UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
--------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ____________________
Commission file number: 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 May 16, 2005 was 641,970,392.
Table of Contents
Page
Part I Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets at December 31, 2004 and March 31, 2005
(Unaudited) 3
Condensed Consolidated Statements of Operations (Unaudited) and Condensed Consolidated
Statements of Comprehensive Loss (Unaudited) for the Three Months
Ended March 31, 2004 and 2005 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Three Months
Ended March 31, 2004 and 2005 5
Notes to the Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
Item 4. Controls and Procedures 28
Part II Other Information
Item 1. Legal Proceedings 29
Item 6. Exhibits 30
Signatures 31
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, March 31,
2004 2005
--------------- ---------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 1,359 $ 1,139
Investment in available-for-sale marketable securities 24 24
Accounts receivable, net 528 993
Inventories, net 364 353
Other current assets (includes $127 and $108, respectively, due fromer officer) 248 136
--------------- ---------------
Total current assets 2,523 2,645
Property and equipment, net 470 437
Goodwill, net 1,252 1,252
Patent rights and other intangibles, net 1,089 1,072
Other assets 120 114
--------------- ---------------
$ 5,454 $ 5,520
=============== ===============
LIABILITIES AND CAPITAL DEFICIT
Current liabilities:
Accounts payable $ 1,909 $ 2,248
Accrued expenses-related parties 8,745 9,852
Accrued expenses-other 9,862 10,040
Notes payable 603 598
Related party convertible notes (due to a stockholder) 40,565 44,482
Current maturities of convertible notes 4,513 4,610
Deferred revenue 885 350
Shares of subsidiary subject to exchange into a variable number of shares 709 643
Other current liabilities 6,990 7,001
--------------- ---------------
Total current liabilities 74,781 79,824
--------------- ---------------
Long-term liabilities:
Convertible notes 5,000 5,000
Other liabilities 63 54
--------------- ---------------
Total long-term liabilities 5,063 5,054
--------------- ---------------
Commitments and contingencies
Minority interest in consolidated subsidiaries 8,645 8,415
--------------- ---------------
Capital deficit:
Preferred stock, $.10 par value, 10,000,000 shares authorized:
Convertible series H preferred stock, issued and outstanding, 1,752 shares,
(redemption amount $20,992,210 and $21,024,000, respectively, liquidation
amount $19,267,746 and $19,442,466, respectively) 19,203 19,376
Convertible series I preferred stock, zero and 975.55767 shares issued and
outstanding, respectively, (redemption amount zero, liquidation amount zero
and $975,558, respectively) - 976
Common stock, $.01 par value, 645,000,000 shares authorized:
issued and outstanding, 641,970,392 shares 6,420 6,420
Additional paid-in capital 245,746 256,790
Common shares payable, 3,029,608 shares - -
Accumulated other comprehensive income 86 106
Accumulated deficit (354,490) (371,441)
--------------- ---------------
Total capital deficit (83,035) (87,773)
--------------- ---------------
$ 5,454 $ 5,520
=============== ===============
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 March 31,
------------------------------
2004 2005
----------- ----------
REVENUE:
Technology licensing fees and royalties $ 721 $ 1,165
Product sales, net 441 472
Advertising 32 36
----------- ----------
Total revenue 1,194 1,673
----------- ----------
COSTS AND EXPENSES:
Cost of product sales 239 169
Cost of advertising 4 3
Selling, general and administrative 2,088 1,298
Research and development 1,070 1,085
----------- ----------
Total operating costs and expenses 3,401 2,555
Non-operating items:
Other (income) expense, net 1,247 2,869
Interest expense, net 12,286 13,200
----------- ----------
Total costs and expenses 16,934 18,624
----------- ----------
NET LOSS $ (15,740) $ (16,951)
Less: Preferred stock dividends and other 401 2,661
----------- ----------
LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (16,141) $ (19,612)
============ ==========
Basic and diluted loss per share attributable to
common stockholders $ (0.03) $ (0.03)
============ ==========
Weighted average common shares outstanding -
basic and diluted 645,000 645,000
============ ==========
NCT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
(in thousands)
Three months ended March 31,
------------------------------
2004 2005
----------- ----------
NET LOSS $ (15,740) $ (16,951)
Other comprehensive income (loss):
Currency translation adjustment (167) 20
Unrealized loss on marketable securities/Adjustment of unrealized loss 26 -
----------- ----------
COMPREHENSIVE LOSS $ (15,881) $ (16,931)
=========== ==========
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)
Three months ended March 31,
----------------------------------------
2004 2005
---------------- ----------------
Cash flows from operating activities:
Net loss $ (15,740) $ (16,951)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 114 76
Common stock, warrants and options issued as consideration for:
Operating expenses 64 -
Provision for inventory reserve (28) (4)
Provision for doubtful accounts and uncollectible amounts (17) (9)
(Gain) on disposition of fixed assets - (12)
Finance costs associated with non-registration of common shares 175 251
Subsidiary preferred stock dividends as interest 5 5
Default penalty on notes (related party) 1,116 2,641
Amortization of discounts on notes (includes $5,443 and $5,290
respectively, with related parties) 5,443 5,318
Amortization of beneficial conversion feature on convertible notes (includes
$5,878 and $6,341, respectively, with related parties) 5,889 6,409
Changes in operating assets and liabilities, net of acquisitions:
Increase in accounts receivable (46) (456)
Decrease in inventories 57 16
(Increase) decrease in other assets (11) 118
Increase (decrease) in accounts payable and accrued expenses 1,949 (1,173)
(Decrease) increase in other liabilities and deferred revenue (538) 1,594
---------------- ----------------
Net cash used in operating activities $ (1,568) $ (2,177)
---------------- ----------------
Cash flows from investing activities:
Capital expenditures $ (3) $ (12)
---------------- ----------------
Cash flows from financing activities:
Proceeds from:
Issuance of convertible notes and notes payable 1,425 1,980
Repayment of notes (26) (31)
---------------- ----------------
Net cash provided by financing activities $ 1,399 $ 1,949
---------------- ----------------
Effect of exchange rate changes on cash $ (69) $ 20
---------------- ----------------
Net increase in cash and cash equivalents $ (241) $ (220)
Cash and cash equivalents at beginning of period 988 1,359
---------------- ----------------
Cash and cash equivalents at end of period $ 747 $ 1,139
================ ================
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 "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 months
ended March 31, 2005 and cash flows for the three months ended March 31, 2005
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, 2004 contained in our Annual
Report on Form 10-K/A.
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 $371.4 million through March 31, 2005. Cash and
cash equivalents amounted to $1.1 million at March 31, 2005, decreasing from
$1.4 million at December 31, 2004. A working capital deficit of $77.2 million
existed at March 31, 2005. We were in default of $0.5 million of our notes
payable and $5.1 million of our convertible notes at March 31, 2005. 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, product sales and advertising. 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. Uncertainty exists about the adequacy of current funds
to support our activities until positive cash flow from operations can be
achieved, and uncertainty exists about the availability of external financing
sources to fund any cash deficiencies.
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 paragraph raise substantial doubt at
March 31, 2005 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.
Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 151, "Inventory Costs--an amendment of ARB No. 43," which is the result
of its efforts to converge U.S. accounting standards for inventories with
International Accounting Standards. SFAS No. 151 requires idle facility
expenses, freight, handling cost and wasted material (spoilage) costs to be
recognized as current-period charges. It also requires that allocation of fixed
production overhead to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 will be effective for us beginning
January 1, 2006. We are evaluating the impact of this standard on our
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based
Payment" that prescribes the accounting for share-based payment transactions in
which a company receives employee services in exchange for (a)
6
equity instruments of the company or (b) liabilities that are based on the fair
value of the company's equity instruments or that may be settled by the issuance
of such equity instruments. SFAS No. 123R addresses all forms of share-based
payment awards, including shares issued under employee stock purchase plans,
stock options, restricted stock and stock appreciation rights. SFAS No. 123R
eliminates the ability to account for share-based compensation transactions
using APB Opinion No. 25, "Accounting for Stock Issued to Employees," that was
previously allowed under SFAS No. 123 as originally issued. Under SFAS No. 123R,
companies are required to record compensation expense for all share-based
payment award transactions measured at fair value. In April 2005, the Securities
and Exchange Commission ("SEC") delayed the effective date of SFAS No. 123R.
Accordingly, this statement is effective for us beginning January 1, 2006. We
have not yet determined the impact of applying the various provisions of SFAS
No. 123R. (See Note 2.)
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets--an amendment of APB Opinion No. 29" that amends Opinion No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The provisions of this statement are
effective for non-monetary asset exchanges for us beginning July 1, 2005. We do
not anticipate that the adoption of SFAS No. 153 will have a material impact on
our financial position, results of operations or cash flows.
2. Stock-Based Compensation:
We have adopted the disclosure only provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," and continue to apply
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations in accounting for our stock-based
compensation plans. 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 the date of grant 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 all 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. Had compensation costs been determined as prescribed by
SFAS No. 123, our net loss attributable to common stockholders and net loss per
share would have been the pro forma amounts indicated below:
(in thousands, except per share amounts)
Three months ended
March 31,
------------------------------------
2004 2005
---------------- ----------------
Net loss attributable to common stockholders $ (16,141) $ (19,612)
Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (452) -
---------------- ----------------
Pro forma net loss attributable to common stockholders $ (16,593) $ (19,612)
================ ================
Net loss per common share (basic and diluted):
As reported $ (0.03) $ (0.03)
================ ================
Pro forma $ (0.03) $ (0.03)
================ ================
Since the options granted normally 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 months ended March 31, 2004
and 2005, respectively, is not necessarily representative of the pro forma
effects on the results of operations for future periods.
7
3. Other Financial Data:
Balance Sheet Items
Investment in marketable securities comprises available-for-sale securities
at fair market value. The following table sets forth the market value, carrying
value, and realized and unrealized gain (loss) of our available-for-sale
securities:
Adjusted
Cost Unrealized Market Market
Basis Gain/ Value Unrealized Realized Value
(In thousands) 01/01/04 (Loss) 12/31/04 Additions Gain Loss 03/31/05
- -------------- ----------- ----------- ----------- ----------- ------------ ----------- ------------
Available-for-sale:
ITC $ 38 $ (28) $ 10 $ - $ - $ - $ 10
Teltran 11 3 14 - - - 14
----------- ----------- ----------- ----------- ------------ ----------- ------------
Totals $ 49 $ (25) $ 24 $ - $ - $ - $ 24
=========== =========== =========== =========== ============ =========== ============
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 three months
ended March 31, 2005, we did not recognize any decline in realizable value of
our investments.
Accounts receivable comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
Technology license fees and royalties $ 472 $ 874
Joint ventures and affiliates 34 34
Other receivables 375 429
--------------- ---------------
$ 881 $ 1,337
Allowance for doubtful accounts (353) (344)
--------------- ---------------
Accounts receivable, net $ 528 $ 993
=============== ===============
8
Inventories comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
Finished goods $ 491 $ 493
Components 215 198
--------------- ---------------
$ 706 $ 691
Reserve for obsolete and slow moving inventory (342) (338)
--------------- ---------------
Inventories, net $ 364 $ 353
=============== ===============
Other current assets comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
Notes receivable $ 1,000 $ 1,000
Due from former officer 127 98
Other 223 136
--------------- ---------------
$ 1,350 $ 1,244
Reserve for uncollectible amounts (1,102) (1,098)
--------------- ---------------
Other current assets $ 248 $ 136
=============== ===============
Other assets (long-term) comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
Advances and deposits $ 70 $ 70
Deferred charges 50 44
--------------- ---------------
Other assets (classified as long term) $ 120 $ 114
=============== ===============
Property and equipment comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
Machinery and equipment $ 1,284 $ 1,294
Furniture and fixtures 585 586
Tooling 493 496
Leasehold improvements 394 393
Other 434 412
--------------- ---------------
$ 3,190 $ 3,181
Accumulated depreciation (2,720) (2,744)
--------------- ---------------
Property and equipment, net $ 470 $ 437
=============== ===============
Depreciation expense for the three months ended March 31, 2004 and 2005 was less
than $0.1million.
9
Accrued expenses comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
Non-conversion fees due to a related party $ 3,972 $ 5,231
Non-registration fees due to a related party 1,446 2,527
Interest due to a related party 1,012 1,153
Consulting fees due to a related party 483 -
Incentive compensation due to officers 1,832 941
--------------- ---------------
Accrued expenses-related parties $ 8,745 $ 9,852
=============== ===============
Non-registration fees $ 4,436 $ 4,753
Interest 1,458 1,633
Commissions payable 372 118
Other 3,596 3,536
--------------- ---------------
Accrued expenses-other $ 9,862 $ 10,040
=============== ===============
Deferred revenue comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
New Transducers Ltd. $ 535 $ -
Other 350 350
--------------- ---------------
$ 885 $ 350
=============== ===============
As of March 31, 2005, we do not expect to realize any additional cash from
revenue that has been deferred.
Other current liabilities comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
License reacquisition payable $ 4,000 $ 4,0000
Royalty payable 1,679 1,679
Development fee payable 650 650
Due to selling shareholders of Theater Radio
Network 557 557
Due to Lernout & Hauspie 100 100
Other 4 15
--------------- ---------------
Other current liabilities $ 6,990 $ 7,001
=============== ===============
Other liabilities (long-term) comprise the following:
December 31, March 31,
(In thousands) 2004 2005
- -------------- --------------- ---------------
Note Payable-BMI $ 53 $ 47
Other long term and capital leases 10 7
--------------- ---------------
Other long term liabilities $ 63 $ 54
=============== ===============
10
Statements of Operations Information
Other (income) expense, net consisted of the following:
Three months ended
March 31,
--------------------------------
(In thousands) 2004 2005
- -------------- --------------- ---------------
Finance costs associated with non-registration
of common shares $ 175 $ 251
Default penalties on debt 1,116 2,641
Other (44) (23)
--------------- ---------------
Other (income) expense $ 1,247 $ 2,869
=============== ===============
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 months ended March 31, 2005 were approximately $75,000. Future
earnings of our 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 ($2.4 million at March 31, 2005).
Supplemental Cash Flow Information
Three months ended March 31,
-------------------------------------
(In thousands) 2004 2005
- -------------- ----------------- -----------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 10 $ 6
================= =================
Supplemental disclosures of non-cash investing and financing activities:
Unrealized holding loss on available-for-sale securities $ (26) $ -
================= =================
Finance costs associated with non-registration of common shares $ 146 $ 1,195
================= =================
Finance costs associated with non-conversion of preferred stock $ - $ 1,210
================= =================
Issuance of series I preferred stock in settlement of accrued consulting fees
and incentive bonuses and exchange of Artera Group Series A preferred stock $ - 976
================= =================
Property and equipment financed through notes payable $ - $ 18
================= =================
Principal on convertible notes and notes payable rolled into new notes $ 9,778 $ 26,408
================= =================
Interest on convertible notes and notes payable rolled into new notes $ 662 $ 1,145
================= =================
Default penalty on convertible notes rolled into new notes $ 829 $ 2,641
================= =================
11
4. Capital Deficit:
The changes in capital deficit during the three months ended March 31, 2005
were as follows:
NCT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITAL DEFICIT
Accumulated
Other
Convertible Preferred Stock Other
Series H Series I Common Stock Additional Accumu- Compre-
--------------- -------------- ----------------- Paid-in lated hensive
(In thousands) Shares Amount Shares Amount Shares Amount Capital Deficit Loss Total
- -------------- --------------- -------------- ---------------- ---------- --------- ------- ------
Balance at December 31, 2004 2 $19,203 - $ 0 641,970 $6,420 $245,746 ($354,490) $ 86 ($83,035)
Conversion of preferred stock - - - - - - 70 - - 70
Issuance of Series I preferred stock - - 1 976 - - 155 - - 1,131
Dividend and amortization of discounts
on beneficial conversion price
to preferred shareholders - 173 - - - - (173) - - -
Dividend and amortization of discounts
on beneficial conversion price to
subsidiary preferred shareholders - - - - - - (83) - - (83)
Charges for the non-registration of the
underlying shares of NCT common stock
to subsidiary preferred shareholders - - - - - - (1,195) - - (1,195)
Charges for the non-conversion/exchange
for common stock of NCT to NCT and
subsidiary preferred shareholders - - - - - - (1,210) - - (1,210)
Warrants issued in conjunction with
convertible debt - - - - - - 7,391 - - 7,391
Beneficial conversion feature on
convertible debt - - - - - - 6,089 - - 6,089
Net loss - - - - - - - (16,951) - (16,951)
Accumulated other comprehensive loss - - - - - - - - 20 20
------- ------- ------ ------ ------- ------- ---------- --------- ------- -------
Balance at March 31, 2005 2 $19,376 1 $ 976 641,970 $6,420 $256,790 ($371,441) $106 $(87,773)
=============== ============== ================ ========== ========= ======= ======
12
5. Notes Payable:
December 31, March 31,
(In thousands) 2004 2005
- -------------- ------------------- -------------------
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 40 30
Interest at 8.5% per annum; monthly payments (including interest) of $3.5
through May 2005, as revised, remainder matures June 27, 2005.
Note due former employee (a) 100 100
$100 bears interest at 8.25% per annum, compounded annually;
past due.
Other financings (a) 78 83
Interest ranging from 7% to 9% per annum;
$35 due July 15, 2003; $42 and $6, respectively, all other.
------------------- -------------------
$ 603 $ 598
=================== ===================
Footnote:
- --------
(a) Notes payable are in default due to nonpayment.
6. Convertible Notes Payable:
December 31, March 31,
(In thousands) 2004 2005
- -------------- ------------------- -------------------
Related Party Convertible Notes:
Issued to Carole Salkind - (a) $ 58,120 $ 63,886
Weighted average effective interest rate of 89.9% per annum; accrues
interest at 8% per annum except $5,000 at 12%; collateralized by
substantially all of the assets of NCT; convertible into NCT common stock
at prices ranging from $0.0166 - $0.02 or exchangeable for common stock
of NCT subsidiaries except Pro Tech; maturing by quarter as follows:
2004 2005
------------------------------
March 31, 2005 $ 26,408 $ -
June 30, 2005 26,712 26,712
September 30, 2005 - 32,174
December 31, 2009 5,000 5,000
Less: unamortized debt discounts (12,555) (14,404)
------------------- -------------------
$ 45,565 $ 49,482
Less: amounts classified as long-term (5,000) (5,000)
------------------- -------------------
$ 40,565 $ 44,482
=================== ===================
13
December 31, March 31,
(In thousands) 2004 2005
- -------------- ------------------- -------------------
Convertible Notes:
8% Convertible Notes past due $ 2,641 $ 2,641
Weighted average effective interest rate of 30.8% per annum;
generally convertible into NCT common stock at 80% of the five-day
average closing bid price preceding conversion; matures
2004 2005
-------------- --------------
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 990 990
6% Convertible Notes past due 2,474 2,474
Weighted average effective interest rate of 85.8% per annum;
convertible into NCT common stock at 100% of the five-day average
closing bid price preceding conversion; past due:
2004 2005
-------------- --------------
January 9, 2002 $ 818 $ 818
April 4, 2002 325 325
May 25, 2002 81 81
June 29, 2002 1,250 1,250
------------------- -------------------
$ 5,115 $ 5,115
Less: unamortized debt discounts (602) (505)
------------------- -------------------
$ 4,513 $ 4,610
=================== ===================
Footnotes:
- ---------
(a) During the three months ended March 31, 2005, we issued an aggregate
of $32.2 million of convertible notes to Carole Salkind, a stockholder
and spouse of a former director of ours. These notes are secured by
substantially all of our assets. During the three months ended March
31, 2005, we defaulted on payment of all notes that matured during the
quarter for an aggregate principal amount of $26.4 million. For the
three months ended March 31, 2005, we refinanced an aggregate of $26.4
million principal amount into new notes along with default penalties
($2.6 million) and accrued interest ($1.1 million) aggregating $30.2
million. In addition, we issued notes aggregating $2.0 million in
consideration of new funding from Carole Salkind. During the three
months ended March 31, 2005, we recorded original issue discounts of
$6.1 million to the notes based upon the relative fair values of the
debt and warrants granted to Ms. Salkind (see Note 10). In addition,
beneficial conversion features totaling $7.4 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. For the three months ended March
31, 2005, $11.6 million of amortization related to these and prior
discounts is classified as interest expense in our condensed
consolidated statements of operations. Unamortized discounts of $14.4
million have been reflected as a reduction to the convertible notes in
our condensed consolidated balance sheet as of March 31, 2005. 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 stated interest rate of the note plus 5%.
We are in default on convertible notes aggregating $1.0 million due to
a cross-default provision and non-payment. In addition, we are in
default on convertible notes aggregating $0.6 million due to a cross
default provision. We are also in default on convertible notes
aggregating $1.0 million dated July 23,2004 due to our inability to
reserve shares of our common stock issuable upon conversion of these
notes.
14
7. Shares of Subsidiary Subject to Exchange into a Variable Number of Shares:
The monetary value of Pro Tech series B convertible preferred stock was
approximately $643,000 in our condensed consolidated balance sheet at March 31,
2005, which is comprised of $575,000 aggregate fair value of shares plus the
accrued dividends of approximately $68,000. We have the option to settle the
accrued dividends in cash or common stock. We would have to issue approximately
36.6 million shares of our common stock if settlement of the stated value along
with accrued dividends had occurred as of March 31, 2005. 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 B preferred stock.
At March 31, 2005, there were no shares of Pro Tech series A preferred
stock and 460 shares of Pro Tech series B preferred stock were outstanding. On
March 31, 2005, 50 shares of the Pro Tech series A preferred stock was converted
into 1,844,007 shares of Pro Tech common stock pursuant to a mandatory
conversion requirement. For the three months ended March 31, 2005, we calculated
the 4% dividends earned by holders of the Pro Tech series A and B preferred
stock at approximately $5,000. Following adoption of SFAS No. 150 effective July
1, 2004, this amount is included on our condensed consolidated financial
statements 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 that superseded and replaced a private equity credit
agreement dated July 25, 2002 between us and Crammer Road. The September 2004
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 91% of 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 March 31, 2005, we were required to reserve for issuance approximately
10.2 billion shares of common stock based on the market price of $0.018 price
per share on that date (or the discount therefrom as provided under applicable
exchange or conversion agreements). The number of shares issuable upon
conversion or exchange of many of our outstanding convertible and exchangeable
securities varies as a function of the market price of our common stock. At
March 31, 2005, the number of shares required to be reserved for issuance
exceeded the number of authorized but unissued shares of our common stock. 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. However, even if our stockholders approve the
proposed amendments, the increase will not be sufficient to fully satisfy our
reserve requirements. At March 31, 2005, we have been unable to satisfy valid
conversion, exchange and share issuance requests to issue approximately 162.8
million shares of our common stock because of an insufficient number of
authorized but unissued shares.
NCT Group, Inc. Preferred Stock
At March 31, 2005, we had two designations of issued and outstanding
preferred stock, our series H convertible preferred stock, consisting of 2,100
designated shares, and our series I convertible preferred stock, consisting of
1,000 designated shares. We are obligated to register for resale shares of our
common stock issuable upon the conversion of our series H preferred stock. At
March 31, 2005, 1,752 shares of series H preferred stock were issued and
outstanding. 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
15
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 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 three
months ended March 31, 2005, we calculated the 4% dividends earned by the holder
of the outstanding series H preferred stock at approximately $0.2 million. The
amortization of beneficial conversion feature and the dividend amount are
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 months ended March
31, 2005, we recorded charges of $1.2 million, for non-conversion of series H
preferred stock into our common stock. The non-conversion charges are included
in the calculation of loss attributable to common stockholders.
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. The non-registration charges are included
in the calculation of loss attributable to common stockholders. For the three
months ended March 31, 2005, this resulted in a charge to additional paid-in
capital of $1.1 million.
At March 31, 2005, 975.55767 shares of our series I preferred stock were
issued and outstanding and held by four of our executive officers, one of our
non-executive officers of NCT, a holder of shares of preferred stock of our
subsidiary, Artera Group, Inc., and Steven Salkind, the son of Carole Salkind
(see Note 10). Our series I preferred stock has a par value of $0.10 per share
and a stated value of $1,000 per share. No dividends are payable on the series I
preferred stock. The series I preferred stock is junior in rank to our series H
convertible preferred stock, but senior in rank to our common stock and has
preferences over the common stock with respect to distributions and payments
upon our liquidation, dissolution or winding up. The holders of our series I
preferred stock have no voting rights (except as may be required by law). Each
share of series I preferred stock is convertible into approximately 47,619
shares of our common stock, determined by dividing the $1,000 stated value by
the fixed conversion price of $0.021 per share. As a result, the 975.55767
issued and outstanding shares of our series I preferred stock are convertible
into approximately 46,455,127 shares of our common stock. However, the series I
preferred stock is not convertible until 20 days after our stockholders approve
an increase in the number of authorized shares of our common stock.
Artera Group, Inc. Preferred Stock
At March 31, 2005, there were 8,299 shares (including 271 shares owned by
NCT) of Artera series A preferred stock outstanding. During the three months
ended March 31, 2005, 271 shares were exchanged for 160 shares of our series I
preferred stock. Each share of series A convertible preferred stock is
convertible into shares of Artera common stock at a conversion price equal to
the average closing price for the five trading days prior to the conversion
date. We entered into an exchange rights agreement in 2001 with ten accredited
investors who hold $4.3 million in aggregate stated value of Artera series A
preferred stock. Each of the ten holders of Artera series A preferred stock is
entitled to exchange the Artera series A preferred stock for shares of our
common stock at an exchange price per share of 100% of the average closing bid
price of our common stock for the five trading days prior to the exchange date
and may not
16
convert into Artera common 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 months ended March 31, 2005, we incurred
charges of approximately $0.1 million 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 the shares of Artera series A preferred stock
subject to the agreement 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 months ended March 31, 2005, we calculated the 4% dividends earned by
holders of the Artera series A preferred stock at $0.1 million. The
non-registration charges and dividends are included in the calculation of loss
attributable to common stockholders.
Transactions Affecting the Common Stock of Pro Tech Communications, Inc.
On April 5, 2004, our subsidiary, 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. On April 27, 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 and on March 31, 2005, the remaining Pro Tech
series A were converted into 1,844,007 shares of Pro Tech common stock. At March
31, 2005, NCT Hearing held approximately 83% of the outstanding Pro Tech common
stock.
Warrants
During the three months ended March 31, 2005, in conjunction with the
issuance of convertible notes, we issued to Carole Salkind warrants to acquire
an aggregate of 532,000,000 shares of our common stock at exercise prices
ranging from $0.0172 to $0.0195 per share. The fair value of these warrants was
approximately $7.5 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 $6.1 million during the three months ended March 31, 2005.
10. Related Parties:
Carole Salkind and Affiliates
During the three months ended March 31, 2005, we issued $32.2 million of 8%
convertible notes due in six months from respective dates of issuance to Carole
Salkind (see Note 6) along with five-year warrants to acquire an aggregate of
532,000,000 shares of our common stock (see Note 9). Consideration paid for
these notes included approximately $2.0 million cash and cancellation and
surrender of notes aggregating approximately $26.4 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
certain legal matters (see Note 11).
On January 7, 2005, we entered into a three-year consulting agreement with
Morton Salkind, the spouse of Carole Salkind, to provide us ongoing financial
and consulting advisory services as we may reasonably request from time to time.
As compensation for these consulting services, we have agreed to pay to Mr.
Salkind a monthly $5,000 cash fee payable at the end of the term of the
agreement, to reimburse Mr. Salkind and his spouse for the cost of health
insurance premiums and to provide Mr. Salkind with the use of an automobile
owned or leased by us, together with auto insurance coverage, through the term
of the agreement. Our expected costs to provide this automobile are $10,800 per
year. The consulting engagement and compensation of Mr. Salkind is not dependent
upon the ongoing funding provided by Ms. Salkind.
In March 2005, we issued 510 shares of our series I convertible preferred
stock to Steven Salkind in exchange for an aggregate of accrued consulting fees
of $510,000 including amounts accrued through June 12, 2005, representing all
consulting fees payable in cash to consulting entities affiliated with Carole
Salkind (but not to Morton Salkind personally pursuant to his January 2005
agreement) (see Note 9). These consulting fees had previously been assigned to
Steven Salkind by these entities.
17
Executive Officer Preferred Stock Issuance
In March 2005, we issued an aggregate of 212.33253 shares of our series I
convertible preferred stock to four executive officers in exchange for accrued
but unpaid incentive cash bonuses of $490,000 (before income tax withholding)
(see Note 9). The specific terms of these issuances are as follows:
Net Bonus Amount
Gross After Tax Shares
Name Bonus Amount Withholding Purchased
---- ------------ ---------------- ----------
Michael J. Parrella, Chief Executive Officer $ 125,000 $ 81,000 81
and Chairman of the Board
Irene Lebovics, President 46,000 27,000 27
Cy E. Hammond, Senior Vice President and 72,000 41,000 41
Chief Financial Officer
R. Wayne Darville, Chief Operating Officer, 100,000 63,332.53 63.33253
Artera Group, Inc.
Incentive Compensation of Management:
On March 31, 2005, three executives agreed to waive a portion of their
incentive bonus earned in 2004. The amounts waived were approximately $326,000,
$107,000 and $158,000 for our Chief Executive Officer, President and Chief
Financial Officer, respectively. In addition, these executives agreed to subject
the payment of a portion of their accrued but unpaid 2004 bonus amounts to
certain conditions. Furthermore, effective January 1, 2005, the incentive cash
compensation arrangements applicable to these executives have been amended. For
the first six months of 2005, these executives will receive incentive cash
compensation consisting of a percentage of the value only of new cash and cash
equivalents received by us, subject to certain payment limitations.
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. Manatt Jones also
provides us with use of their Washington, D.C. and New York City offices. Under
this agreement, we pay a monthly fee of $16,000 to Manatt Jones for these
services. Manatt Jones recruited our former Senior Vice President, Corporate
Development 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. The total paid in the three
months ended March 31, 2005 under this agreement was approximately $49,000.
On May 1, 2005, we and Spyder Technologies Group, LLC, a company in which
our Chairman and Chief Executive Officer Michael Parrella and members of his
family have interests, amended the arrangement under which Spyder provides
technical consulting services to our subsidiary Artera Group, Inc. The amendment
was to change the cash compensation payable by Artera to Spyder from $20 per
hour to $365 per day (or $45.63 per hour for a pro rata portion thereof based on
an eight-hour day). No additional compensation is paid for hours in excess of
eight per day. In addition, Spyder received a one-time payment of approximately
$11,900, which effectively made the rate increase retroactive to January 1,
2005. The fees for services provided by Spyder under this amended arrangement
are at or below the fees that would be payable for similar services provided by
an unrelated consultant.
11. Litigation:
Founding Midcore Shareholder Litigation:
This action was filed in Connecticut state court in April 2004 by Jerrold
Metcoff and David Wilson against us and Michael Parrella, our Chairman and Chief
Executive Officer. The complaint was then amended to add Carole Salkind as a
defendant. The plaintiffs allege that we and Mr. Parrella breached a number of
representations, warranties and obligations under or relating to the August 29,
2000 Agreement and Plan of Merger by which Metcoff, Wilson and others sold to us
100% of the outstanding shares of a corporation that became our subsidiary,
18
Midcore Software, Inc. Among those obligations was the obligation for us to
issue to Metcoff and Wilson an aggregate of 60,359,576 shares of our common
stock, which we have not done. The complaint, as amended, seeks damages,
punitive damages, interest and attorneys' fees, all in unspecified amounts.
On January 7, 2005, the court granted our motion to strike one of the
claims against Midcore Software in the amended complaint, pertaining to
Midcore's responsibility for our failure to issue shares of its common stock to
Metcoff and Wilson. However, on or about January 24, 2005, Metcoff and Wilson
filed a substitute complaint to reformulate the claim against Midcore Software
that had been struck. On April 25, 2005, at our request, the court required the
plaintiffs to revise their substitute complaint with respect to certain
distinctions in the August 29, 2000 Agreement and Plan of Merger between
potential liabilities of NCT and potential liabilities of Midcore Software.
Discovery in the case is ongoing. On May 10, 2005, Metcoff and Wilson informed
the court that they intend to seek to further amend their complaint to add all
or some members of the our board of directors, in addition to Michael Parrella,
as defendants in the action, and to seek to make claims against Mr. Parrella and
those other Board members for breach of fiduciary duty owed to the plaintiffs as
alleged creditors. Once the proposed further amended complaint is filed by the
plaintiffs, we will evaluate any director and officer indemnification and
indemnification insurance issues implicated.
Carole Salkind has demanded that we indemnify her, in connection with her
security interests under our promissory notes to her, for legal fees she incurs
in this action. During the three months ended March 31, 2005, Ms. Salkind
incurred approximately $6,000 in such legal fees, of which we paid approximately
$2,000 during that period.
Reference is made to our Annual Report on Form 10-K/A for the year ended
December 31, 2004, 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:
We are 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. Other-consolidating
consists of items eliminated in consolidation, such as intercompany revenue.
During the three months ended March 31, 2005, 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 months ended March 31, 2005 and March 31,
2004 is as follows:
Reportable segment data for the three months ended March 31, 2005 and March
31, 2004 is as follows:
(In thousands)
For the three months ended Communi- Reportable ---------- Other ---------- Grand
March 31, 2005 cations Media Technology Segments Corporate Consolidating Total
- --------------------------------------- ---------- ---------- ------------ ----------- ---------------------------------------
License Fees and Royalties - External $ 630 $ 535 $ - $ 1,165 $ 6 $ (6) $ 1,165
Other Revenue - External 470 38 - 508 - 508
Revenue - Other Operating Segments 271 - - 271 5 (276) -
Net Income (loss) (2,681) (1,023) 74 (3,630) (34,757) 21,436 (16,951)
For the three months ended Communi- Reportable ---------- Other ---------- Grand
March 31, 2004 cations Media Technology Segments Corporate Consolidating Total
- --------------------------------------- ---------- ---------- ------------ ----------- ---------------------------------------
License Fees and Royalties - External $ 84 $ 535 $ 102 $ 721 $ - $ - $ 721
Other Revenue - External 436 37 - 473 - 0 473
Revenue - Other Operating Segments 305 1 - 306 3 (309) -
Net Income (loss) (2,720) (926) 70 (3,576) (12,753) 589 (15,740)
19
13. Subsequent Events:
On April 14, 2005, we issued Carole Salkind an 8% convertible note in the
principal amount of $0.39 million, for which Ms. Salkind paid us $0.39 million
in cash. The note is due October 14, 2005 and may be converted into our common
stock (at $0.013 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 7.0 million shares of our
common stock at an exercise price per share of $0.013.
Also on April 14, 2005, we issued Carole Salkind an 8% convertible note in
the principal amount of $0.46 million to cure our default under a note dated
October 1, 2004. The principal amount of the new note represents the aggregate
principal rolled over ($400,000), default penalty (10% of the principal in
default) and accrued interest. The note is due on October 14, 2005 and may be
converted into shares of our common stock at a conversion price per share of
$0.013 and exchanged for shares of common stock of any of our subsidiaries
(other than Pro Tech) that makes a public offering of its common stock (at the
public offering price). In connection with the issuance of this note, we issued
Ms. Salkind a five-year warrant to purchase 7,750,000 shares of our common stock
at an exercise price per share of $0.013.
On April 26, 2005, we issued Carole Salkind an 8% convertible note in the
principal amount of $0.39 million, for which Ms. Salkind paid us $0.39 million
in cash. The note is due October 26, 2005 and may be converted into our common
stock (at $0.011 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 7.0 million shares of our
common stock at an exercise price per share of $0.011.
On April 29, 2005, we issued Carole Salkind two 8% convertible notes in the
principal amount of $1.03 million to cure our default under notes dated October
15, 2004 and October 21, 2004. The principal amount of the new note represents
the aggregate principal rolled over ($0.9 million), default penalty (10% of the
principal in default) and accrued interest. The note is due on October 29, 2005
and may be converted into shares of our common stock at a conversion price per
share of $0.012 and exchanged for shares of common stock of any of our
subsidiaries (other than Pro Tech) that makes a public offering of its common
stock (at the public offering price). In connection with the issuance of this
note, we issued Ms. Salkind a five-year warrant to purchase 17,250,000 shares of
our common stock at an exercise price per share of $0.012.
20
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 our substantial level of indebtedness;
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, 2004 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.
Overview
We design products and develop and license 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 three months
ended March 31, 2005 consisted of approximately 69.6% in technology licensing
fees and royalties, 28.2% in product sales, 2.2% in advertising and zero 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.
Going Concern Risks
Since inception, we have experienced substantial recurring losses from
operations, which amounted to $371.4 million on a cumulative basis through March
31, 2005. 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
21
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 any
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 $1.1 million at March 31,
2005 and our working capital deficit was $77.2 million. We have been able to
continue our operations by raising additional capital through the sale of
convertible notes. We have been primarily dependent upon funding from Carole
Salkind in 2003, 2004 and to date in 2005. 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.
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
March 31, 2005 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, 2004.
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. Artera recognizes revenue ratably over the period
service is provided known as the subscription period. 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
operating results. 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
22
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 March 31, 2005, our deferred revenue aggregated $0.4 million. We do not
expect to realize any additional cash in connection with recognizing revenue
from our deferred revenue.
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, 2004, we evaluated the goodwill allocated to our Advancel
reporting unit, NCT Hearing reporting unit and Midcore/Artera reporting unit and
determined no impairment existed for Advancel or NCT Hearing.
In our annual assessment of the goodwill of the Midcore/Artera reporting
unit (included in the communications segment), we considered the results of
operations in relation to previous estimates of activity, as well as estimates
of anticipated operations. Based on our inability to develop the anticipated
lines of businesses and to realize results as budgeted, in part because of
changes at our enterprise systems business co-developer during the last quarter
of 2004, we have determined, for the purposes of our current assessment of
goodwill, not to anticipate the development of additional lines of business.
Although we are currently in negotiations with other parties for further
development and utilization of our system, we cannot be reasonably assured such
negotiations will be successful. As a result, our assessment of the value of the
reporting unit, based on existing operations, is not sufficient to carry the
goodwill without impairment. Based on our assessment, as of December 31, 2004,
we concluded that the goodwill of the Midcore/Artera reporting unit was impaired
and we recorded an impairment of $5.9 million. At March 31, 2005, our goodwill,
net consisting of the Advancel and NCT Hearing reporting units was $1.3 million.
Our next annual evaluation is planned for December 31, 2005.
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 each of the three months ended March 31, 2004 and 2005 was $0.1
million.
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 March 31, 2005, our patent rights and other
intangibles, net were $1.1 million. Our next evaluation is planned for December
31, 2005.
Results of Operations
Three months ended March 31, 2005 compared to three months ended March 31, 2004.
Revenue. Total revenue for the three months ended March 31, 2005 was $1.7
million as compared to $1.2 for same period in 2004, an increase of $0.5 or
41.7%, primarily due to the timing of reporting of royalties from OKI Electric
Industry Ltd. Total revenue for the three months ended March 31, 2005 consisted
of approximately 69.6% in technology licensing fees and royalties, 28.2% in
product sales and 2.2% in advertising revenue as compared to
23
the three months ended March 31, 2004 of approximately 60.4% in technology
licensing fees and royalties, 36.9% in product sales and 2.7% in advertising
revenue.
Technology licensing fees and royalties were $1.2 million for the three
months ended March 31, 2005 as compared to $0.7 million for the same period in
2004, an increase of $0.5 million, or 71.4%. 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 March 31, 2005, our
deferred revenue related to NXT was zero. No additional cash will be realized
from our deferred revenue.
For the three months ended March 31, 2005 product sales were $0.5 million
compared to $0.4 million for the same period in 2004. Gross profit on product
sales, as a percentage of product sales, for the three months ended March 31,
2005 and 2004 was 64.2% and 45.8%, respectively, primarily due to the change in
product mix in the Communications Segment. For the three months ended March 31,
2005 and 2004, 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 March 31, 2005 included 62% of Pro Tech products and 19% of
Artera Turbo subscriptions whereas the same period in the prior year included
61% of Pro Tech products and 13% of Artera Turbo subscriptions. Our subscriber
base that generated the Artera Turbo product sales for the three months ended
March 31, 2005 consisted of residential and small business users.
Advertising revenue was $36,000 for the three months ended March 31, 2005
compared to $32,000 for the same period in 2004.
Costs and expenses. Total costs and expenses for the three months ended
March 31, 2005 were $18.6 million compared to $16.9 million for the same period
in 2004, an increase of $1.7 million, or 10.1%, due primarily to an $1.5 million
increase in default penalties on convertible notes and an increase of $0.9
million in interest expense partially offset by a decrease in selling, general
and administrative expenses of $0.8 million.
For the three months ended March 31, 2005, selling, general and
administrative expenses totaled $1.3 million as compared to $2.1 million for the
three months ended March 31, 2004, a decrease of $0.8 million, or 38.1%. This
decrease was due primarily to the waiver by three executives of a portion of
their incentive bonus earned in 2004. These amounts waived were approximately
$326,000, $107,000 and $158,000 for our Chief Executive Officer, President and
Chief Financial Officer, respectively.
For each of the three months ended March 31, 2005 and March 31, 2004,
research and development expenditures totaled $1.1 million due primarily to
Artera research and development efforts including the development of other
components of our Artera Turbo and Rev The Web product offerings.
For the three months ended March 31, 2005, other (income) expense, net
totaled $2.9 million as compared to $1.2 million for the three months ended
March 31, 2004, an increase of $1.7 million, or 141.7%. The increase was due
primarily to a $1.5 million increase in default penalties on convertible notes.
For the three months ended March 31, 2005, interest expense, net totaled
$13.2 million as compared to $12.3 million for the three months ended March 31,
2004, an increase of $0.9 million, or 7.3%. The increase in interest expense was
attributable to the increase in debt and 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 March
31, 2005 included amortization of original issue discounts of $5.3 million,
amortization of beneficial conversion features in convertible debt of $6.4
million, and interest on convertible debt issued by us of $1.5 million.
Liquidity and Capital Resources
We have experienced substantial losses from operations since inception,
which have been recurring and amounted to $371.4 million on a cumulative basis
through March 31, 2005. These losses, which include the costs for development of
technologies and products for commercial use, have been funded primarily from:
o the issuance of our and our subsidiaries' convertible debt;
o the sale of our and our subsidiaries' common stock;
o the sale of our and our subsidiaries' convertible preferred stock;
o technology licensing fees;
24
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, product sales and advertising. 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. In addition, we currently do not have a
sufficient number of authorized but unissued shares of our common stock to
effect conversions and exchanges of our and our subsidiaries' derivative
securities. At our next annual meeting of stockholders, to be held in June 2005,
we will ask our stockholders to consider and approve an amendment to our
certificate of incorporation to increase the number of authorized shares of our
common stock. However, we can give no assurance that our stockholders will
approve this amendment, or that if approved, the increase will be sufficient to
satisfy all requests to convert or exchange derivative securities into shares of
our common stock. 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 March 31, 2005 about our ability to continue as a going concern.
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 three months ended March
31, 2005 are described in the notes to the condensed consolidated financial
statements. In 2005, 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 2003, 2004 and to date in 2005 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.
Our monthly use of operating cash for each of the three months ended March
31, 2005 was approximately $797,000. In the absence of a significant infusion of
new capital, we anticipate that our monthly use of cash over the next 12 months
will not exceed this level, assuming continued funding from Carole Salkind or
other sources to satisfy the amounts not funded by royalty collections and
product sales. Of our monthly cash expenditures, approximately $725,000 is used
to fund payroll and payroll-related costs (such as taxes and health insurance)
and the balance is used for other operating expenses, (including rents,
utilities, and arrearage arrangements).
At March 31, 2005, our cash and cash equivalents aggregated $1.1 million.
Our working capital deficit was $77.2 million at March 31, 2005, compared to a
deficit of $72.3 million at December 31, 2004, a $4.9 million increase. Our
current assets were approximately $2.6 million at March 31, 2005 compared to
approximately $2.5 million at December 31, 2004. Our current liabilities were
approximately $79.8 million at March 31, 2005 compared to approximately $74.8
million at December 31, 2004. The $5.0 million increase in current liabilities
was due primarily to the issuance and refinancing of convertible notes to Carole
Salkind of $3.9 million (net of discounts), an increase in accrued expenses due
to non-registration costs and liquidated damages of $2.7 million offset by
reductions in consulting fees of $0.5 million and incentive compensation of $0.9
million. At March 31, 2005, our current liabilities consisted of indebtedness
($49.7 million), accrued liabilities ($19.9 million), other current liabilities
($7.0 million), accounts payable ($2.2 million), deferred revenue ($0.4 million)
and shares of subsidiary subject to exchange rights ($0.6 million). We
anticipate that we may not be required to settle all of our current liabilities
in cash. Most of our indebtedness (and accrued interest thereon) is convertible
into shares of our common stock and may be converted to the extent we are able
to obtain stockholder approval of a proposal to increase the number of
authorized shares of our common stock.
At March 31, 2005, we were in default of $0.5 million of our notes payable
and $5.1 million of our convertible notes. The following table summarizes our
indebtedness in default at March 31, 2005:
25
New Defaults
(in millions) Indebtedness Defaults Cured Indebtedness
- ------------- In Default during during In Default
Notes Payable: 12/31/04 the Period the Period 03/31/05
--------------- ------------- ------------- ----------------
Former Employee / Other $ 0.5 (a) - - $ 0.5 (a)
--------------- ------------- ------------- ----------------
Subtotal $ 0.5 $ - $ - $ 0.5
--------------- ------------- ------------- ----------------
Convertible Notes Payable:
Carole Salkind Notes $ - $ 26.4 $ (26.4) $ - (a)
8% Notes 2.6 (a,b) - - 2.6 (a,b)
6% Notes 2.5 (a) - - 2.5 (a)
--------------- ------------- ------------- ----------------
Subtotal $ 5.1 $ 26.4 $ (26.4) $ 5.1
--------------- ------------- ------------- ----------------
Grand Total $ 5.6 $ 26.4 $ (26.4) $ 5.6
=============== ============= ============= ================
Footnotes:
- ----------
(a) Default due to nonpayment.
(b) Default due to cross default provision (default on other debt).
Net cash used in operating activities for the three months ended March 31,
2005 was $2.2 million due primarily to funding the 2005 net loss of $17.0
million, as adjusted to reconcile to net cash.
Our deferred revenue balance at March 31, 2005 was $0.4 million. No
additional cash will be realized from our deferred revenue balance.
Net cash used in investing activities was less than $0.1 million for the
three months ended March 31, 2005.
At each of March 31, 2005 and December 31, 2004, 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
price volatility and other market conditions.
Net cash provided by financing activities was $1.9 million for the
three-month period ended March 31, 2005 and was primarily due to the issuance
and sale of convertible notes to Ms. Salkind for cash consideration of $2.0
million.
At March 31, 2005, our short-term debt was $49.7 million (principally
comprised of $49.1 million face value of outstanding convertible notes payable,
net and $0.6 million of outstanding notes payable), shown net of discounts of
approximately $14.4 million on our condensed consolidated balance sheet,
compared to $45.7 million of short-term debt, net at December 31, 2004, an
increase of $4.0 million due to Carole Salkind. The cash proceeds from debt
issued in the three months ended March 31, 2005 was primarily used for working
capital purposes.
During the three months ended March 31, 2005, we issued an aggregate of
$32.2 million of convertible notes to Carole Salkind as consideration for $2.0
million cash and refinancing of $26.4 million in principal of matured notes,
along with default penalties and accrued interest.
As described above, as of March 31, 2005, we are in default (primarily from
non-payment) on $5.6 million of our indebtedness.
We believe that the level of financial resources available to us is
critical to our ability to continue as a going concern. From time to time, we
may need to raise additional capital through equity or debt financing in order
to sustain our operations or capitalize upon business opportunities and market
conditions. Presently we do not have a sufficient number of authorized common
shares to effect conversions of security instruments into our common stock. We
expect that from time to time our outstanding short-term debt may be replaced
with new short-term or long-term borrowings. Although we believe that we can
continue to access the capital markets in 2005 on acceptable terms and
conditions, our flexibility with regard to long-term financing activity could be
limited by the liquidity of our common stock on the open market, our current
level of short-term debt and our credit ratings.
26
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
assurance that we will continue to have access to the capital markets on
favorable terms. In addition, our subsidiaries are at a stage where they may not
separately be able to obtain financing or other funding based upon their lack of
or limited performance history.
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 any
financing under our private equity credit agreement dated September 30, 2004
until our stockholders approve a sufficient increase in the number of authorized
shares of our common stock and we register for resale shares of our common stock
to be sold pursuant to the agreement.
Capital Expenditures
We currently anticipate Pro Tech incurring approximately $0.1 million in
tooling costs, in connection with our expected release of a new industrial
hearing protection product in 2005. Other than this expenditure, we had no
material commitments for capital expenditures as of March 31, 2005 and no
material commitments are anticipated in the near future.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposures include fluctuations in interest 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 March 31, 2005. Based on that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures as of March 31, 2005 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 March 31, 2005 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
28
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.
29
ITEM 6. EXHIBITS
3.1 Certificate of Designation, Preferences and Rights of Series I
Convertible Preferred Stock of NCT Group, Inc. (incorporated herein by
reference to Exhibit 3.1 of the registrant's Current Report on Form
8-K dated march 16, 2005 (File No. 0-18267)).).
10.1(a) Form of Secured Convertible Note (new financings) issued by NCT Group,
Inc. to Carole Salkind (incorporated herein by reference to Exhibit
10.8(a) of the registrant's Annual Report on Form 10-K for the year
ended December 31, 2004 (File No. 0-18267)).
10.1(b) Schedule of Secured Convertible Notes (new financings) issued by NCT
Group, Inc. to Carole Salkind and outstanding as of March 31, 2005.
10.2(a) Form of Secured Convertible Note (refinancings) issued by NCT Group,
Inc. to Carole Salkind (incorporated herein by reference to Exhibit
10.9(a) of the registrant's Annual Report on Form 10-K for the year
ended December 31, 2004 (File No. 0-18267)).
10.2(b) Schedule of Secured Convertible Notes (refinancings) issued by NCT
Group, Inc. to Carole Salkind and outstanding as of March 31, 2005.
10.3(a) Form of Warrant (new financings) issued by NCT Group, Inc. to Carole
Salkind (incorporated herein by reference to Exhibit 10.10(a) of the
registrant's Annual Report on Form 10-K for the year ended December
31, 2004 (File No. 0-18267)).
10.3(b) Schedule of Warrants (new financings) issued by NCT Group, Inc. to
Carole Salkind and outstanding as of March 31, 2005.
10.4(a) Form of Warrant (refinancings) issued by NCT Group, Inc. to Carole
Salkind (incorporated herein by reference to Exhibit 10.11(a) of the
registrant's Annual Report on Form 10-K for the year ended December
31, 2004 (File No. 0-18267)).
10.4(b) Schedule of Warrants (refinancings) issued by NCT Group, Inc. to
Carole Salkind and outstanding as of March 31, 2005.
10.5 Consulting Agreement, dated as of January 7, 2005, by and between NCT
Group, Inc. and Morton Salkind.
10.6(a) Form of Preferred Stock Purchase Agreement between NCT Group, Inc. and
certain NCT Group, Inc. executive officers (incorporated herein by
reference to Exhibit 10.1(a) of the registrant's Current Report on
Form 8-K dated March 16, 2005 (File No. 0-18267)).
10.6(b) Schedule of Purchasers (incorporated herein by reference to Exhibit
10.1(b) of the registrant's Current Report on Form 8-K dated March 16,
2005 (File No. 0-18267)).
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934.
31.2 Certification of Chief Financial Officer pursuant Rule 13a-14(a) under
the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive 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.
30
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: May 16, 2005
31