current liabilities 62,927 67,239
Long-term liabilities:
Deferred revenue 535 -
Convertible notes 675 -
Other liabilities 1,536 73
-------------- --------------
Total long-term liabilities 2,746 73
Commitments and contingencies
Minority interest in consolidated subsidiaries 8,313 8,562
-------------- --------------
Capital deficit:
Preferred stock, $.10 par value, 10,000,000 shares authorized:
Convertible series H preferred stock, issued and outstanding, 1,725 and
1,752 shares, respectively; (redemption amount $20,700,000 and
$20,970,000, respectively; liquidation amount $18,300,822 and $19,093,026, respectively) 18,301 19,028
Common stock, $.01 par value, authorized 645,000,000 shares:
issued and outstanding, 641,970,392 shares 6,420 6,420
Additional paid-in capital 205,102 235,943
Accumulated other comprehensive loss (1,170) (14)
Accumulated deficit (289,864) (326,066)
Common shares payable, 3,029,608 shares - -
-------------- --------------
Total capital deficit (61,211) (64,689)
-------------- --------------
$ 12,775 $ 11,185
============== ==============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
NCT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Note 1)
(Unaudited)
(in thousands, except per share amounts)
Three months ended Nine months ended
September 30, September 30,
------------------------- -----------------------
2003 2004 2003 2004
----------- ----------- ---------- ----------
REVENUE:
Technology licensing fees and royalties $ 711 $ 982 $ 2,022 $ 2,665
Product sales, net 446 418 1,322 1,301
Advertising 33 35 53 103
Engineering and development services - 4 25 4
----------- ----------- ---------- ----------
Total revenue 1,190 1,439 3,422 4,073
COSTS AND EXPENSES:
Cost of product sales 215 193 603 632
Cost of advertising 5 4 9 12
Selling, general and administrative (includes $941, $45 $3,755,
and $135, respectively, related party consulting expenses) 3,070 2,552 10,112 6,798
Research and development 870 943 2,702 3,113
Other operating income (80) - (102) -
----------- ----------- ---------- ----------
Total operating costs and expenses 4,080 3,692 13,324 10,555
Non-operating items:
Other (income) expense, net (includes related party expenses
of $618, $1,321, $1,090 and $4,704, respectively) (3,636) (3,194) (2,205) 685
Interest expense, net (includes related party expenses
of $2,862, $10,937, $7,638 and $28,162, respectively) 3,058 11,355 9,307 29,035
----------- ----------- ---------- ----------
Total costs and expenses 3,502 11,853 20,426 40,275
----------- ----------- ---------- ----------
NET LOSS $ (2,312) $ (10,414) $ (17,004) $ (36,202)
Less: Preferred stock dividends 262 260 795 771
Beneficial conversion feature - - - 104
Non-registration charges 494 532 1,749 824
Non-conversion/exchange charges - 1,039 - 2,741
----------- ----------- ---------- ----------
LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (3,068) $ (12,245) $ (19,548) $ (40,642)
=========== =========== ========== ==========
Basic and diluted loss per share attributable to
common stockholders $ (0.01) $ (0.02) $ (0.04) $ (0.06)
=========== =========== ========== ==========
Weighted average common shares outstanding -
basic and diluted 570,030 645,000 536,092 645,000
=========== =========== ========== ==========
NCT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
(in thousands)
Three months ended Nine months ended
September 30, September 30,
------------------------- -----------------------
2003 2004 2003 2004
NET LOSS $ (2,312) $ (10,414) $ (17,004) $ (36,202)
Other comprehensive income (loss):
Currency translation adjustment (158) 1,213 (162) 1,110
Unrealized loss on marketable securities/Adjustment of unrealized loss 7 (18) (2) 46
----------- ----------- ---------- ----------
COMPREHENSIVE LOSS $ (2,463) $ (9,219) $ (17,168) $ (35,046)
=========== =========== ========== ==========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
NCT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Notes 1 and 3)
(Unaudited)
(in thousands)
Nine months ended September 30,
----------------------------------
2003 2004
------------- -------------
Cash flows from operating activities:
Net loss $ (17,004) $ (36,202)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 571 290
Common stock, warrants and options issued as consideration for:
Operating expenses (includes $3,665 and zero of related party consulting, respectively) 3,746 170
Common stock of subsidiary conveyed as consideration for operating expenses - 46
Provision for inventory (105) (47)
Provision for doubtful accounts and uncollectible amounts 20 91
Loss on disposition of fixed assets 33 1
Gain on settlement of lawsuit (4,888) -
Gain on dissolution of Artera International - (4,567)
Finance costs associated with non-registration of common shares 2,031 526
Finance costs associated with non-conversion or exchange for common shares - -
Preferred stock dividends as interest 6 16
Default penalty on notes (related party) 1,090 4,704
Amortization of discounts on notes (includes $3,208 and $12,349,
respectively, with related parties) 3,842 12,371
Amortization of beneficial conversion feature on convertible notes (includes
$3,027 and $13,243, respectively, with related parties) 3,147 13,306
Issuance of convertible note for placement fees 40 -
Realized loss on fair value of warrant 1 -
Realized loss on available-for-sale securities - 77
Settlement of debt (231) -
Changes in operating assets and liabilities, net of acquisitions:
Increase in accounts receivable (213) (476)
Decrease in inventories 218 38
Decrease in other assets 163 170
Increase in accounts payable and accrued expenses 983 3,910
Decrease in other liabilities and deferred revenue (1,120) (1,623)
------------- -------------
Net cash used in operating activities $ (7,670) $ (7,199)
------------- -------------
Cash flows from investing activities:
Capital expenditures $ (127) $ (72)
------------- -------------
Net cash used in investing activities $ (127) $ (72)
------------- -------------
Cash flows from financing activities:
Proceeds from:
Convertible notes and notes payable, net $ 7,820 $ 7,133
Repayment of notes (298) (80)
------------- -------------
Net cash provided by financing activities $ 7,522 $ 7,053
------------- -------------
Effect of exchange rate changes on cash $ (1) $ 25
------------- -------------
Net decrease in cash and cash equivalents (276) (193)
Cash and cash equivalents - beginning of period 806 988
------------- -------------
Cash and cash equivalents - end of period $ 530 $ 795
============= =============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
NCT GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation:
Throughout this document, "NCT" (which may be referred to as the "company,"
"we," "our" or "us") means NCT Group, Inc. or NCT Group, Inc. and its
subsidiaries, as the context requires. The accompanying condensed consolidated
financial statements are unaudited but, in the opinion of management, contain
all the adjustments (consisting of those of a normal recurring nature)
considered necessary to present fairly the condensed consolidated financial
position and the results of operations and cash flows for the periods presented
in conformity with accounting principles generally accepted in the United States
of America applicable to interim periods. The results of operations for the
three and nine months ended September 30, 2004 and cash flows for the nine
months ended September 30, 2004 are not necessarily indicative of the results
that may be expected for any other interim period or the full year. These
condensed consolidated financial statements should be read in conjunction with
the audited financial statements and notes thereto for the year ended December
31, 2003 contained in the company's Annual Report on Form 10-K.
The preparation of condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires us to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from these estimates.
We have experienced substantial losses from operations since our inception,
which cumulatively amounted to $326.1 million through September 30, 2004. Cash
and cash equivalents amounted to $0.8 million at September 30, 2004, decreasing
from $1.0 million at December 31, 2003. A working capital deficit of $65.0
million existed at September 30, 2004. We were in default of $0.5 million of our
notes payable and $5.5 million of our convertible notes at September 30, 2004
and were subject to a judgment of approximately $2.1 million (excluding accrued
interest at 10%). Our management believes that internally generated funds are
currently insufficient to meet our short-term and long-term operating and
capital requirements. These funds include available cash and cash equivalents
and revenue derived from technology licensing fees and royalties and product
sales. Our ability to continue as a going concern is substantially dependent
upon future levels of funding from our revenue sources, which are currently
uncertain. If we are unable to generate sufficient revenue to sustain our
current level of operations and to execute our business plan, we will need to
obtain additional financing to maintain our current level of operations. We are
attempting to obtain additional working capital through debt and equity
financings. However, we can give no assurance that additional financing will be
available to us on acceptable terms or at all. The failure to obtain any
necessary additional financing would have a material adverse effect on us,
including causing a substantial reduction in the level of our operations. These
reductions, in turn, could have a material adverse effect on our relationships
with our licensees, customers and suppliers.
The accompanying condensed consolidated financial statements have been
prepared assuming that we will continue as a going concern, which contemplates
continuity of operations, realization of assets and satisfaction of liabilities
in the ordinary course of business. Our ability to continue as a going concern
is dependent upon, among other things, the achievement of future profitable
operations and the ability to generate sufficient cash from operations, equity
and/or debt financing and other funding sources to meet our obligations. The
uncertainties described in the preceding paragraphs raise substantial doubt at
September 30, 2004 about our ability to continue as a going concern. The
accompanying condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of the carrying
amount of recorded assets or the amount and classification of liabilities that
might result should we be unable to continue as a going concern.
6
2. Stock-Based Compensation:
We have elected to apply the disclosure-only provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." Accordingly, we account for
stock-based compensation transactions with employees using the intrinsic value
method prescribed in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations. Under
APB No. 25, no compensation costs are recognized if the option exercise price is
equal to or greater than the fair market price of the common stock on the date
of the grant. Under SFAS No. 123, stock options are valued at grant date using
the Black-Scholes option pricing model and compensation costs are recognized
ratably over the vesting period. No stock-based employee compensation cost is
reflected in our net loss attributable to common stockholders, as options
granted under our plans have an exercise price equal to or greater than the
market value of the underlying common stock on the date of grant. During 2004,
we granted options and stock awards under the 2001 Stock and Incentive Plan (the
"2001 Plan") for an aggregate of 29,380,000 shares of our common stock at
exercise prices reflecting market prices on the dates of grant (see Note 9). Of
these grants, 27,380,000 were granted to officers, directors and employees. At
September 30, 2004, we have options outstanding under our 1992 Stock Incentive
Plan and 2001 Plan. In addition, options are outstanding that have been granted
to consultants outside of our stockholder approved stock-based compensation
plans. The following table illustrates the effect on net loss attributable to
common stockholders and net loss per share if we had applied the fair value
recognition provisions of SFAS No. 123, as amended by SFAS 148, to stock-based
employee compensation:
(in thousands, except per share amounts)
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
2003 2004 2003 2004
------------ ------------ ------------ ------------
Net loss attributable to common stockholders $ (3,068) $ (12,245) $ (19,548) $ (40,642)
Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (876) (41) (1,011) (943)
------------ ------------ ------------ ------------
Pro forma net loss attributable to common stockholders $ (3,944) $ (12,286) $ (20,559) $ (41,585)
============ ============ ============ ============
Net loss per common share (basic and diluted):
As reported $ (0.01) $ (0.02) $ (0.04) $ (0.06)
============ ============ ============ ============
Pro forma $ (0.01) $ (0.02) $ (0.04) $ (0.06)
============ ============ ============ ============
Since the options granted vest over several years and additional option
grants are expected to be made in future years, the pro forma impact on the
results of operations for the three and nine months ended September 30, 2003 and
2004, respectively, is not necessarily representative of the pro forma effects
on the results of operations for future periods.
3. Other Financial Data:
Balance Sheet Items
Investments in marketable securities include available-for-sale securities
at market value. The following table displays the market value; cost basis and
realized/unrealized gain (loss) of NCT's available-for-sale securities (in
thousands):
7
Adjusted Market Adjustment Market
Cost Basis Unrealized Value Unrealized of Unrealized Realized Value
01/01/03 Gain (Loss) 12/31/03 Additions Gain Loss Loss 09/30/04
---------- ----------- ---------- ----------- ----------- -------------- ---------- ----------
Available-for-sale:
ITC $ 94 $ (56) $ 38 $ 13 (a) $ - $ 38 $ (77) $ 12
Teltran 8 3 11 - 9 - 20
---------- ----------- ---------- ----------- ----------- -------------- ---------- ----------
Totals $ 102 $ (53) $ 49 $ 13 $ 9 $ 38 $ (77) $ 32
========== =========== ========== =========== =========== ============== ========== ==========
Footnote:
- --------
(a) Represents shares previously classified as "Other assets" valued at
$5.00 per share as such shares were, by contract, available to offset
an amount due to Infinite Technology Corporation ("ITC"). As a result
of the cross-release entered into on March 31, 2004 (see below), NCT
was released from the amount due and these shares were reclassified as
marketable securities at their market value at that date.
We review declines in the value of our investment portfolio when general
market conditions change or specific information pertaining to an industry or to
an individual company becomes available. We consider all available evidence to
evaluate the realizable value of our investments and to determine whether the
decline in realizable value may be other-than-temporary. During the nine months
ended September 30, 2004, we recognized an other-than-temporary decline of
approximately $0.1 million.
Accounts receivable comprise the following (in thousands):
December 31, September 30,
2003 2004
------------- -------------
Technology license fees and royalties $ 278 $ 682
Joint ventures and affiliates 34 34
Other receivables 284 356
------------- -------------
$ 596 $ 1,072
Allowance for doubtful accounts (341) (329)
------------- -------------
Accounts receivable, net $ 255 $ 743
============= =============
Inventories comprise the following (in thousands):
December 31, September 30,
2003 2004
------------- -------------
Finished goods $ 588 $ 528
Components 203 226
------------- -------------
$ 791 $ 754
Reserve for obsolete and slow moving inventory (282) (235)
------------- -------------
Inventories, net $ 509 $ 519
============= =============
8
Other current assets comprise the following (in thousands):
(In thousands of dollars)
December 31, September 30,
2003 2004
------------- -------------
Notes receivable $ 1,000 $ 1,000
Due from officers 138 -
Due from former officer (Note 10) - 132
Other 172 107
------------- -------------
$ 1,310 $ 1,239
Reserve for uncollectible amounts (Note 10) (1,000) (1,103)
------------- -------------
Other current assets $ 310 $ 136
============= =============
Other assets (long-term) comprise the following (in thousands):
December 31, September 30,
2003 2004
------------- -------------
Marketable ITC securities (a) $ 1,320 $ -
Advances and deposits 73 72
Deferred charges 223 57
------------- -------------
Other assets (classified as long term) $ 1,616 $ 129
============= =============
Footnote:
- --------
(a) Valued at agreed amount of $5.00 per share returnable to ITC in
settlement of an obligation at December 31, 2003. The market value of
these shares at December 31, 2003, if they had not been returnable in
settlement of the obligation, would have been less than $0.1 million.
On March 31, 2004, ITC, Advancel and NCT entered into a cross-release
agreement that released the parties from any and all claims, through the date of
the cross-release, under prior agreements and acknowledged our ownership of ITC
common stock. The agreement resulted in the elimination of $1.4 million as an
obligation of Advancel and the reduction in the carrying amount of the ITC
common stock to its fair value (see other liabilities below). The effects of
this release were a decrease in liabilities and other assets of $1.4 million and
$1.3 million, respectively, and an increase in paid-in capital of $0.1 million.
Property and equipment comprise the following (in thousands):
December 31, September 30,
2003 2004
------------ ------------
Machinery and equipment $ 1,210 $ 1,279
Furniture and fixtures 622 576
Leasehold improvements 392 391
Tooling 632 495
Other 429 430
------------ ------------
$ 3,285 $ 3,171
Accumulated depreciation (2,644) (2,645)
------------ ------------
Property and equipment, net $ 641 $ 526
============ ============
Depreciation expense for the nine months ended September 30, 2003 and 2004
was approximately $0.4 and $0.2 million, respectively.
9
Accrued expenses comprise the following (in thousands):
December 31, September 30,
2003 2004
------------- -------------
Non-registration fees $ 3,147 $ 4,112
Interest 1,484 1,783
Interest due to a related party 818 849
Judgments 2,072 2,066
Non-conversion fees due to a related party - 2,741
Non-registration fees due to a related party - 385
Default penalties due to a related party - 40
Consulting fees due to a related party 310 445
Executive compensation payable 378 1,401
Commissions payable 276 361
Legal fees 669 563
Other 4,645 2,918
------------- -------------
Accrued Expenses $ 13,799 $ 17,644
============= =============
Deferred revenue comprise the following (in thousands):
December 31, September 30,
2003 2004
------------- -------------
New Transducers Ltd. $ 2,675 $ 1,070
Other 623 360
------------- -------------
$ 3,298 $ 1,430
Less: amount classified as current (2,763) (1,430)
------------- -------------
Deferred revenue (classified as long term) $ 535 $ -
============= =============
As of September 30,2004, we do not expect to realize any additional cash
from revenue that has been deferred.
Other current liabilities comprise the following (in thousands):
December 31, September 30,
2003 2004
------------- -------------
License reacquisition payable $ 4,000 $ 4,000
Development fee payable 650 650
Royalty payable 1,679 1,679
Due to selling shareholders of Theater Radio Network 557 557
Due to Lernout & Hauspie 100 100
Advance by investor 230 -
Other 11 1
------------- -------------
Other current liabilities $ 7,227 $ 6,987
============= =============
10
Other liabilities (long-term) comprise the following (in thousands):
December 31, September 30,
2003 2004
------------- -------------
Due to ITC (a) $ 1,422 $ -
Other 114 73
------------- -------------
Other liabilities (classified as long term) $ 1,536 $ 73
============= =============
Footnote:
- --------
(a) Refer to the discussion of the ITC cross-release agreement under other
assets (long-term) above.
Statements of Operations Information
Other operating income consisted of the following:
(in thousands)
Three months ended Nine months ended
September 30, September 30,
-------------------------- --------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
Settlement of accounts payable $ (31) $ - $ (49) $ -
Other (49) - (53) -
----------- ----------- ----------- -----------
Other operating income $ (80) $ - $ (102) $ -
=========== =========== =========== ===========
Non-operating Other expense, net consisted of the following:
Non-operating other (income)/expense, net consisted of the following:
(in thousands)
Three months ended Nine months ended
September 30, September 30,
-------------------------- --------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
Finance costs associated with non-registration
of common shares $ 613 $ 74 $ 2,031 $ 526
Default penalties on debt 619 1,321 1,090 4,704
Dissolution of Artera International - (4,567)(a) - (4,567) (a)
Settlement of notes payable - - (27) -
Litigation settlement (4,888) - (5,317) -
Other 20 (22) 18 22
----------- ----------- ----------- -----------
Other (income)/expense, net $ (3,636) $ (3,194) $ (2,205) $ 685
=========== =========== =========== ===========
Footnote
- --------
(a) The three and nine months ending September 30, 2004 included a $4.6
million gain on the dissolution and liquidation of Artera Group
International Limited, a United Kingdom limited company. On April 5,
2002 Artera International ceased its Internet service provider
operations and entered into liquidation proceedings. On July 22, 2004
the liquidator concluded the liquidation of Artera International and
the notification was registered at Companies House in the UK on July
27, 2004. On October 27, 2004 the Registrar of Companies removed
Artera International from its register.
We include losses from our majority-owned subsidiaries in our condensed
consolidated statements of operations exclusive of amounts attributable to
minority shareholders' common equity interests only up to the basis of the
minority shareholders' interests. Losses in excess of that amount are borne by
us. Such amounts from our Pro Tech Communications, Inc. subsidiary borne by us
for the three and nine months ended September 30, 2004 were approximately
$47,000 and $136,000, respectively. Future earnings of our
11
majority-owned subsidiaries otherwise attributable to minority shareholders'
interests will be allocated again to minority shareholders only after future
earnings are sufficient to recover the cumulative losses previously absorbed by
us ($2.3 million at September 30, 2004).
Supplemental Cash Flow Information
(in thousands)
Nine months ended
September 30,
---------------------------------------
2003 2004
------------------ ------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 35 $ 20
================== ==================
Supplemental disclosures of non-cash investing and financing activities:
Unrealized holding loss on available-for-sale securities $ (2) $ (30)
================== ==================
Finance costs associated with non-registration of common shares
on preferred stock of subsidiary $ 1,749 $ 439
================== ==================
Finance costs associated with non-conversion for common on preferred stock $ - $ 2,741
================== ==================
Receipt of common stock of subsidiary as consideration for license amendment $ - $ 275
================== ==================
Receipt of common stock of subsidiary for payment of note receivable $ - $ 640
================== ==================
Issuance of preferred stock for advance by investor in prior years $ - $ 230
================== ==================
Principal on convertible notes and notes payable rolled into new notes $ - $ 46,637
================== ==================
Interest on convertible notes and notes payable rolled into new notes $ - $ 2,540
================== ==================
Default penalty on convertible notes rolled into new notes $ - $ 4,664
================== ==================
Issuance of common stock upon conversion of preferred stock and dividends $ 785 $ -
================== ==================
Issuance of common stock upon exchange of convertible notes of subsidiary $ 1,754 $ -
================== ==================
Issuance of common stock to fulfill common stock payable obligation $ 2,296 $ -
================== ==================
Issuance of common stock to settle litigation $ 4,125 $ -
================== ==================
12
4. Capital Deficit:
The changes in capital deficit during the nine months ended September 30,
2004 were as follows (in thousands):
NCT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Series H Accumulated
Convertible Other
Preferred Stock Common Stock Additional Accumu- Compre- Common
--------------- ------------ Paid-in lated hensive Shares
Shares Amount Shares Amount Capital Deficit Loss Payable Total
--------------- --------------- ---------- --------- -------- -------- ----------
Balance at December 31, 2003 2 $18,301 641,970 $6,420 $ 205,102 $(289,864) $(1,170) $ - $ (61,211)
Sale of preferred stock, net - 205 - - 25 - - - 230
Beneficial conversion feature
on preferred stock - (104) - - 104 - - - -
Dividend and amortization of discounts
on beneficial conversion price
to preferred shareholders - 626 - - (626) - - - -
Dividend and amortization of discounts
on beneficial conversion price to
subsidiary preferred shareholders - - - - (249) - - - (249)
Charges for the non-registration of the
underlying shares of NCT common stock
to subsidiary preferred shareholders - - - - (824) - - - (824)
Charges for the non-conversion/exchange
for common stock of NCT to NCT and
subsidiary preferred shareholders - - - - (2,741) - - - (2,741)
Warrants issued in conjunction with
convertible debt - - - - 17,162 - - - 17,162
Beneficial conversion feature on
convertible debt - - - - 17,619 - - - 17,619
Net loss - - - - - (36,202) - - (36,202)
Accumulated other comprehensive loss - - - - - - 1,156 - 1,156
Compensatory stock options and warrants - - - - 170 - - - 170
Other - - - - 201 - - - 202
--- ------- ------- ------ --------- ---------- -------- ------ ----------
Balance at September 30, 2004 2 $19,028 641,970 $6,420 $ 235,943 $(326,066) $ (14) $ - $ (64,689)
=== ======= ======= ====== ========= ========== ======== ====== ==========
13
5. Notes Payable:
(in thousands)
December 31, September 30,
2003 2004
------------ ------------
Logical eBusiness Solutions Limited (f/k/a DataTec) $ 2,679 $ -
Obligation of subsidiary to a prior owner of Web Factory;
past due; payable in 1,500 British Pounds Sterling;
interest accrues at 4% per annum above the base rate
of National Westminister Bank plc.
Note due investor (a) 385 385
Interest at 8% per annum payable at maturity; effective interest rate
of 80.3% per annum resulting from the issuance of warrants and finders
fees; matured April 7, 2003; default interest accrues at 18% per annum.
Note due stockholder of subsidiary 142 49
Interest at 8.5% per annum; monthly payments (including interest)
of $3.5 through May 2004, remainder matured June 27, 2004.
Remainder rolled into note bearing interest at 8.5% per annum; monthly
payments (including interest) of $3.5 through May 2005, remainder matures
June 27, 2005.
Note due former employee (a) 100 100
Interest at 8.25% per annum, compounded annually.
Other financings 97 87
Interest ranging from 7% to 9% per annum;
$35 due July 15, 2003 (a); $52 all other.
------------ ------------
$ 3,403 $ 621
============ ============
Footnote:
- --------
(a) Notes payable are in default due to nonpayment.
6. Convertible Notes Payable:
(in thousands)
December 31, September 30,
Related Party Convertible Notes 2003 2004
--------------- ---------------
Issued to Carole Salkind - related party (a) $ 33,824 $ 47,288
Weighted average effective interest rate of 110.9% per annum; accrues
interest at 8% per annum; collateralized by substantially all of the
assets of NCT; convertible into NCT common stock at prices ranging
from $0.020 - $0.037 or exchangeable for common stock of NCT
subsidiaries except Pro Tech; maturing by quarter as follows:
2003 2004
----------- -----------
Past due $ - $ 400
On demand 3,050 425
March 31, 11,163 26,408
June 30, 19,611 -
December 31, - 20,055
Less: unamortized debt discounts (5,174) (13,591)
--------------- ---------------
$ 28,650 $ 33,697
=============== ===============
14
(in thousands)
December 31, September 30,
Convertible Notes 2003 2004
--------------- ---------------
8% Convertible Notes (b) $ 1,651 $ 2,641
Weighted average effective interest rate of 30.8% per annum;
convertible into NCT common stock at various rates; matures:
2003 2004
----------- -----------
March 14, 2002 $ 17 $ 17
April 12, 2002 9 9
January 10, 2004 550 550
March 11, 2004 400 400
April 22, 2005 235 235
September 4, 2005 440 440
July 23, 2006 990
6% Convertible Notes (c) 2,474 2,474
Weighted average effective interest rate of 85.8% per annum;
exchangeable into NCT common stock at 100% of the five-day average
closing bid price preceding conversion; past due:
2003 2004
----------- -----------
January 9, 2002 $ 818 $ 818
April 4, 2002 325 325
May 25, 2002 81 81
June 29, 2002 1,250 1,250
--------------- ---------------
$ 4,125 $ 5,115
Less: unamortized debt discounts (12) (699)
Less: amounts classified as long term (675) -
--------------- ---------------
$ 3,438 $ 4,416
=============== ===============
Footnotes:
- ---------
(a) During the nine months ended September 30, 2004, we issued an
aggregate of $60.1 million of convertible notes to Carole Salkind, a
stockholder of NCT, an accredited investor and spouse of a former
director of NCT. These notes are secured by substantially all of our
assets. During the nine months ended September 30, 2004, we defaulted
on payment of all notes upon their maturity and upon receipt of demand
for payment for an aggregate principal amount of $47.0 million. For
the nine months ended September 30, 2004, an aggregate of $46.6
million principal was rolled into new notes along with default
penalties ($4.7 million) and accrued interest ($2.5 million)
aggregating $53.8 million. We are currently in negotiation to cure the
remaining $0.4 million principal in default. In addition, we issued
notes aggregating $6.3 million in consideration of new funding from
Carole Salkind. During the nine months ended September 30, 2004, we
recorded original issue discounts of $16.9 million to the notes based
upon the relative fair values of the debt and warrants granted to Ms.
Salkind (see Note 9). In addition, beneficial conversion features
totaling $17.1 million have been recorded as a discount to the notes.
These discounts are amortized over the terms of the related notes. The
notes entered into during the first quarter of 2004 were payable on
demand requiring an immediate expensing of their related discounts.
The majority of the notes entered into during the second and third
quarter of 2004 had a six-month maturity. For the three and nine
months ended September 30, 2004, $10.0 million and $25.6 million,
respectively, of amortization related to these and prior discounts is
classified as interest expense in our condensed consolidated
statements of operations. Unamortized discounts of $13.6 million have
been reflected as a reduction to the convertible notes in our
condensed consolidated balance sheet as of September 30, 2004. The
default provisions in these notes impose a penalty of 10% of the
principal payments in default and interest calculated from the date of
default at the
15
stated interest rate of the note plus 5%. As of September 30 2004,
$40,000 of accrued default penalties are included in accrued expenses
on our condensed consolidated balance sheet.
(b) Notes totaling $26,000 are convertible at 80% of the lowest closing
bid price of our common stock for the five days preceding conversion;
a note totaling $0.6 million is convertible at the lower of $0.07 per
share or 80% of the lowest closing bid price for the five days
preceding conversion; a note totaling $0.4 million is convertible at
$0.0647 per share; a note totaling $0.2 million is convertible at
$0.04 per share and notes totaling approximately $0.4 million are
convertible at 80% of the average of the closing bid price for the
five days preceding conversion.
On July 23, 2004, we issued subordinated secured convertible notes to
Alpha Capital Aktiengesellschaft and Longview Fund LP for an aggregate
principal amount of $0.9 million. These notes are secured by
substantially all of our assets. In addition, we issued unsecured
convertible notes to Libra Finance S.A. and Bi-Coastal Consulting
Corp., as finders, in the aggregate principal amount of $0.1 million.
The net proceeds of approximately $0.9 million were used for working
capital requirements. The notes mature on July 23, 2006 and bear
interest at 8% per annum, payable at maturity. Until the notes are
paid in full, the holders have the right to convert any outstanding
principal of the notes and, at their election, the interest accrued on
the notes into shares of our common stock at a conversion price per
share of the lesser of $0.0232 or 80% of the average of the closing
bid price for the five days immediately preceding conversion. Discount
features were recorded to the notes and are being amortized over the
term of the notes. For the three and nine months ended September 30,
2004, $0.1 of amortization related to these discounts is classified as
interest expense in our condensed consolidated statements of
operations.
The convertible note for $0.6 million is collateralized by
substantially all of the assets of our subsidiary, Artera Group, Inc.
Beneficial conversion features were recorded as a discount to the
notes and are being amortized over the term of the notes. For the
three and nine months ended September 30, 2004, zero and approximately
$11,000, respectively, of amortization related to these discounts is
classified as interest expense in our condensed consolidated
statements of operations. We did not fulfill registration obligations
and settled finance costs associated with non-registration of common
shares underlying convertible notes during 2003.
We are in default on convertible notes aggregating $1.0 million due to
a cross default provision and nonpayment. In addition, we are in
default on convertible notes aggregating $0.6 million due to a cross
default provision. We are also default on convertible notes
aggregating $1.0 effective August 31, 2004 due to our inability to
reserve shares of our common stock issuable upon conversion of these
notes.
(c) We were obligated but unable to register for resale shares of our
common stock issuable upon exchange of these notes at various dates
during 2001. For the three and nine months ended September 30, 2004,
we have recorded charges of approximately $0.1 million and $0.5
million, respectively, as a component of finance costs associated with
non-registration of common shares underlying convertible notes
included in other expense, net (see Note 3). The aggregate outstanding
debt of $2.5 million is in default for nonpayment. These notes are
senior debt of Artera Group. We had received requests for exchange of
subsidiary convertible notes into our common stock and have been
unable to fulfill such requests. The note holders granted a waiver
related to these requests. The waivers expired on April 10, 2004. and
have not been renegotiated.
7. Shares of Subsidiary Subject to Exchange into a Variable Number of Shares:
The monetary value of Pro Tech series A and B convertible preferred stock
was $0.7 million in our condensed consolidated balance sheet at September 30,
2004, which is comprised of $0.6 million of shares plus the accrued dividends of
approximately $0.1 million. We would have to issue approximately 31.9 million
shares of our common stock if settlement of the stated value had occurred as of
September 30, 2004. We have the option to settle the accrued dividends in cash
or common stock. As of September 30,
16
2004, settlement in common stock for the accrued dividends would require the
issuance of approximately 4.2 million shares of our common stock. There is no
limit on the number of shares of common stock that we could be required to issue
upon exchange of the Pro Tech series A and B preferred stock.
During the nine months ended September 30, 2004, 40 shares of Pro Tech
series B preferred stock plus accrued dividends were converted into 2,522,042
shares of Pro Tech common stock. At September 30, 2004, there were 50 shares of
Pro Tech series A preferred stock and 460 shares of Pro Tech series B preferred
stock outstanding. For the three and nine months ended September 30, 2004, we
calculated the 4% dividends earned by holders of the Pro Tech series A and B
preferred stock at approximately $5,000 and $16,000, respectively. Following
adoption of SFAS No. 150 effective July 1, 2003, this amount is included in
interest expense.
8. Commitments and Contingencies:
On September 30, 2004, we entered into an amended and restated private
equity credit agreement with Crammer Road LLC ("Crammer Road"), a Cayman Islands
limited liability company. The September 30, 2004 private equity credit
agreement superseded and replaced a private equity credit agreement dated July
25, 2002 between us and Crammer Road. The new agreement permits us to sell to
Crammer Road shares of our common stock having an aggregate value of up to $50
million (the maximum commitment amount), in exchange for cash, pursuant to puts
made by us. The agreement requires us to sell to Crammer Road at least an
aggregate of $5 million of our common stock (the minimum commitment amount), in
exchange for cash. All sales of our common stock to Crammer Road pursuant to the
agreement will be at a 9% discount from the market price of our common stock
(defined as the average of the lowest closing bid price for any three trading
days during the ten trading days immediately following the put date). We are
obligated to register for resale shares of our common stock sold pursuant to the
agreement in an amount no less than the number of shares for which puts are
made, but in no event less than 150% of the minimum commitment amount. In order
for us to be able to sell shares to Crammer Road pursuant to the agreement, we
must obtain stockholder approval of an amendment to our Second Restated
Certificate of Incorporation to sufficiently increase the number of authorized
shares of our common stock and must establish and maintain an effective
registration statement with the Securities and Exchange Commission to permit the
resale of shares sold to Crammer Road pursuant to the agreement.
9. Capital Stock:
Common Shares Available for Future Issuance
At September 30, 2004, we were required to reserve for issuance
approximately 6.6 billion shares of common stock calculated at the $0.020 price
per share on that date (or the discount therefrom as provided under applicable
exchange or conversion agreements). At September 30, 2004, the number of shares
required to be reserved for issuance exceeded the number of authorized but
unissued shares of our common stock. As a result, at our next stockholder
meeting, we intend to seek stockholder approval of an amendment to our Restated
Certificate of Incorporation to increase the number of authorized shares of
common stock. At September 30, 2004, we have been unable to satisfy valid
conversion, exchange and share issuance requests to issue approximately 157.6
million shares of our common stock because of an insufficient number of
authorized but unissued shares.
NCT Group, Inc. Preferred Stock
At September 30, 2004, we had one designation of issued and outstanding
preferred stock, our series H convertible preferred stock, consisting of 2,100
designated shares. We are obligated to register for resale shares of our common
stock issuable upon the conversion of the 1,752 issued and outstanding shares of
series H preferred stock at September 30, 2004. The series H preferred stock is
senior in rank to our common stock and has a liquidation value equal to the
dividends plus the stated value ($10,000 per share) in the case of our
liquidation, dissolution or winding up. The holder of our series H preferred
stock (Crammer Road) has no voting rights (except as may be required by law).
Each share of series H preferred stock is convertible into shares of our common
stock at 75% of the average closing bid price of our
17
common stock for the five-day trading period immediately preceding conversion.
Crammer Road is subject to a limitation on its percentage ownership of our
outstanding common stock. The series H preferred stock is redeemable by us in
cash at any time at a redemption price that is a function of the time between
the date the series H was originally issued and the redemption date. The
redemption price ranges from 85% of stated value (within three months of
issuance) to 120% of stated value (after nine months from issuance). On May 11,
2004, we issued 27 shares ($270,000 stated value) of our series H preferred
stock to Crammer Road for cash advanced in prior years of $230,000 less related
fees of $24,500. In connection with the issuance, a beneficial conversion
feature of $0.1 million was recorded as a reduction to the outstanding balance
of the preferred stock and an increase to additional paid-in capital. The
beneficial conversion feature was immediately amortized because the series H
preferred is eligible to be converted on the date of issuance. For the nine
months ended September 30, 2004, amortization of the beneficial conversion
feature on the series H preferred stock was $0.1 million. For the three and nine
months ended September 30, 2004, we calculated the 4% dividends earned by the
holder of the outstanding series H preferred stock at approximately $0.2 million
and $0.5 million, respectively. The amortization of beneficial conversion
feature and the dividend amount is included in the calculation of loss
attributable to common stockholders.
We received a request to convert 189 shares ($1,890,000 stated value) of
series H preferred stock plus accrued dividends into 52.5 million shares of our
common stock that we could not fulfill because of an insufficient number of
authorized but unissued shares of common stock. Under the Certificate of
Designations, Preferences and Rights governing the series H preferred stock and
incorporated into the June 21, 2002 exchange agreement pursuant to which these
shares were sold by us to Crammer Road, Crammer Road is entitled to (i)
compensation for late delivery of conversion shares of 1% of the stated value of
series H not converted ($18,900) per business day beginning March 4, 2004, the
12th business day after the conversion date; or (ii) ordinary contract breach
damages. In addition, if Crammer Road elects to purchase on the open market the
number of our common shares it should have been issued upon exchange of the
series H shares, Crammer Road is entitled to a payment equal to the excess, if
any, of the open market price over the conversion price. Neither of these
remedies has yet been demanded by Crammer Road. For the three and nine months
ended September 30, 2004, we recorded charges of $1.2 million and $2.7 million,
respectively, for non-conversion of series H preferred stock into our common
stock. The non-conversion charges and dividends are included in the calculation
of loss attributable to common stockholders.
We are obligated to register for resale shares of our common stock issuable
upon the conversion of the 1,752 issued and outstanding shares of series H
preferred stock at September 30, 2004. Pursuant to the terms of a registration
rights agreement with Crammer Road, we were obligated to file a registration
statement covering these shares no later than August 28, 2004. Because we do not
have a sufficient number of authorized shares of NCT common stock to issue these
shares, we have not been able to file a registration statement. As a result,
Crammer Road is entitled to liquidated damages at the rate of 2% per month of
the stated value of our outstanding series H preferred stock. For the three and
nine months ended September 30, 2004 this resulted in a charge to Additional
Paid In Capital of $0.4 million.
Artera Group, Inc. Preferred Stock
We are obligated to register for resale shares of our common stock issuable
upon the exchange of 4,276 shares of Artera series A preferred stock. For the
three and nine months ended September 30, 2004, we incurred charges of
approximately $0.1 million and $0.4 million, respectively, for non-registration
of the underlying shares of our common stock. Pursuant to the exchange rights
agreement, we have the option at any time to redeem any outstanding Artera
series A preferred stock by paying the holder cash equal to the aggregate stated
value of the preferred stock being redeemed (together with accrued and unpaid
dividends thereon). Pursuant to an exchange rights and release agreement dated
April 10, 2003, three holders of an aggregate of 3,154 shares of Artera series A
preferred stock received an additional right to exchange their shares into our
preferred stock (a series to be designated) thirty days after receipt of written
notice. In 2003, we received requests to exchange Artera series A preferred
stock into our common stock and have been unable to fulfill these requests. For
the three and nine months ended September 30, 2004, we calculated the 4%
dividends earned by holders of the Artera series A preferred stock at $0.1
million and $0.2 million, respectively. The non-registration charges and
dividends are included in the calculation of loss attributable to common
stockholders.
18
Transactions Affecting the Common Stock of Pro Tech Communications, Inc.
At March 31, 2004, NCT Hearing Products, Inc., our wholly-owned subsidiary,
owned approximately 82% of the outstanding Pro Tech Communications, Inc. common
stock. On April 5, 2004, NCT Hearing converted $0.6 million of its notes
receivable due from Pro Tech into 27,846,351 shares of Pro Tech common stock. In
addition, on April 6, 2004, NCT Hearing transferred 2,000,000 shares of its Pro
Tech common stock to outside consultants as consideration for consulting
services valued at approximately $46,000. On April 21, 2004, NCT Hearing
expanded its existing exclusive worldwide technology license with Pro Tech. As
consideration, NCT Hearing was issued 9,821,429 shares of Pro Tech common stock
valued at $0.3 million. As noted above in 2004, 40 shares of Pro Tech series B
preferred stock, plus accrued dividends, were converted into 2,522,042 shares of
Pro Tech common stock. At September 30, 2004, NCT Hearing held approximately 86%
of the outstanding Pro Tech common stock.
Options
During the nine months ended September 30, 2004, our Board of Directors
granted options and stock awards under the 2001 Stock and Incentive Plan (the
"2001 Plan") for an aggregate of 29,380,000 shares of our common stock at
exercise prices reflecting market prices on the dates of grant subject to
sufficient increases in the number of authorized shares of common stock and the
number under the 2001 plan (see Note 2) subject to stockholder approval of
sufficient increases in the number of shares of our common stock (i) authorized
and (ii) available for issuance under the 2001 plan. (i) At the time of such
stockholder approval, if the market value of our common stock exceeds the
exercise price of the subject options, the company will incur a non-cash charge
to earnings equal to the spread between the exercise price of the option and the
market price, times the number of options involved. If stockholder approval of
the increase is not obtained at an annual meeting of shareholders, options
granted will be reduced pro rata for the excess unauthorized shares and (ii)
upon such stockholder approval, if the market value of our common stock on that
date exceeds the market price on the award date, we will incur a non-cash charge
to earnings equal to the difference between the two market prices, times the
number of shares under the stock award. Of these grants, 27,380,000 were granted
to officers, directors and employees and 2,000,000 were granted as partial
consideration for consulting services. We estimated the fair value of these
consulting options using the following assumptions in applying the Black-Scholes
option pricing model: dividend yield of 0%; risk-free interest rate of 1.94%;
volatility of 100%; and an expected life of three and one-half years. For the
three and nine months ended September 30, 2004, we recorded charges for
consulting services of approximately $0.1 million and $0.2 million,
respectively, classified as selling, general and administrative expense. On
March 17, 2004, the Board of Directors deemed all options granted to directors,
officers and employees on September 10, 2003 as fully vested pending the
stockholder approval. Although the acceleration of vesting schedules was a
modification of the original grants, there was no accounting consequence because
the market price on the date of the modification was lower than the original
exercise price of the grants.
Warrants
During the nine months ended September 30, 2004, in conjunction with the
issuance of convertible notes, we issued to Carole Salkind warrants to acquire
an aggregate of 987,000,000 shares of our common stock at exercise prices
ranging from $0.020 to $0.053 per share. The fair value of these warrants was
approximately $24.0 million (determined using the Black-Scholes option pricing
model). Based upon the allocation of the relative fair values of the
instruments, we recorded a discount to the convertible notes issued to Carole
Salkind of $16.9 million during the nine months ended September 30, 2004.
19
10. Related Parties:
Carole Salkind
During the nine months ended September 30, 2004, we issued $60.1 million of
8% convertible notes due upon demand to Carole Salkind (see Note 6) along with
five-year warrants to acquire an aggregate of 987,000,000 shares of our common
stock (see Note 9). Consideration paid for these notes included approximately
$6.3 million cash and cancellation and surrender of notes aggregating
approximately $46.6 million, along with default penalty and accrued interest.
Carole Salkind has demanded, and we have agreed, that to the extent required in
connection with her security interests under our secured notes to her, we will
pay the legal fees she incurs as a result of legal matters (see Note 11).
Indebtedness of Former Management
On January 30, 2002, NCT's Chairman of the Board of Directors and Chief
Executive Officer, entered into a promissory note in the principal amount of
$29,510 to borrow funds from NCT in anticipation of cash overrides due under his
incentive compensation arrangement. The note matured on January 31, 2004. The
note bore interest at 5.75% per annum payable at maturity and default interest
at the stated rate plus 5%. The note plus accrued interest was paid in February
2004.
Effective April 30, 2004, Jonathan M. Charry, Ph.D. resigned from his
employment with us as our Senior Vice President, Corporate Development. On
various dates in 2000 and 2001, Dr. Charry had entered into short-term
promissory notes to borrow funds from us in anticipation of cash overrides due
him under his incentive compensation arrangement. As of May 1, 2002, the
borrowed funds had not been repaid but were consolidated with interest into an
outstanding promissory note due January 15, 2003 for a principal amount of
$107,960. The note bore interest at an annual rate of 6.0% through its due date
of January 15, 2003, and bears interest at prime plus 5% thereafter. This note
was not paid when due on January 15, 2003 and became past due. We continue to
seek collection on the May 1, 2002 note. In 2004, we recorded an allowance of
approximately $0.1 million for the portion of a May 1, 2002 note receivable from
Dr. Charry (plus accrued interest) exceeding the amount we owed to Dr. Charry.
Kambrium, AB
On May 20, 2004, we entered into a one-year consulting agreement with
Kambrium, AB, a Swedish consulting firm. Under this agreement, Kambrium is
assisting us in establishing distribution relationships, large end user sales,
resellers, capital funding, joint venture partners and private network
opportunities for our Artera Group business and our Artera Turbo product lines,
primarily in Scandinavia. We paid Kambrium an up-front, one-time engagement fee
of $32,800 to cover Kambrium's first-year expenses for their provision of
services to us. In addition, our agreement with Kambrium provides for future
pay-for-performance consideration that is generally based on a percentage of the
value of the revenue or funding received by us as a result of Kambrium's
efforts. Kambrium is currently developing several significant business prospects
for our Artera Group business and our Artera Turbo product lines. Dr. Charry was
engaged by Kambrium to provide Kambrium with product expertise to facilitate
Kambrium's efforts on our behalf.
Manatt Jones Global Strategies, LLC
On July 1, 2004, we entered into a sixteen-month consulting agreement with
Manatt Jones Global Strategies, LLC, a consulting firm. Under this agreement,
Manatt Jones is assisting us in establishing distribution relationships, large
end user sales, resellers, capital funding, joint venture partners and private
network opportunities for our Artera Group business and our Artera Turbo product
lines, primarily in Mexico, Latin America and Asia through the firm's extensive
contacts in those regions, but also in the United States and elsewhere through
the firm's extensive contacts in the Washington, D.C. area. For example, two of
the principals of Manatt Jones, one a former United States ambassador to Mexico
and the other a former United States ambassador to Malaysia, are currently
pursuing potential business opportunities on our behalf. Manatt Jones also
provides us with use of their Washington, D.C. and New
20
York City offices. Under this agreement, we pay a monthly fee of $16,250 to
Manatt Jones for these services. Manatt Jones recruited Dr Charry to serve as a
Managing Director in which capacity he is able to support Manatt Jones's efforts
on our behalf as a result of his availability and his experience with our Artera
Group business.
LightSpeed Networks, Inc.
On July 30, 2004, we entered into a two-year consulting agreement with
LightSpeed Networks, Inc., a consulting firm. Under this agreement, LightSpeed
will assist us, in particular Artera Group, in establishing distribution
relationships and securing capital, funding and joint ventures. Our agreement
with LightSpeed provides for future pay-for-performance consideration (after a
threshold is met) that is generally based on a percentage of the value of the
revenue or funding received by us as a result of LightSpeed's efforts. Dr.
Charry is the President and sole stockholder of LightSpeed. In addition, under
the agreement with LightSpeed, we agreed to waive the expiration of Dr. Charry's
options that otherwise would have expired three months after Dr. Charry's
resignation from NCT and to accelerate the vesting of any unvested options then
held by Dr. Charry, in order to provide Dr. Charry additional incentive to
further our business objectives through his efforts with LightSpeed, resulting
in a charge of $0.1 million.
Alpha Capital Aktiengesellschaft and Libra Finance, S.A.
In April 2003, we issued a convertible note in the aggregate principal
amount of $235,000 to Alpha Capital Aktiengesellschaft, a beneficial owner of
more than 5% of NCT common stock. The note matures on April 22, 2005 and bears
interest at 8% per annum. The note is convertible into shares of NCT common
stock at a conversion price per share of $0.04. We would be required to make
certain liquidating damages payments if we fail to effect a requested conversion
in a timely manner. We also have an obligation to register for resale the shares
of NCT common stock issuable upon conversion of the note.
In September 2003, we issued a convertible note in the aggregate principal
amount of $400,000 to Alpha Capital and an additional convertible note in the
aggregate principal amount of $40,000 to Libra Finance, S.A., a third party
finder and a beneficial owner of more than 5% of NCT common stock. The notes
mature on September 4, 2005 and bear interest at 8% per annum. The notes are
convertible into shares of NCT common stock at a conversion price per share of
80% of the average closing bid price of NCT common stock for the five trading
days prior to conversion. We would be required to make certain liquidating
damages payments if we fail to effect a requested conversion in a timely manner.
We also have an obligation to register for resale the shares of NCT common stock
issuable upon conversion of the note.
In July 2004, we issued a subordinated secured convertible note in the
aggregate principal amount of $400,000 to Alpha Capital and an unsecured
convertible note in the aggregate principal amount of $40,000 to Libra Finance,
as third party finder. The notes mature on July 23, 2006 and bear interest at 8%
per annum. The notes are convertible into shares of NCT common stock at a
conversion price per share equal to the lesser of $0.0232 or 80% of the average
closing bid price of NCT common stock for the five trading days prior to
conversion. We would be required to make certain payments if we fail to effect a
requested conversion in a timely manner. In connection with the issuance of the
note to Alpha Capital, we issued Alpha Capital five-year warrants to acquire
5,555,556 shares of NCT common stock at an exercise price per share equal to the
conversion price of the note. We also have an obligation to register for resale
the shares of NCT common stock issuable upon conversion of the notes and
exercise of the warrants.
Indemnification of Management
In January 2004, we agreed to indemnify five of our directors and officers
for any liabilities that may arise against them in a lawsuit brought in Delaware
against them, NCT and NCT's subsidiary Distributed Media Corporation by
Production Resource Group ("PRG") and to provide them with legal representation
in the suit. This Delaware suit is separate from but related to the Connecticut
suits brought by PRG (see Note 11).
21
In May 2004, we agreed to indemnify our Chairman and Chief Executive
Officer for any liabilities that may arise against him in a lawsuit brought in
Connecticut against him, NCT and NCT's subsidiaries Midcore Software, Inc. and
Artera Group, Inc. by Jerrold Metcoff and David Wilson and to provide him with
legal representation in the suit (see Note 11).
11. Litigation:
Production Resource Group Litigation
On June 6, 2001, PRG brought suit in Connecticut state court against us and
our subsidiary, Distributed Media Corporation ("DMC"), for breach of agreements
and instruments relating to the lease of some Sight & Sound(R) equipment. On
December 20, 2001, NCT and DMC accepted an Offer of Judgment in the suit
requiring NCT and DMC to pay PRG $2.0 million. On January 2, 2002, outside the
scope of that judgment, PRG amended its complaint to allege that Michael
Parrella (our Chairman and Chief Executive Officer), in dealing with PRG on our
behalf, committed breaches of good faith and fair dealing, unfair trade
practices and fraud. On or about December 15, 2003, PRG brought suit in Delaware
state court against NCT, DMC, Michael Parrella, Irene Lebovics (our President
and a Director), John McCloy II (a Director) and Sam Oolie (a Director). On or
about May 14, 2004, PRG brought a second suit in Connecticut state court, this
one against NCT and Carole Salkind (a secured lender to NCT), alleging
fraudulent transfers in connection with certain collateral Ms. Salkind has for
her loans to NCT.
In the first Connecticut case, in the portion against NCT and DMC, on
February 25, 2004 we surrendered our 5,876 shares of common stock of our
subsidiary, NCT Audio Products, Inc., representing 100% of the issued and
outstanding shares of NCT Audio, for possible sale for the benefit of PRG. This
surrender may adversely affect our right to any further proceeds from the
TSA/TST bankruptcy estate, in which NCT Audio is a creditor with a continuing
interest under the plan of reorganization approved by the court in the
bankruptcy case. At the same time, DMC surrendered DMC's 20,000 shares of common
stock of our subsidiary, DMC Cinema, Inc., representing 84% of the issued and
outstanding shares of DMC Cinema, its 100 shares of common stock of our
subsidiary, Health Radio Network, Inc. (f/k/a DMC HealthMedia Inc.),
representing 100% of the issued and outstanding shares of Health Radio Network,
a $153,956 principal amount promissory note from (and related security agreement
with) DMC Cinema and a $1,388,666 principal amount promissory note from (and
related security agreement with) Health Radio Network, for possible sale for the
benefit of PRG. We reported to the court that all of the other equity and debt
securities we own could not be surrendered because they are covered by security
interests in favor of Carole Salkind and are in her possession. On June 4, 2004,
PRG filed a motion for an Order in Aid of Execution (i) authorizing PRG to
institute collections proceedings and property executions against subsidiaries
of NCT and DMC for amounts owed to NCT and DMC under intercompany notes and
licenses, (ii) authorizing PRG to institute collections proceedings and
executions directly against others owing money to NCT and DMC and to their
subsidiaries (e.g., licensees paying royalties), (iii) prohibiting intercompany
transfers of cash or other assets among NCT, DMC and their subsidiaries and (iv)
compelling additional post-judgment discovery disclosures by NCT and DMC. A
hearing on the motion was held on August 2, 2004 but was adjourned pending
submission of additional briefs on issues (i) and (ii) above. Those briefs were
submitted in early September 2004. On October 27, 2004, the Court denied PRG's
motion on issues (i) and (ii) above. The Court's ruling on issues (iii) and (iv)
above has not yet been issued. Carole Salkind has demanded, and we have agreed,
that to the extent required in connection with her security interests under our
secured convertible notes to her, we will pay the legal fees she incurs as a
result of PRG's efforts to collect on its judgment against NCT in this
Connecticut action. At September 30, 2004, approximately $20,000 in such legal
fees have been incurred by Carole Salkind and will be paid by NCT. At December
31, 2003, the net liabilities included in our condensed consolidated balance
sheet related to NCT Audio, DMC Cinema and Health Radio Network were $16.1
million, $4.9 million and $1.7 million, respectively. At September 30, 2004, the
net liabilities included in our condensed consolidated balance sheet related to
NCT Audio, DMC Cinema and Health Radio Network were $15.1 million, $5.0 million
and $2.1 million, respectively. For the nine months ended September 30, 2003,
the net earnings (loss) before income taxes included in our condensed
consolidated statement of operation related to NCT Audio, DMC Cinema and Health
Radio Network were $1.8 million, less than $(0.1) million and $(0.4) million,
respectively. For the nine months ended September 30, 2004, the net earnings
(loss) before
22
income taxes included in our condensed consolidated statement of operation
related to NCT Audio, DMC Cinema and Health Radio Network were $1.1 million,
$(0.1) million and $(0.4) million, respectively.
In the first Connecticut case, in the portion against Michael Parrella (as
to which we have agreed to indemnify Mr. Parrella), on March 11, 2004 the court
denied Mr. Parrella's motion to dismiss all then remaining claims against him in
the case. On October 25, 2004, shortly before trial was scheduled to begin on
these remaining claims, PRG withdrew its complaint against Mr. Parrella without
prejudice. No payment was made or agreed to be made by Mr. Parrella to PRG in
connection with this withdrawal.
In the Delaware case, on January 6, 2004, PRG amended its Delaware
complaint to add Cy Hammond (Chief Financial Officer and, as of March 17, 2004,
a Director of NCT) as a defendant. On or about March 30, 2004, PRG again amended
its complaint, this time to refine and expand some of its claims relating to the
alleged mismanagement of the affairs of NCT and its subsidiaries (including
DMC). PRG's complaint as amended alleges that NCT and DMC are insolvent, that
during the insolvency the individual defendants owe a fiduciary duty to PRG as a
judgment creditor of NCT and DMC in the Connecticut litigation described above,
and that they breached that duty. The amended complaint seeks money damages
against the individual defendants in an amount at least equal to the amount of
the Connecticut judgment described above remaining unsatisfied and the
appointment of a receiver over the business and assets of NCT and DMC. On
February 13, 2004, the defendants filed a motion to dismiss all claims in this
case. On April 12, 2004, the defendants amended their motion to dismiss. We have
agreed to indemnify the individual defendants, to the extent permitted by our
Certificate of Incorporation and applicable law, for any liabilities (including
legal fees) they may incur as a result of the PRG claims against them in this
Delaware action. On February 25, 2004 and May 5, 2004, our director and officer
indemnification insurers, respectively, initially denied coverage. We intend to
challenge the initial indemnification insurance denials if our amended motion to
dismiss all claims in the case is denied. Discovery in the action has begun. A
hearing on the defendants' amended motion to dismiss (and on some discovery
motions by plaintiff) occurred September 20, 2004. NCT and DMC intend, and the
individual defendants have told us that they intend, to deny and defend against
all allegations remaining after the court's decision on the amended motion to
dismiss.
In the second Connecticut case, PRG seeks to have the court void our
transfer of possession of stock certificates and promissory notes we held to
Carole Salkind (who has security interests in such assets), so that the
certificates and notes, once returned, may be subject to judicial process in
PRG's first Connecticut case, described above. In addition, PRG seeks to have
the court re-characterize Salkind's secured loans to us as equity rather than
debt, which would give PRG greater rights against the secured assets in the
first Connecticut case. PRG seeks, in the alternative, to have the court
subordinate the Salkind debt to our debts to other creditors (including PRG),
again increasing PRG's rights against these assets in the first Connecticut
case. PRG also seeks compensatory damages, punitive damages and attorneys' fees,
all in unspecified amounts. We intend to deny all of the material allegations
against us in the suit and to defend the suit vigorously. Ms. Salkind has told
us that she intends to deny all of the material allegations against her in the
suit and defend herself in the suit vigorously. Ms. Salkind has demanded, and we
have agreed, that to the extent required in connection with her security
interests under our secured convertible notes to her, we will pay the legal fees
she incurs as a result of the PRG claims in this second Connecticut action. At
September 30, 2004, approximately $2,000 in such legal fees have been incurred
by Carole Salkind and will be paid by NCT.
Founding Midcore Shareholder Litigation
On or about April 16, 2004, Jerrold Metcoff and David Wilson filed a
complaint against NCT, its subsidiaries, Midcore Software, Inc. and Artera
Group, Inc., and its Chairman and Chief Executive Officer, Michael Parrella, in
the Superior Court for the Judicial District of Waterbury, Connecticut. On or
about June 17, 2004, Messrs. Metcoff and Wilson amended their complaint to add
claims against the existing defendants relating primarily to their dealings with
Carole Salkind and, in a related filing on July 12, 2004, asked the court for
permission to add Ms. Salkind as a defendant. On October 26, 2004, the Court
granted the permission to add Carole Salkind as a defendant. This action arose
out of the August 29, 2000 Agreement and Plan of Merger pursuant to which
Messrs. Metcoff, Wilson and others sold to us 100% of the outstanding shares of
a corporation that was merged into and became Midcore Software, Inc.
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A look-back provision in the agreement requires us to issue additional shares of
our common stock to Messrs. Metcoff and Wilson to guarantee a fixed value to a
prior share issuance by us that served as partial consideration under the
agreement. Under the formula in the agreement, we are required to issue
26,193,025 shares for the look-back. In addition, the agreement provides for a
minimum royalty amount through August 29, 2003, with a payment of cash or shares
of common stock by us to reach the minimum amount for that date. On September
23, 2003, Messrs. Metcoff and Wilson elected to receive this royalty payment in
shares. Under the formula in the agreement, we are required to issue 34,166,551
shares for the royalty payment. We did not issue any of the total of 60,359,576
shares to Messrs. Metcoff or Wilson. After demand for the shares was made, the
parties attempted to reach a settlement of this matter, but with no settlement
reached, Messrs. Metcoff and Wilson brought this action. The complaint, as
amended, alleges breaches of the August 29, 2000 agreement and related improper
acts and omissions, including (i) our failure to issue the look-back and royalty
shares; (ii) breach by NCT and Midcore of representations and warranties in or
relating to the agreement; (iii) "unjust enrichment" of Artera in its use of
intellectual property owned by the entity that became Midcore; (iv)
misrepresentations by Mr. Parrella in connection with the agreement and the
operation of Midcore since August 29, 2000; (v) tortious interference by Artera
and Mr. Parrella with Messrs. Metcoff's and Wilson's contractual relations with
NCT and Midcore; (vi) our failure to deliver documents pertaining to resales by
Messrs. Metcoff and Wilson of the shares of our common stock they did receive
under the August 29, 2000 agreement and (vii) fraudulent transfers and civil
conspiracy of NCT and Ms. Salkind in a number of our financing transactions and
in the treatment of our assets constituting collateral in such financings. The
complaint, as amended, seeks damages, punitive damages, interest and attorneys'
fees, all in unspecified amounts. On July 2, 2004, NCT, Midcore, Artera and Mr.
Parrella filed a motion to strike a number of the claims against them in the
amended complaint. A hearing on that motion is scheduled for November 22, 2004.
On July 6, 2004, the case was transferred to Connecticut's Complex Litigation
Docket in Waterbury. On September 24, 2004, the plaintiffs filed an application
for a prejudgment attachment and garnishment of the assets of NCT, Midcore and
Mr. Parrella to the extent of $4,200,000, which they asserted is likely to be
the amount of a judgment in their favor in the case. NCT and Midcore intend, and
Mr. Parrella has told us that he intends, to object to this application.
Discovery in the case has begun. We have agreed to indemnify Mr. Parrella, to
the extent permitted by our Certificate of Incorporation and applicable law, for
any liabilities (including legal fees) Mr. Parrella may incur as a result of the
claims against him in this action. We have submitted the claims against Mr.
Parrella to its director and officer indemnification insurance carrier, but the
carrier has not yet responded to confirm or initially deny coverage. Carole
Salkind has demanded, and we have agreed, that to the extent required in
connection with her security interests under our secured notes to her, we will
pay the legal fees she incurs as a result of the claims in this action. At
September 30, 2004, approximately $1,000 in such legal fees have been incurred
by Carole Salkind and will be paid by NCT. With respect to all claims remaining
after the court's decision on the motion to strike described above, we intend to
defend against all claims against us in the action and Midcore and Artera intend
to deny and defend against all claims against them in the action. Mr. Parrella
has told us that he intends to deny and defend against all claims against him in
the action. Ms. Salkind has told us that, if she is served as a defendant under
the amended complaint, she intends to deny and defend against all claims against
her therein.
Reference is made to our Annual Report on Form 10-K for the year ended
December 31, 2003, for further information regarding the foregoing as well as
other litigation related matters. We believe there are no other patent
infringement claims, litigation, matters or unasserted claims other than the
matters discussed above or in our most recent Form 10-K that could have a
material adverse effect on our financial position and results of operations.
12. Segment Information:
NCT is organized into three operating segments: communications, media and
technology. To reconcile the reportable segment data to the condensed
consolidated financial statements, we capture other information in two
categories: other-corporate and other-consolidating. Other-corporate consists of
items maintained at our corporate headquarters and not allocated to the
segments. This includes most of our debt and related cash and equivalents and
related net interest expense, some litigation liabilities and non-operating
fixed assets. Also included in the components of revenue attributed to
other-corporate are license fees and royalty revenue from subsidiaries, which
are offset (eliminated) in the other-consolidating column.
24
Other-consolidating consists of items eliminated in consolidation, such as
intercompany revenue.
During the three and nine months ended September 30, 2004, no geographic
information for revenue from external customers or for long-lived assets is
disclosed, as our primary markets and capital investments were concentrated in
the United States.
Reportable segment data for the three and nine months ended September 30,
2004 and September 30, 2003 is as follows (in thousands):
For the three months ended Communi- Reportable --------- Other --------- Grand
September 30, 2004: cations Media Technology Segments Corporate Consolidating Total
- ------------------------------------- --------------------------------------------------------------------------------------------
License fees and royalties - external $ 432 $ 535 $ 15 $ 982 $ - $ - $ 982
Other revenue - external 418 39 - 457 - - 457
Other revenue - other operating
segments 303 3 - 306 14 (320) -
Net (loss) income 1,796 (1,014) 83 865 (11,881) 602 (10,414)
For the three months ended Communi- Reportable --------- Other --------- Grand
September 30, 2003: cations Media Technology Segments Corporate Consolidating Total
- ------------------------------------- --------------------------------------------------------------------------------------------
License fees and royalties - external $ 160 $ 535 $ 14 $ 709 $ 2 $ - $ 711
Other revenue - external 440 39 - 479 - - 479
Other revenue - other operating
segments 266 3 - 269 1 (270) -
Net (loss) income (2,398) (897) 26 (3,269) 361 596 (2,312)
For the three months ended Communi- Reportable --------- Other --------- Grand
September 30, 2004: cations Media Technology Segments Corporate Consolidating Total
- ------------------------------------- --------------------------------------------------------------------------------------------
License fees and royalties - external $ 914 $ 1,605 $ 146 $ 2,665 $ - $ - $ 2,665
Other revenue - external 1,288 120 - 1,408 1,408
Other revenue - other operating
segments 886 5 - 891 342 (1,233) -
Net (loss) income (3,714) (2,982) 140 (6,556) (31,441) 1,795 (36,202)
For the three months ended Communi- Reportable --------- Other --------- Grand
September 30, 2003: cations Media Technology Segments Corporate Consolidating Total
- ------------------------------------- --------------------------------------------------------------------------------------------
License fees and royalties - external $ 396 $ 1,605 $ 14 $ 2,015 $ 7 $ - $ 2,022
Other revenue - external 1,317 83 - 1,400 - - 1,400
Other revenue - other operating
segments 802 6 - 808 170 (978) -
Net (loss) income (8,367) (2,440) 84 (10,723) (8,070) 1,789 (17,004)
13. Subsequent Events:
On October 1, 2004, we issued Ms. Salkind an 8% convertible note in the
principal amount of $0.4 million, for which Ms. Salkind paid us $0.4 million in
cash. The note is due April 1, 2005 and may be converted into our common stock
(at $0.020 per share) and exchanged for shares of common stock of any of our
subsidiaries (except Pro Tech) that makes a public offering of its common stock
(at the public offering price). In conjunction with this note issuance, we
issued Ms. Salkind a five-year warrant to acquire 6.75 million shares of our
common stock at an exercise price per share of $0.020. The relative estimated
fair value of the warrant will be reflected as original issue discount to the
note and amortized as interest expense over the term of the note.
On October 15, 2004, we issued Ms. Salkind an 8% convertible note in the
principal amount of $0.425 million, for which Ms. Salkind paid us $0.425 million
in cash. The note is due April 15, 2005 and may be converted into our common
stock (at $0.019 per share) and exchanged for shares of common stock of any our
subsidiaries (except Pro Tech) that makes a public offering of its common stock
(at the public offering price). In conjunction with this note issuance, we
issued Ms. Salkind a five-year warrant to acquire 7.5 million shares of our
common stock at an exercise price per share of $0.019. The relative
25
estimated fair value of the warrant will be reflected as original issue discount
to the note and amortized as interest expense over the term of the note.
On October 21, 2004, we issued Carole Salkind an 8% convertible note in the
principal amount of approximately $0.5 million to cure our default under a
demand note dated June 16, 2004. On October 19, 2004, Ms. Salkind made a demand
for payment of the note. The principal amount of the October 21, 2004 note
represents the principal rolled over ($0.425 million), default penalty (10% of
the principal in default) and accrued interest. The note is due April 21, 2005
and may be converted into our common stock at a conversion price per share of
$0.019 and exchanged for shares of common stock of any of our subsidiaries
(except Pro Tech) that makes a public offering of its common stock (at the
public offering price). In conjunction with this note issuance, we issued Ms.
Salkind a five-year warrant to acquire 8.0 million shares of our common stock at
an exercise price per share of $0.019. The relative estimated fair value of the
warrant will be reflected as original issue discount to the note and amortized
as interest expense over the term of the note
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Caution Concerning Forward-Looking Statements
This report contains forward-looking statements, in accordance with Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, that reflect our current estimates,
expectations and projections about our future results, performance, prospects
and opportunities. Forward-looking statements include all statements that are
not historical facts. These statements are often identified by words such as
"anticipate," "believe," "could," "estimate," "expect," "intend," "plan," "may,"
"should," "will," "would" and similar expressions. These forward-looking
statements are based on information currently available to us and are subject to
numerous risks and uncertainties that could cause our actual results,
performance, prospects or opportunities to differ materially from those
expressed in, or implied by, the forward-looking statements we make in this
report. Important factors that could cause our actual results to differ
materially from the results referred to in the forward-looking statements we
make in this report include:
o our ability to generate sufficient revenues to sustain our current level of
operations and to execute our business plan;
o our ability to obtain additional financing if and when necessary;
o the level of demand for our products and services;
o the level and intensity of competition in our industries;
o our ability to develop new products and the market's acceptance of these
products;
o our ability to maintain and expand our strategic relationships;
o our ability to protect our intellectual property;
o difficulties or delays in manufacturing;
o our ability to effectively manage our operating costs;
o our ability to attract and retain key personnel; and
o additional factors discussed in our Annual Report on Form 10-K for the year
ended December 31, 2003 and our other filings with the Securities and
Exchange Commission.
You should not place undue reliance on any forward-looking statements.
Except as otherwise required by federal securities laws, we undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events, changed circumstances or any
other reason after the date of this report.
All references to years, unless otherwise noted, refer to our fiscal year,
which ends on December 31. All references to quarters, unless otherwise noted,
refer to the quarters of our fiscal year.
26
Overview
NCT designs products and develops and licenses technologies based upon our
portfolio of patents and related proprietary rights and extensive technological
know-how. Our business operations are organized into three operating segments:
communications, media and technology. Our operating revenue is comprised of
technology licensing fees and royalties, product sales, advertising and
engineering and development services. Operating revenue for the nine months
ended September 30, 2004 consisted of approximately 65.4% in technology
licensing fees and royalties, 31.9% in product sales, 2.5% in advertising and
0.2% in engineering and development. The mix of our revenue sources during any
reporting period may have a material impact on our results of operations. In
particular, our execution of technology licensing agreements and the timing of
the revenue recognized from these agreements has not been predictable.
We have continued our practice of marketing our technologies through
licensing to third parties for fees, generally by obtaining technology license
fees when initiating strategic relationships with new partners, and subsequent
royalties. We have entered into a number of licensing agreements with
established firms for the integration of our technologies into their products.
The speed with which we can achieve the commercialization of our technologies
and subsequently receive royalties depends, in part, upon the time taken by
these firms for product testing and their assessment of how best to integrate
our technology into their products and manufacturing operations. While we work
with these firms on product testing and integration, we are not always able to
influence how quickly this process can be completed and a resulting revenue
stream can be generated. Currently, we are selling products through several of
our licensees, including Oki, which is integrating our ClearSpeech(R) algorithms
into large scale integrated circuits for communications applications, Sharp,
which is incorporating our ClearSpeech(R) adaptive speech filter algorithm into
third-generation cellular telephones and STMicroelectonics, which is integrating
our T2J microprocessor core into smart card applications.
Going Concern Risks
Since inception, we have experienced substantial recurring losses from
operations, which amounted to $326.1 million on a cumulative basis through
September 30, 2004. Internally generated funds from our revenue sources have not
been sufficient to cover our operating costs. The ability of our revenue
sources, especially technology license fees, royalties, product sales and
advertising, to generate significant cash for our operations is critical to our
long-term success. We cannot predict whether we will be successful in obtaining
market acceptance of our new products or technologies or in completing our
current licensing agreement negotiations. To the extent our internally generated
funds are not adequate, our management believes we will need to obtain
additional working capital through equity and/or debt financings. However, we
can give no assurance that any additional financing will be available to us on
acceptable terms or at all. In addition, in order to obtain additional financing
through the sale of shares of our common stock, we will need to obtain the
approval of our stockholders of an amendment to our certificate of incorporation
to sufficiently increase the number of authorized shares of our common stock.
However, we can give no assurance that our stockholders would approve a
sufficient increase in our authorized shares of common stock.
Our management believes that currently available funds will not be
sufficient to sustain our operations at current levels through the next six
months. These funds consist of available cash and the funding derived from our
revenue sources. Cash and cash equivalents amounted to $0.8 million at September
30, 2004 and our working capital deficit was $65.0 million. We have been able to
continue our operations by raising additional capital. We have been primarily
dependent upon funding from Carole Salkind in 2003 and to date in 2004. In the
event that external financing is not available or timely, we will be required to
substantially reduce our level of operations in order to conserve cash. These
reductions could have an adverse effect on our relationships with our customers
and suppliers. Reducing operating expenses and capital expenditures alone may
not be adequate, and continuation as a going concern is dependent upon the level
of funding realized from our internal and external funding sources, all of which
are currently uncertain.
27
Our condensed consolidated financial statements have been prepared assuming
that we will continue as a going concern, which contemplates continuity of
operations, realization of assets and satisfaction of liabilities in the
ordinary course of business. Our ability to continue as a going concern is
dependent upon, among other things, the achievement of future profitable
operations and the ability to generate sufficient cash from operations, equity
and/or debt financings and other funding sources to meet our obligations. The
uncertainties described in the preceding paragraphs raise substantial doubt at
September 30, 2004 about our ability to continue as a going concern. Our
accompanying condensed consolidated financial statements do not include any
adjustments relating to the recoverability of the carrying amount of recorded
assets or the amount of liabilities that might result from the outcome of these
uncertainties.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires our management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of contingent assets
and liabilities. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis of making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting
estimate to be made based upon assumptions about matters that are highly
uncertain at the time the estimate is made, and if different estimates that
reasonably could have been used, or changes in the accounting estimates that are
reasonably likely to occur periodically, could materially impact the financial
statements. Management believes the following critical accounting policies
reflect its more significant estimates and assumptions used in the preparation
of the condensed consolidated financial statements. Additional information
regarding our critical accounting policies and significant accounting policies
is contained in our filings with the Securities and Exchange Commission,
including our Annual Report on Form 10-K for the year ended December 31, 2003.
Revenue Recognition
Revenue is recognized when earned. Technology licensing fees are generally
recognized upon execution of the agreement but are deferred if subject to
completion of any performance criteria and later recognized once the performance
criteria have been met. Revenue from royalties is recognized ratably over the
royalty period based upon periodic reports submitted by the royalty obligor or
based on minimum royalty requirements. Revenue from product sales is recognized
when the product is shipped and title has passed. Revenue from subscription
services (included in product sales) is deferred and recognized ratably over the
period when the service is provided (subscription period). Revenue from
advertising sales is recognized when the advertisements are aired or displayed.
Revenue from engineering and development services is generally recognized and
billed as the services are performed. The mix of our revenue sources during any
reporting period may have a material impact on our results of operations. In
particular, our execution of technology licensing agreements and the timing of
the revenue recognized from these agreements has not been predictable. Our
preference is to collect amounts due from the sale of our technologies, services
and products in cash. However, from time to time, receivables may be settled by
securities transferred to us by the customer in lieu of cash payment.
At September 30, 2004, our deferred revenue aggregated $1.4 million. We do
not expect to realize any additional cash in connection with recognizing revenue
from our deferred revenue.
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Goodwill, Patent Rights, Other Intangible Assets
The excess of the consideration paid over the fair value of net assets
acquired in business combinations is recorded as goodwill. We also record
goodwill upon the acquisition of some or all of the stock held by minority
stockholders of a subsidiary, except where such accounting is, in substance, the
purchase of licenses previously sold to such minority stockholders or their
affiliates.
Annually, or if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
amount, we test our goodwill for impairment. We also recognize an impairment
loss on goodwill acquired upon the acquisition of stock held by minority
stockholders of subsidiaries if the subsidiary's minority interest has no
carrying value, the subsidiary has a capital deficit and the projected future
operating results of the subsidiary are not positive. At December 31, 2003, we
evaluated the goodwill allocated to our Advancel reporting unit, NCT Hearing
reporting unit and Midcore/Artera reporting unit and determined no impairment
existed. Our next annual evaluation is planned for December 31, 2004. At
September 30, 2004, our goodwill, net was $7.2 million.
Patent rights and other intangible assets with finite useful lives, which
includes the cost to acquire rights to patents and other rights under licenses,
are stated at cost and amortized using the straight-line method over the
remaining useful lives, ranging from one to seventeen years. Amortization
expense for the nine months ended September 30, 2003 and 2004 was $0.2 million
and $0.1 million, respectively.
We evaluate the remaining useful life of intangible assets with finite
useful lives each reporting period to determine whether events and circumstances
warrant a revision to the remaining period of amortization. If the evaluation
determines that the intangible asset's remaining useful life has changed, the
remaining carrying amount of the intangible asset is amortized prospectively
over that revised remaining useful life. We evaluate our intangible assets with
finite useful lives for impairment whenever events or other changes in
circumstances indicate that the carrying amount may not be recoverable. The
testing for impairment includes evaluating the undiscounted cash flows of the
asset and the remaining period of amortization or useful life. The factors used
in evaluating the undiscounted cash flows include: current operating results,
projected future operating results and cash flows and any other material factors
that may effect the continuity or the usefulness of the asset. If impairment
exists, the intangible asset is written down to its fair value based upon
discounted cash flows. At September 30, 2004, our patent rights and other
intangibles, net were $1.1 million.
Results of Operations
Three months ended September 30, 2004 compared to three months ended September
30, 2003.
Revenue. Total revenue for the three months ended September 30, 2004 was
$1.4 million as compared to $1.2 for same period in 2003. Total revenue for the
three months ended September 30, 2004 consisted of approximately 68.2% in
technology licensing fees and royalties, 29.0% in product sales, 2.4% in
advertising revenue and 0.4% in engineering and development services as compared
to the three months ended September 30, 2003 of approximately 59.7% in
technology licensing fees and royalties, 37.5% in product sales and 2.8% in
advertising.
Technology licensing fees and royalties were $1.0 million for the three
months ended September 30, 2004 as compared to $0.7 million for the same period
in 2003, an increase of $0.3 million, or 42.9%. This increase was due primarily
to royalties resulting from the license of our ClearSpeech(R) adaptive speech
filter algorithm to Sharp for use in third generation cellular phones and the
license of our ClearSpeech(R) algorithms to Oki for use in large scale
integrated circuits for communications applications. Our recognition of license
fee revenue for both periods was due primarily to recognition of deferred
revenue from the New Transducers Ltd. ("NXT") license. At September 30, 2004,
our deferred revenue related to NXT was $1.1 million. No additional cash will be
realized from our deferred revenue.
For each of the three months ended September 30, 2004 and 2003, product
sales were $0.4 million. Gross profit on product sales, as a percentage of
product sales, for the three months ended
29
September 30, 2004 and 2003 was 53.8% and 51.8%, respectively. For the three
months ended September 30, 2004 and 2003, 92% of our product sales were
attributable to our communications segment. The mix of our product sales within
the communications segment for the three months ended September 30, 2004
included 73% of Pro Tech products and 23% of Artera Turbo subscriptions whereas
the same period in the prior year included 72% of Pro Tech products and 2% of
Artera Turbo subscriptions. Our subscriber base that generated the Artera Turbo
product sales for the three months ended September 30, 2004 consisted of
residential and small business users.
Advertising revenue was $35,000 for the three months ended September 30,
2004 compared to $33,000 for the same period in 2003. Health Radio Network
(shares of which were surrendered in the PRG litigation - see Note 11 - notes to
the condensed consolidated financial statements) is the business responsible for
the sale of audio and visual advertising in healthcare venues employing our
Sight & Sound(R) systems and contributed 100% of total advertising revenue for
both periods.
Costs and expenses. Total costs and expenses for the three months ended
September 30, 2004 were $11.9 million compared to $3.5 million for the same
period in 2003, an increase of $8.4 million, or 240%, due primarily to an $8.3
million increase in interest expense.
For the three months ended September 30, 2004, selling, general and
administrative expenses totaled $2.6 million as compared to $3.1 million for the
three months ended September 30, 2003, a decrease of $0.5 million, or 16.1%.
This decrease was due primarily to a $0.8 million decrease in consulting expense
resulting from decreased non-cash charges from the issuance of options during
the three months ended September 30, 2004.
For each of the three months ended September 30, 2004 and September 30,
2003, research and development expenditures totaled $0.9 million due primarily
to Artera Turbo research and development efforts including the development of
other components of our Artera Turbo product offering.
For the three months ended September 30, 2004, other (income)/expense, net
totaled ($3.2) million as compared to ($3.6) million for the three months ended
September 30, 2003, an increase of $0.4 million, or 11.1%. The increase was due
primarily to a $0.7 million increase in default penalties on convertible notes
partially offset by a decrease of $0.3 million in finance costs associated with
non-registration of common shares underlying convertible notes. The three months
ended September 30, 2004 includes a $4.6 million gain on the dissolution and
liquidation of Artera Group International Limited and the three months ended
September 30, 2003 included gains on the settlement of lawsuits in the amount of
$4.9 million.
For the three months ended September 30, 2004, interest expense, net
totaled $11.4 million as compared to $3.1 million for the three months ended
September 30, 2003, an increase of $8.3 million, or 268%. The increase in
interest expense was attributable to the amortization of the relative fair value
of warrants (original issue discounts and beneficial conversion features)
allocated to the related debt. Interest expense for the three months ended
September 30, 2004 included amortization of original issue discounts of $5.0
million, amortization of beneficial conversion features in convertible debt of
$5.1 million, and interest on convertible debt issued by us of $1.1 million.
Nine months ended September 30, 2004 compared to nine months ended September 30,
2003.
Revenue. For the nine months ended September 30, 2004, total revenue
amounted to $4.1 million, compared to $3.4 million for nine months ended
September 30, 2003, an increase of $0.7 million, or 20.6 %, due primarily to
increases in our technology licensing fees and royalties. Total revenue for the
nine months ended September 30, 2004 consisted of approximately 65.4% in
technology licensing fees and royalties, 31.9% in product sales and 2.5% in
advertising as compared to the nine months ended September 30, 2003 of
approximately 59.1% in technology licensing fees and royalties, 38.6% in product
sales, 1.5% in advertising and 0.7 % in engineering and development services.
Technology licensing fees and royalties were $2.7 million for the nine
months ended September
30
30, 2004 as compared to $2.0 million for the same period in 2003, an increase of
$0.7 million, or 35.0%. The increase was due primarily to an increase in
royalties resulting from the license of our ClearSpeech(R) adaptive speech
filter algorithm to Sharp for use in third generation cellular phones. In
addition, our technology license fees increased by $0.1 million resulting from
the cross-release agreement with Infinite Technology Corporation (see Note 3 -
notes to the condensed consolidated financial statements). The technology
licensing fees for the nine months ended September 30, 2004 and 2003 were due
primarily to the recognition of deferred revenue from the NXT license. As of
September 30, 2004, our deferred revenue for NXT was $1.1 million. No additional
cash will be realized from our deferred revenue balance.
For each of the nine months ended September 30, 2004 and 2003, product
sales were $1.3 million. Gross profit on product sales, as a percentage of
product sales, for the nine months ended September 30, 2004 and 2003 was 51.4%
and 54.4%, respectively. For the nine months ended September 30, 2004 and 2003,
92% and 94%, respectively, of our product sales were attributable to our
communications segment. The mix of our product sales within the communication
segment for the nine months ended September 30, 2004 included 65% of Pro Tech
products and 19% of Artera Turbo subscriptions whereas the same period in the
prior year included 72% of Pro Tech products and 1% of Artera Turbo
subscriptions. Our subscriber base that generated the Artera Turbo product sales
for the nine months ended September 30, 2004 consisted of residential and small
business users. On March 22, 2004, Avaya Inc. announced it is offering our
product within its Network Bandwidth Optimization software solution to
enterprise subscribers (businesses with 250 or more users) under a marketing and
distribution agreement that, as amended, expires on October 14, 2005. At
September 30, 2004, we had no enterprise subscribers.
Advertising revenue was $103,000 for the nine months ended September 30,
2004 compared to $53,000 for the same period in 2003. Health Radio Network
(shares of which were surrendered in the PRG litigation - see Note 11 - notes to
the condensed consolidated financial statements) is the business responsible for
the sale of audio and visual advertising in healthcare venues employing our
Sight & Sound(R) systems and contributed 100% of total advertising revenue for
both periods.
Costs and expenses. Total costs and expenses for the nine months ended
September 30, 2004 were $40.3 million compared to $20.4 million for the same
period in 2003, an increase of $19.9 million, or 98%, due to a $19.7 million
increase in interest expense, net and a $2.9 million increase in other
(income)/expense, net, partially offset by a $3.3 million decrease in selling,
general and administrative expenses.
Cost of product sales was $632,000 for the nine months ended September 30,
2004 and $603,000 for the nine months ended September 30, 2003. The increase
resulted from an expansion of our Artera Turbo data centers. Cost of advertising
revenue was $12,000 for the nine months ended September 30, 2004 compared to
$9,000 for the same period in 2003. These costs included the commissions paid to
advertising representative companies and agencies and communication expenses
related to the Sight & Sound(R) locations in commercial and healthcare venues.
For the nine months ended September 30, 2004, selling, general and
administrative expenses totaled $6.8 million as compared to $10.1 million for
the nine months ended September 30, 2003, a decrease of $3.3 million, or 32.7%.
This decrease was due primarily to a $3.4 million decrease in consulting expense
resulting from decreased non-cash charges from the issuance of options during
the nine months ended September 30, 2004.
For the nine months ended September 30, 2004, research and development
expenditures totaled $3.1 million as compared to $2.7 million for the nine
months ended September 30, 2003, an increase of $.0.4 million, or 14.8%. This
increase was due primarily to: (i) a $0.4 million increase in compensation and
benefit costs related to Artera Group, Inc.; (ii) a $0.1 million increase
related to the cross-release entered into with Infinite Technology Corporation
(see Note 3 - notes to the condensed consolidated financial statements); and
(iii) a $0.1 million increase in the amortization of deferred charges related to
the installation costs of our Sight & Sound(R) systems in commercial venues.
These increases were partially offset by a decrease in our depreciation and
amortization expense related to our research equipment. Our research and
development efforts during the nine months ended September 30, 2004 included
development
31
of other components of our Artera Turbo product offering, particularly for use
in the enterprise market version of Artera Turbo.
For the nine months ended September 30, 2004, other (income)/expense, net
totaled $0.7 million as compared to ($2.2) million for the nine months ended
September 30, 2003, an increase of $2.9 million, or 132%. The increase was due
primarily to a $3.6 million increase in default penalties on convertible notes,
a $1.5 million decrease in finance costs associated with non-registration of
common shares underlying convertible notes. The nine months ending September 30,
2004 included a $4.6 million gain on the dissolution and liquidation of Artera
Group International Limited and the nine months ended September 30, 2003
included gains on the settlement of lawsuits in the amount of $5.3 million.
For the nine months ended September 30, 2004, interest expense, net totaled
$29.0 million as compared to $9.3 million for the nine months ended September
30, 2003, an increase of $19.7 million, or 212%. The increase in interest
expense was primarily attributable to the immediate expensing of the relative
fair value of warrants (original issue discounts and beneficial conversion
features) allocated to the related debt that is due upon demand. Interest
expense for the nine months ended September 30, 2004 included amortization of
original issue discounts of $12.4 million, amortization of beneficial conversion
features of $13.3 million, and interest on debt issued by us of $3.2 million.
Liquidity and Capital Resources
We have experienced substantial losses from operations since inception,
which have been recurring and amounted to $326.1 million on a cumulative basis
through September 30, 2004. These losses, which include the costs for
development of technologies and products for commercial use, have been funded
primarily from:
o the sale of our and our subsidiaries' common stock;
o the sale of our and our subsidiaries' preferred stock convertible into
common stock;
o the issuance of our and our subsidiaries' convertible debt;
o technology licensing fees;
o royalties;
o product sales;
o advertising revenue; and
o engineering and development services.
We believe that internally generated funds are currently insufficient to
meet our short-term and long-term operating and capital requirements. These
funds include available cash and cash equivalents and revenues derived from
technology licensing fees and royalties and product sales. Our ability to
continue as a going concern is substantially dependent upon future levels of
funding from our revenue sources, which are currently uncertain. If we are
unable to generate sufficient revenue to sustain our current level of operations
and to execute our business plan, we will need to obtain additional financing to
maintain our current level of operations. We are attempting to obtain additional
working capital through debt and/or equity financings. However, we can give no
assurance that additional financing will be available to us on acceptable terms
or at all. The failure to obtain any necessary additional financing would have a
material adverse effect on us, including causing a substantial reduction in the
level of our operations. These reductions, in turn, could have a material
adverse effect on our relationships with our licensees, customers and suppliers.
The uncertainty surrounding future levels of funding from our revenue sources
and the availability of any necessary additional financing raises substantial
doubt at September 30, 2004 about our ability to continue as a going concern.
32
We have entered into financing transactions because internally generated
funding sources have been insufficient to maintain our operations. Our financing
transactions to fund our business pursuits during the nine months ended
September 30, 2004 are described in the notes to the condensed consolidated
financial statements. In 2004, we have continued to be primarily dependent upon
funding from Carole Salkind. Although we do not have a formal agreement
requiring her to do so, we believe that Ms. Salkind will continue to provide
funds to us. Our belief that funding from her will continue is based primarily
upon her continued funding of us during 2002, 2003 and 2004 despite our failure
to repay her notes as the notes matured. However, we have no legally binding
assurance that Ms. Salkind will continue to fund us in the short-term or that
the amount, timing and duration of the funding from her will be adequate to
sustain our business operations.
At September 30, 2004, our cash and cash equivalents aggregated $0.8
million. Our working capital deficit was $65.0 million at September 30, 2004,
compared to a deficit of $60.8 million at December 31, 2003, a $4.2 million
increase. Our current assets were approximately $2.2 million at September 30,
2004 compared to approximately $2.1 million at December 31, 2003. Our current
liabilities were approximately $67.2 million at September 30, 2004 compared to
approximately $62.9 million at December 31, 2003. The $4.3 million increase in
current liabilities was due primarily to the issuance and rollover of
convertible notes to Carole Salkind of $5.0 million (net of discounts) and an
increase in accrued expenses of $3.9 million. We are in default of $0.5 million
of our notes payable and $5.5 million of our convertible notes at September 30,
2004 and are subject to a judgment of approximately $2.1 million (excluding
accrued interest at 10%). The following table summarizes our indebtedness in
default at September 30, 2004.
(in millions)
New Defaults
Indebtedness Defaults Cured Indebtedness
In Default during during In Default
Notes Payable: 12/31/03 the Period the Period 09/30/04
------------- ------------- ------------- -------------
Obligation to prior owner
of Web Factory $ 2.7 (a) $ - $ (2.7) (c) $ -
Former Employee / Other 0.5 (a) - - 0.5 (a)
------------- ------------- -------------- --------------
Subtotal $ 3.2 $ - $ (2.7) $ 0.5
------------- ------------- -------------- --------------
Convertible Notes Payable:
Carole Salkind Notes $ - $ 47.0 $ (46.6) $ 0.4 (a)
8% Notes 1.0 (b) 1.6 - 2.6 (a,b)
6% Notes 2.5 (a) - - 2.5 (a)
------------- ------------- -------------- --------------
Subtotal $ 3.5 $ 48.6 $ (46.6) $ 5.5
------------- ------------- -------------- --------------
Grand Total $ 6.7 $ 48.6 $ (49.3) $ 6.0
============= ============= ============= =============
Footnotes:
- ---------
(a) Default due to nonpayment.
(b) Default due to cross default provision (default on other debt).
(c) Dissolution of Artera Group International Limited.
Net cash used in operating activities for the nine months ended September
30, 2004 was $7.2 million due primarily to funding the 2004 net loss of $36.2
million, as adjusted to reconcile to net cash.
Our deferred revenue balance at September 30, 2004 was $1.4 million,
primarily attributed to NXT. No additional cash will be realized from our
deferred revenue balance. Our NXT deferred revenue balance originated at the
value of the securities received from our licensee, which was not realized in
cash because the value of the underlying securities declined before we sold
these securities.
Net cash used in investing activities was $0.1 million for the nine-month
period ended September
33
30, 2004 due to the purchase of capital equipment. The capital expenditures were
primarily for Artera Group, Inc. as we added an Artera Turbo data center in
anticipation of future growth.
At each of September 30, 2004 and December 31, 2003, our available-for-sale
securities had approximate fair market values of less than $0.1 million. These
securities represent investments in technology companies and, accordingly, the
fair market values and realizable values of these securities are subject to
substantial price volatility and other market conditions.
Net cash provided by financing activities was $7.1 million for the
nine-month period ended September 30, 2004 and was due to the issuance and sale
of convertible notes to Ms. Salkind for cash consideration of $6.3 million and
other debt proceeds of approximately $0.9 million.
At September 30, 2004, our short-term debt was $38.7 million (principally
comprised of $38.1 million face value of outstanding convertible notes payable,
net and $0.6 million of outstanding notes payable), shown net of discounts of
approximately $13.6 million on our condensed consolidated balance sheet,
compared to $35.5 million of short-term debt, net at December 31, 2003, an
increase of $3.2 million. The cash proceeds from debt issued in 2004 were
primarily used for working capital purposes.
During the nine months ended September 30, 2004, we issued an aggregate of
$60.1 million of convertible notes to Carole Salkind, as consideration for $6.3
million of cash and the rollover of $46.7 million in principal of matured
convertible notes along with $2.5 million of interest, and $4.7 million of
default penalties (10% of the principal in default).
As of September 30, 2004, we are in default (primarily from nonpayment) on
$6.0 million of our indebtedness, including $0.5 million of notes payable and
$5.5 million of convertible notes (refer to Notes 5 and 6 - notes to the
condensed consolidated financial statements for disclosure of material
defaults). We expect that from time to time outstanding short-term debt may be
replaced with new short- or long-term borrowings. Although we believe that we
can continue to access the capital markets in 2004 on acceptable terms and
conditions, our flexibility with regard to long-term financing activity could be
limited by: (i) the liquidity of our common stock on the open market; (ii) our
current level of short-term debt; and (iii) our credit ratings. In addition,
many of the factors that affect our ability to access the capital markets, such
as the liquidity of the overall capital markets and the current state of the
economy, are outside of our control. We can give no assurances that we will
continue to have access to the capital markets on favorable terms.
We have no lines of credit with banks or other lending institutions and
therefore have no unused borrowing capacity. We will not have access to the
private equity credit agreement dated September 30, 2004 until our stockholders
approve an increase in authorized shares of our common stock and we register for
resale the underlying shares of NCT common stock.
Capital Expenditures
We intend to continue our business strategy of working with supply,
manufacturing, distribution and marketing partners to commercialize our
technology. The benefits of this strategy include:
o dependable sources of electronic and other components, which leverages on
their purchasing power, provides important cost savings and accesses the
most advanced technologies;
o utilization of manufacturing capacity, enabling us to integrate our
technology into products with limited capital investment; and
o access to well-established channels of distribution and marketing
capability of leaders in several market segments.
At September 30, 2004, in connection with the proposed release of a new
industrial hearing protection product, we anticipate incurring approximately
$0.1 million in tooling costs.
Other than the above-mentioned expenditures, there were no material
commitments for capital expenditures as of September 30, 2004, and no material
commitments are anticipated in the near future.
34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposures include fluctuations in interest rates
and foreign exchange rates. We are exposed to short-term interest rate risk on
some of our obligations. We do not use derivative financial instruments to hedge
cash flows for these obligations. In the normal course of business, we employ
established policies and procedures to manage these risks.
Based upon a hypothetical 10% proportionate increase in interest rates from
the average level of interest rates during the last twelve months, and taking
into consideration commissions paid to selling agents, growth of new business
and the expected borrowing level of variable-rate debt, the expected effect on
net income related to our financial instruments would be immaterial.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Our management, with the participation of our Chief Executive Officer and
Chief Financial Officer, evaluated the effectiveness of our disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Securities Act of 1934,
as amended) as of September 30, 2004. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures as of September 30, 2004 were effective in ensuring that
information required to be disclosed by us in reports that we file or submit
under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. We believe that a control system, no
matter how well designed and operated, cannot provide absolute assurance that
the objectives of the control system are met, and no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, could be detected within a company.
Changes in internal controls
There were no changes in our internal control over financial reporting that
occurred during the quarter ended September 30, 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
35
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a discussion of our legal proceedings, see Note 11 - Litigation
included in the notes to the condensed consolidated financial statements herein.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The table below identifies all unregistered sales of our securities from
July 1, 2004 through September 30, 2004, as well as the amount and nature of the
consideration paid by each purchaser. The issuances of these securities were not
registered under the Securities Act of 1933, as amended, pursuant to the
exemption from registration provided by Section 4(2) of the Securities Act
and/or Regulation D under the Act.
- ------------------------------------------------------ ----------------------------------- --------------------------------
SECURITY SOLD PURCHASER(S) CONSIDERATION
- --------------- -------------------------------------- ----------------------------------- --------------------------------
Date of Name of Person/Entity to whom
Sale Amount and Type securities were sold Aggregate Amount and Type
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
7/16/04 NCT Convertible Note ($400,000.00 Carole Salkind $400,000 in cash
principal amount)
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
7/16/04 Warrant to purchase 6,750,000 shares Carole Salkind Agreement to purchase NCT
of NCT common stock at $0.0290 per Convertible Note
share
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
7/16/04 NCT Convertible Note ($9,469,467.03 Carole Salkind Cancellation and surrender of
principal amount) $7,479,384.54 and $785,000
convertible notes dated
12/31/03 along with accrued
interest and default penalty
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
7/16/04 Warrant to purchase 156,000,000 Carole Salkind Agreement to purchase NCT
shares of NCT common stock at Convertible Note
$0.0296 per share
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
7/23/04 NCT Convertible Notes ($990,000 Alpha Capital Aktiengesellschaft $873,000 in cash
aggregate principal amount) ($400,000 principal amount);
Longview Fund LP ($500,000
principal amount); and as
finders: Libra Finance S.A.
($40,000 principal amount) and
Bi-Coastal Consulting Corp.
($50,000 principal amount)
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
07/23/04 Warrant to purchase 5,555,556 shares Alpha Capital Aktiengesellschaft Agreement to purchase NCT
of NCT common stock at exercise Convertible Note
price of the lesser of $0.0232 or 80%
of the average of the closing bid
price for the five days immediately
preceding exercise
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
07/23/04 Warrant to purchase 6,944,445 shares Longview Fund LP Agreement to purchase NCT
of NCT common stock at exercise Convertible Note
price of the lesser of $0.0232 or
80% of the average of the closing
bid price for the five days
immediately preceding exercise
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
8/02/04 NCT Convertible Note ($13,587,645.08 Carole Salkind Cancellation and surrender of
principal amount) $425,000, $410,000,
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
36
- ------------------------------------------------------ ----------------------------------- --------------------------------
SECURITY SOLD PURCHASER(S) CONSIDERATION
- --------------- -------------------------------------- ----------------------------------- --------------------------------
Date of Name of Person/Entity to whom
Sale Amount and Type securities were sold Aggregate Amount and Type
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
$6,171,275.69, $3,606,526.83,
$410,000, $180,000, $410,000
and $400,000 convertible
demand notes dated 02/13/04,
3/15/04, 4/1/04 and 4/14/04
along with accrued interest
and default penalty
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
8/02/04 Warrant to purchase 223,750,000 Carole Salkind Agreement to purchase NCT
shares of NCT common stock at Convertible Note
$0.0270 per share
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
8/02/04 NCT Convertible Note ($400,000.00 Carole Salkind $400,000 in cash
principal amount)
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
8/02/04 Warrant to purchase 7,000,000 shares Carole Salkind Agreement to purchase NCT
of NCT common stock at $0.0270 per Convertible Note
share
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
8/10/04 NCT Convertible Note ($400,000.00 Carole Salkind $400,000 in cash
principal amount)
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
8/10/04 Warrant to purchase 6,750,000 shares Carole Salkind Agreement to purchase NCT
of NCT common stock at $0.0211 per Convertible Note
share
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
9/02/04 NCT Convertible Note ($400,000.00 Carole Salkind $400,000 in cash
principal amount)
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
9/02/04 Warrant to purchase 6,750,000 shares Carole Salkind Agreement to purchase NCT
of NCT common stock at $0.0210 per Convertible Note
share
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
9/14/04 NCT Convertible Note ($400,000.00 Carole Salkind $400,000 in cash
principal amount)
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
9/14/04 Warrant to purchase 6,750,000 shares Carole Salkind Agreement to purchase NCT
of NCT common stock at $0.0200 per Convertible Note
share
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
9/14/04 NCT Convertible Note ($1,351,034.50 Carole Salkind Cancellation and surrender of
principal amount) convertible demand notes dated
5/07/04, 5/21/04, 6/04/04 each
in the principal amount of
$400,000 along with accrued
interest and default penalty
- ---------------- -------------------------------------- ----------------------------------- --------------------------------
9/14/04 Warrant to purchase 22,500,000 Carole Salkind Agreement to purchase NCT
shares of NCT common stock at Convertible Note
$0.0200 per share
- ----------------------------------------------------------------------------------------------------------------------------
ITEM 6. EXHIBITS
4(a) Warrant dated July 16, 2004 issued to Carole Salkind for the purchase
of 6,750,000 shares of NCT common stock at a purchase price of $0.0290
per share, incorporated by reference to Exhibit 4(ed) of NCT's
Pre-Effective Amendment No. 12 to Registration Statement on Form S-1
(Registration No. 333-60574), filed on July 28, 2004.
4(b) Warrant dated July 16, 2004 issued to Carole Salkind for the purchase
of 156,000,000 shares of NCT common stock at a purchase price of
$0.0296 per share, incorporated by
37
reference to Exhibit 4(ee) of NCT's Pre-Effective Amendment No. 12 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on July 28, 2004.
4(c) Warrant dated July 23, 2004 issued to Alpha Capital Aktiengesellschaft
for the purchase of 5,555,556 shares of NCT common stock at an
exercise price of the lesser of $0.0232 or 80% of the average of the
closing bid price for the five days immediately preceding exercise,
incorporated by reference to Exhibit 4(ef) of NCT's Pre-Effective
Amendment No. 12 to Registration Statement on Form S-1 (Registration
No. 333-60574), filed on July 28, 2004.
4(d) Warrant dated July 23, 2004 issued to Longview Fund LP for the
purchase of 6,944,445 shares of NCT common stock at an exercise price
of the lesser of $0.0232 or 80% of the average of the closing bid
price for the five days immediately preceding exercise, incorporated
by reference to Exhibit 4(eg) of NCT's Pre-Effective Amendment No. 12
to Registration Statement on Form S-1 (Registration No. 333-60574),
filed on July 28, 2004.
4(e) Warrant dated August 2, 2004 issued to Carole Salkind for the purchase
of 223,750,000 shares of NCT common stock at a purchase price of
$0.0270 per share, incorporated by reference to Exhibit 4(eh) of NCT's
Post-Effective Amendment No. 1 to Registration Statement on Form S-1
(Registration No. 333-60574), filed on October 7, 2004.
4(f) Warrant dated August 2, 2004 issued to Carole Salkind for the purchase
of 7,500,000 shares of NCT common stock at a purchase price of $0.0270
per share, incorporated by reference to Exhibit 4(ei) of NCT's
Post-Effective Amendment No. 1 to Registration Statement on Form S-1
(Registration No. 333-60574), filed on October 7, 2004.
4(g) Warrant dated August 10, 2004 issued to Carole Salkind for the
purchase of 6,750,000 shares of NCT common stock at a purchase price
of $0.0211 per share, incorporated by reference to Exhibit 4(ej) of
NCT's Post-Effective Amendment No. 1 to Registration Statement on Form
S-1 (Registration No. 333-60574), filed on October 7, 2004.
4(h) Warrant dated September 2, 2004 issued to Carole Salkind for the
purchase of 6,750,000 shares of NCT common stock at a purchase price
of $0.0210 per share, incorporated by reference to Exhibit 4(ek) of
NCT's Post-Effective Amendment No. 1 to Registration Statement on Form
S-1 (Registration No. 333-60574), filed on October 7, 2004. . 4(i)
Warrant dated September 14, 2004 issued to Carole Salkind for the
purchase of 6,750,000 shares of NCT common stock at a purchase price
of $0.0200 per share, incorporated by reference to Exhibit 4(el) of
NCT's Post-Effective Amendment No. 1 to Registration Statement on Form
S-1 (Registration No. 333-60574), filed on October 7, 2004.
4(j) Warrant dated September 14, 2004 issued to Carole Salkind for the
purchase of 22,250,000 shares of NCT common stock at a purchase price
of $0.0200 per share. , Incorporated by reference to Exhibit 4(em) of
NCT's Post-Effective Amendment No. 1 to Registration Statement on Form
S-1 (Registration No. 333-60574), filed on October 7, 2004
4(k) Warrant dated October 1, 2004 issued to Carole Salkind for the
purchase of 6,750,000 shares of NCT common stock at a purchase price
of $0.0200 per share.
4(l) Warrant dated October 15, 2004 issued to Carole Salkind for the
purchase of 7,500,000 shares of NCT common stock at a purchase price
of $0.0190 per share.
4(m) Warrant dated October 21, 2004 issued to Carole Salkind for the
purchase of 8,000,000 shares of NCT common stock at a purchase price
of $0.0190 per share.
38
10(a) Secured Convertible Note in principal amount of $400,000 dated July
16, 2004 issued by NCT to Carole Salkind, incorporated by reference to
Exhibit 10(ew) of NCT's Pre-Effective Amendment No. 12 to Registration
Statement on Form S-1 (Registration No. 333-60574), filed on July 28,
2004.
10(b) Secured Convertible Note in principal amount of $9,469,467.03 dated
July 16, 2004 issued by NCT to Carole Salkind, incorporated by
reference to Exhibit 10(ex) of NCT's Pre-Effective Amendment No. 12 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on July 28, 2004.
10(c) Subscription Agreement dated July 23, 2004 between NCT Group, Inc.
and Alpha Capital Aktiengesellschaft and Longview Fund LP,
incorporated by reference to Exhibit 10(ey) of NCT's Pre-Effective
Amendment No. 12 to Registration Statement on Form S-1 (Registration
No. 333-60574), filed on July 28, 2004.
10(d) Security Agreement dated July 23, 2004 between NCT Group, Inc. and
Alpha Capital Aktiengesellschaft and Longview Fund LP, incorporated by
reference to Exhibit 10(ez) of NCT's Pre-Effective Amendment No. 12 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on July 28, 2004.
10(e) Secured Convertible Note in principal amount of $400,000 dated July
23, 2004 issued by NCT to Alpha Capital Aktiengesellschaft,
incorporated by reference to Exhibit 10(fa) of NCT's Pre-Effective
Amendment No. 12 to Registration Statement on Form S-1 (Registration
No. 333-60574), filed on July 28, 2004.
10(f) Secured Convertible Note in principal amount of $500,000 dated July
23, 2004 issued by NCT to Longview Fund LP, incorporated by reference
to Exhibit 10(fb) of NCT's Pre-Effective Amendment No. 12 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on July 28, 2004.
10(g) Convertible Note in principal amount of $40,000 dated July 23, 2004
issued by NCT to Libra Finance S.A, incorporated by reference to
Exhibit 10(fc) of NCT's Pre-Effective Amendment No. 12 to Registration
Statement on Form S-1 (Registration No. 333-60574), filed on July 28,
2004.
10(h) Convertible Note in principal amount of $50,000 dated July 23, 2004
issued by NCT to Bi-Coastal Consulting Corp., incorporated by
reference to Exhibit 10(fd) of NCT's Pre-Effective Amendment No. 12 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on July 28, 2004.
10(i) Consulting Agreement dated July 1, 2004 between NCT Group, Inc. and
Manatt Jones Global Strategies, LLC, incorporated by reference to
Exhibit 10(fe) of NCT's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (Registration No. 333-60574), filed on October
7, 2004.
10(j) Consulting Agreement dated July 30, 2004 between NCT Group, Inc. and
Light Speed Networks, Inc. incorporated by reference to Exhibit 10(ff)
of NCT's Post-Effective Amendment No. 1 to Registration Statement on
Form S-1 (Registration No. 333-60574), filed on October 7, 2004.
10(k) Finder Agreement dated August 1, 2004 between Artera Group, Inc. and
Spyder Technologies Group, LLC, incorporated by reference to Exhibit
10(fg) of NCT's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (Registration No. 333-60574), filed on October
7, 2004.
39
10(l)1 Amendment No. 1 to the September 1, 2003 Master Distributor
Agreement dated August 1, 2004 between Artera Group, Inc. and Spyder
Technologies Group, LLC, incorporated by reference to Exhibit 10(fg) 1
of NCT's Post-Effective Amendment No. 1 to Registration Statement on
Form S-1 (Registration No. 333-60574), filed on October 7, 2004.
10(l)2 Amendment No. 1 to the September 1, 2003 Reseller Agreement dated
August 1, 2004 between Artera Group, Inc. and Spyder Technologies
Group, LLC, incorporated by reference to Exhibit 10(fg) 2 of NCT's
Post-Effective Amendment No. 1 to Registration Statement on Form S-1
(Registration No. 333-60574), filed on October 7, 2004.
10(l)3 Amendment and Waiver to Master Distributor Agreement (for Puerto
Rico and The Caribbean) dated August 1, 2004 between Artera Group, Inc
and Spyder Technologies Group, LLC, incorporated by reference to
Exhibit 10(fg) 3 of NCT's Post-Effective Amendment No. 1 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on October 7, 2004.
10(m) Secured Convertible Note in principal amount of $13,587,645.08 dated
August 2, 2004 issued by NCT to Carole Salkind, incorporated by
reference to Exhibit 10(fh) of NCT's Post-Effective Amendment No. 1 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on October 7, 2004.
10(n) Secured Convertible Note in principal amount of $400,000 dated August
2, 2004 issued by NCT to Carole Salkind, incorporated by reference to
Exhibit 10(fi) of NCT's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (Registration No. 333-60574), filed on October
7, 2004.
10(o) Secured Convertible Note in principal amount of $400,000 dated August
10, 2004 issued by NCT to Carole Salkind, incorporated by reference to
Exhibit 10(fj) of NCT's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (Registration No. 333-60574), filed on October
7, 2004.
10(p) Secured Convertible Note in principal amount of $400,000 dated
September 2, 2004 issued by NCT to Carole Salkind, incorporated by
reference to Exhibit 10(fk) of NCT's Post-Effective Amendment No. 1 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on October 7, 2004.
10(q) Secured Convertible Note in principal amount of $400,000 dated
September 14, 2004 issued by NCT to Carole Salkind, incorporated by
reference to Exhibit 10(fl) of NCT's Post-Effective Amendment No. 1 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on October 7, 2004.
10(r) Secured Convertible Note in principal amount of $1,351,034.50 dated
September 14, 2004 issued by NCT to Carole Salkind, incorporated by
reference to Exhibit 10(fm) of NCT's Post-Effective Amendment No. 1 to
Registration Statement on Form S-1 (Registration No. 333-60574), filed
on October 7, 2004.
10(s) Amended and Restated Private Equity Credit Agreement dated as of
September 30, 2004 by and between NCT Group, Inc. and Crammer Road
LLC, incorporated by reference to Exhibit 10(fn) of NCT's
Post-Effective Amendment No. 1 to Registration Statement on Form S-1
(Registration No. 333-60574), filed on October 7, 2004.
10(t)1 Registration Rights Agreement dated September 30, 2004 between NCT
Group, Inc. and Crammer Road LLC, incorporated by reference to Exhibit
10(fn) 1 of NCT's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (Registration No. 333-60574), filed on October
7, 2004.
40
10(u) Amendment No. 8 dated September 30, 2004 to the Distribution and
Marketing Agreement dated April 21, 2003 between Artera Group, Inc.
and Avaya Inc, incorporated by reference to Exhibit 10(fo) 1 of NCT's
Post-Effective Amendment No. 1 to Registration Statement on Form S-1
(Registration No. 333-60574), filed on October 7, 2004.
10(v) Secured Convertible Note in principal amount of $400,000 dated
October 1, 2004 issued by NCT to Carole Salkind.
10(w) Amendment No. 9 dated October 14, 2004 to the Distribution and
Marketing Agreement dated April 21, 2003 between Artera Group, Inc.
and Avaya Inc.
10(x) Secured Convertible Note in principal amount of $425,000 dated
October 15, 2004 issued by NCT to Carole Salkind.
10(y) Secured Convertible Note in principal amount of $479,392.54 dated
October 21, 2004 issued by NCT to Carole Salkind.
31(a) Certification of Chief Executive Officer pursuant to Rule 13a - 14(a)
under the Securities Exchange Act of 1934.
31(b) Certification of Chief Financial Officer pursuant to Rule 13a - 14(a)
under the Securities Exchange Act of 1934.
32(a) Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Rule 13a - 14(b) under the Securities Exchange Act of 1934
and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
41
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.
NCT GROUP, INC.
By: /s/ Michael J. Parrella
----------------------------------
Michael J. Parrella
Chief Executive Officer and
Chairman of the Board of Directors
By: /s/ Cy E. Hammond
----------------------------------
Cy E. Hammond
Senior Vice President,
Chief Financial Officer
Dated: November 15, 2004
42