UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2006
-------------
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
(Check one):
Large Accelerated Filer /_/ Accelerated Filer /_/ Non-Accelerated Filer /X/
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
/ / Yes /X/ No
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of August 1, 2006 was 931,175,126.
Table of Contents
Page
Part I Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets at December 31, 2005 (As Restated) and June 30, 2006
(Unaudited) 3
Condensed Consolidated Statements of Operations (Unaudited) and Condensed Consolidated
Statements of Comprehensive Loss (Unaudited) for the Three and Six Months
Ended June 30, 2005 (As Restated) and 2006 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months
Ended June 30, 2005 (As Restated) and 2006 5
Notes to the Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 32
Part II Other Information
Item 1. Legal Proceedings 33
Item 1A. Risk Factors 33
Item 3. Defaults Upon Senior Securities 33
Item 6. Exhibits 33
Signatures 35
2
PART I FINANCIAL INFORMATION
NCT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Notes 1 and 6)
(In thousands, except share data)
December 31, June 30,
2005 2006
(As Restated)
---------------- ---------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 451 $ 339
Investment in available-for-sale marketable securities 20 16
Accounts receivable, net 640 286
Inventories, net 253 251
Other current assets (includes $98 due from former officer) 181 179
---------------- ---------------
Total current assets 1,545 1,071
Property and equipment, net 849 733
Goodwill, net 1,252 1,252
Patent rights and other intangibles, net 1,021 739
Other assets 53 24
---------------- ---------------
$ 4,720 $ 3,819
================ ===============
LIABILITIES AND CAPITAL DEFICIT
Current liabilities:
Accounts payable $ 3,095 $ 3,014
Accrued expenses-related parties 3,649 4,148
Accrued expenses-other 11,811 12,272
Notes payable 576 553
Stockholder convertible notes 73,111 97,124
Current maturities of convertible notes 4,884 5,078
Deferred revenue 350 350
Shares of subsidiary subject to exchange into a variable number of shares 656 666
Preferred stock subject to conversion into a variable number of shares 25,157 24,589
Derivative liabilities 7,965 3,728
Other current liabilities 7,098 7,014
---------------- ---------------
Total current liabilities 138,352 158,536
Long-term liabilities:
Stockholder convertible notes 5,000 5,000
Other liabilities 27 13
---------------- ---------------
Total long-term liabilities 5,027 5,013
---------------- ---------------
Minority interest in consolidated subsidiaries 8,655 8,815
---------------- ---------------
Capital deficit:
Preferred stock, $.10 par value; 10,000,000 shares authorized:
Convertible series I preferred stock, 510 shares issued and outstanding
(liquidation amount $510) 510 510
Common stock, $.01 par value; 5,622,000,000 shares authorized;
838,983,565 and 913,719,236 shares issued and outstanding, respectively 8,389 9,137
Additional paid-in capital 233,079 233,167
Accumulated deficit (389,572) (411,700)
Accumulated other comprehensive income 280 341
---------------- ---------------
Total capital deficit (147,314) (168,545)
---------------- ---------------
$ 4,720 $ 3,819
================ ===============
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 Six months ended
June 30, June 30,
-------------------------- -------------------------
2005 2006 2005 2006
(As Restated) (As Restated)
------------- ----------- ------------- ----------
REVENUE:
Technology licensing fees and royalties $ 328 $ 56 $ 1,493 $ 513
Product sales, net 515 472 987 970
Other revenue 1 1 1 4
------------- ----------- ------------- ----------
Total revenue 844 529 2,481 1,487
------------- ----------- ------------- ----------
COSTS AND EXPENSES:
Cost of product sales 256 239 425 470
Cost of other revenue 2 2 4 4
Selling, general and administrative 1,956 1,692 3,239 3,450
Research and development 1,047 877 2,067 1,808
Impairment of intangible assets - 249 - 249
------------- ----------- ------------- ----------
Total operating costs and expenses 3,261 3,059 5,735 5,981
Non-operating items:
Other (income) expense, net 3,628 (650) 4,464 2,126
Interest expense, net (Including amortization of debt discounts of
$6,292, $3,559, $13,980 and $8,238, respectively, and beneficial
conversion features of $7,207, $257, $15,982 and $2,558, respectively) 15,183 6,272 33,292 15,508
------------- ----------- ------------- ----------
Total costs and expenses 22,072 8,681 43,491 23,615
Add back: Minority interest in subsidiary's net loss 59 - 59 -
------------- ----------- ------------- ----------
Loss from continuing operations (21,169) (8,152) (40,951) (22,128)
Loss from discontinued operations (70) - (116) -
------------- ----------- ------------- ----------
NET LOSS $ (21,239) $ (8,152) $ (41,067) $ (22,128)
Less: Subsidiary preferred stock dividends 82 80 165 160
------------- ----------- ------------- ----------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (21,321) $ (8,232) $ (41,232) $ (22,288)
============ ============ ============= ==========
Net loss per share attributable to common stockholders:
Loss per share-continuing operations $ (0.03) $ (0.01) $ (0.06) $ (0.03)
-discontinued operations - - - -
------------- ----------- ------------- ----------
Net loss per share attributable to common stockholders-basic and diluted $ (0.03) $ (0.01) $ (0.06) $ (0.03)
============ ============ ============= ==========
Weighted average common shares outstanding -
basic and diluted 645,025 906,528 645,012 872,742
============ ============ ============= ==========
NCT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited; in thousands)
Three months ended Six months ended
June 30, June 30,
-------------------------- -------------------------
2005 2006 2005 2006
(As Restated) (As Restated)
------------- ----------- ------------- ----------
NET LOSS $ (21,239) $ (8,152) $ (41,067) $ (22,128)
Other comprehensive income:
Foreign currency translation adjustment 104 26 124 65
Adjustment of unrealized gain (loss) on marketable securities 2 (4) 2 (4)
------------- ----------- ------------- ----------
COMPREHENSIVE LOSS $ (21,133) $ (8,130) $ (40,941) $ (22,067)
============ ============ ============= ==========
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)
Six months ended June 30,
----------------------------------------
2005 2006
(As Restated)
------------------- ------------------
Cash flows from operating activities:
Net loss $ (41,067) $ (22,128)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 151 231
Provision for inventory (7) (5)
Provision for doubtful accounts and uncollectible amounts (6) -
Gain on disposition of fixed assets (12) -
Finance costs associated with non-registration of common shares 697 729
Finance costs associated with non-conversion or exchange of common shares 2,442 -
Preferred stock dividends as interest 357 331
Accrued default penalties subsequently converted to principal (with a stockholder) 2,942 8,865
Accrued interest subsequently converted to principal (with a stockholder) 1,279 3,632
Amortization of discounts on notes (includes $13,924 and $8,181,
respectively, with a stockholder) 13,980 8,238
Amortization of beneficial conversion feature on convertible notes (includes
$15,846 and $2,421, respectively, with a stockholder) 15,982 2,558
Loss attributable to minority interest (59) -
Change in fair value of derivative liabilities (1,745) (7,174)
Impairment of intangible assets - 249
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (39) 354
Decrease in inventories 6 8
Decrease in other assets 69 29
(Decrease) increase in accounts payable and accrued expenses (2,259) 258
Increase (decrease) in other liabilities and deferred revenue 2,903 (83)
------------------- ------------------
Net cash used in operating activities (4,386) (3,908)
------------------- ------------------
Cash flows from investing activities:
Capital expenditures (39) (82)
Proceeds from sale of equipment - -
------------------- ------------------
Net cash used in investing activities (39) (82)
------------------- ------------------
Cash flows from financing activities:
Proceeds from:
Issuance of stockholder convertible notes 4,036 3,850
Repayment of notes (46) (37)
------------------- ------------------
Net cash provided by financing activities 3,990 3,813
------------------- ------------------
Effect of exchange rate changes on cash 124 65
------------------- ------------------
Net decrease in cash and cash equivalents (311) (112)
Cash and cash equivalents at beginning of period 1,359 451
------------------- ------------------
Cash and cash equivalents at end of period $ 1,048 $ 339
=================== ==================
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 and six
months ended June 30, 2006 and cash flows for the six months ended June 30, 2006
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, 2005 contained in our Annual
Report on Form 10-K, as amended.
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 since our inception, which
cumulatively amounted to $411.7 million through June 30, 2006. Cash and cash
equivalents amounted to $0.3 million at June 30, 2006, decreasing from $0.5
million at December 31, 2005. A working capital deficit of $157.5 million
existed at June 30, 2006. We were in default of $0.5 million of our notes
payable and $5.1 million of our convertible notes at June 30, 2006. Our
management believes that internally generated funds are currently insufficient
to meet our operating and capital requirements. These funds include available
cash and cash equivalents and revenue derived from technology licensing fees and
royalties and product sales. Our ability to continue as a going concern is
substantially dependent upon our current and any future revenue sources and
future levels of funding from debt and equity transactions, all 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
June 30, 2006 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.
Restatement of Consolidated Financial Statements to Reflect Derivative
Accounting
Our condensed consolidated balance sheet as of June 30, 2005 and our
results of operations for the three and six months ended June 30, 2005 have been
restated to account for the effect of certain restatements of our condensed
consolidated statements of operations and cash flows for the three and six
months ended June 30, 2005. These restatements reflect the effects of
adjustments to the accounting treatment for various convertible equity
instruments in accordance with the requirements of Emerging Issues Task Force
("EITF") Issue No. 00-19, "Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock" and the reversal
of an accrual for the non-registration penalties related to a convertible equity
instrument. As a result of these adjustments, as of June 30, 2005, additional
paid in capital decreased by $38.7 million, retained earnings decreased by $1.7
million and current liabilities increased by $59.9 million. In addition, for the
three and
6
six months ended June 30, 2005, net loss increased by $4.5 million and $7.4
million, and net loss attributable to common stockholders increased by $2.0
million and $2.3 million, respectively.
Patent Rights and Other Intangible Assets with Finite Useful Lives
Under the guidelines in the Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets," and SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," intangible assets with finite lives are tested
for impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. We test our intangible assets with
finite useful lives for impairment by using the estimated future cash flows
directly associated with, and that are expected to arise as a direct result of,
the use of the intangible asset. We do so by projecting the future estimated
revenue and costs and comparing the resultant undiscounted cash flows to the
carrying amount of the intangible asset. If the carrying amount exceeds the
undiscounted cash flows, an impairment may be indicated. The carrying amount is
then compared to the discounted cash flows, and if there is excess, such amount
is recorded as an impairment. We also evaluate the useful lives each reporting
period. The factors we use in evaluating the period of amortization include
current operating results, anticipated future operating results and any other
material factors that affect the continuity of the business.
Based on an evaluation as of June 30, 2006, our subsidiary, Pro Tech
Communications, Inc., determined an impairment was present with respect to our
license granted to Pro Tech. The impairment charge to Pro Tech, on its
accounting records, was $1.5 million. After consolidation of Pro Tech's results
of operations in our financial statements, the resulting impairment was
approximately $0.2 million, representing the minority shareholders' portion of
Pro Tech's impairment recognized in our condensed consolidated statements of
operations for the three months and six months ended June 30, 2006. Our next
evaluation is planned for our next reporting date.
Recent Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments." SFAS No. 155 amends SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," and SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," and addresses the application of SFAS No. 133 to beneficial
interests in securitized financial assets. SFAS No. 155 establishes a
requirement to evaluate interests in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation.
Additionally, SFAS No. 155 permits fair value measurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation. SFAS No. 155 is effective for all financial instruments
acquired or issued after fiscal years beginning after September 15, 2006. We do
not expect that the adoption of SFAS No. 155 will have a material impact on our
consolidated financial condition or results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets," which also amends SFAS No. 140. SFAS No. 156 provides
guidance on the accounting for servicing assets and servicing liabilities when
an entity undertakes an obligation to service a financial asset by entering into
a servicing contract. This statement is effective for all transactions in fiscal
years beginning after September 15, 2006. We do not expect that the adoption of
SFAS No. 156 will have a material impact on our consolidated financial condition
or results of operations.
In June 2006, the FASB issued Financial Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes - an interpretation of SFAS No. 109" ("FIN 48").
FIN 48 prescribes a recognition threshold and measurement attribute, as well as
criteria for subsequently recognizing, derecognizing and measuring uncertain tax
positions for financial statement purposes. This interpretation also requires
expanded disclosure with respect to the uncertainty in income taxes. FIN 48 is
effective for us beginning January 1, 2007. We do not anticipate that the
adoption of FIN 48 will have a material impact on our financial position,
results of operations or cash flows.
2. Stock-Based Compensation:
Effective January 1, 2006, we adopted SFAS No. 123 (Revised 2004),
"Share-Based Payment" ("SFAS No. 123(R)"), using the modified prospective
application transition method. The modified prospective application transition
method requires compensation cost to be recognized beginning on the effective
date (a) based on the requirements of SFAS No. 123(R) for all share-based
payments granted after the effective date and (b) based on the requirements of
SFAS No. 123 for all awards granted to employees prior to the effective date of
SFAS No. 123(R) that remain unvested on the effective date. Stock options under
SFAS No. 123(R) are valued at the date of grant using the Black-Scholes option
pricing model. Prior periods will not reflect restated amounts to reflect the
impact of
7
SFAS No. 123(R). Prior to January 1, 2006, we accounted for our stock-based
compensation plans in accordance with Accounting Principles Board ("APB")
Opinion No. 25 and related interpretations. Under APB Opinion No. 25, no
compensation cost was recognized if the option exercise price was equal to or
greater than the fair market price of the common stock on the date of the grant.
Prior to January 1, 2006, no stock-based employee compensation cost was
reflected in our net loss, as options granted under our plans had an exercise
price equal to or greater than the market value of the underlying common stock
on the date of grant. There was no stock-based employee compensation cost
recognized during the six months ended June 30, 2005 nor any compensation cost
that would have been recognized had we used the fair value method under SFAS No.
123.
There was no impact on our financial position, results of operations or
cash flows upon the adoption of SFAS No. 123(R). We had no outstanding unvested
options at January 1, 2006 and there were no new option grants during the six
months ended June 30, 2006.
We have stock option plans under which directors, officers, employees and
consultants may be granted options to purchase common stock or other
equity-based awards. Our stock option plans that have been approved by our
stockholders are as follows: the NCT Group, Inc. 1992 Stock Incentive Plan, as
amended (the "1992 Plan"), and the NCT Group, Inc. 2001 Stock and Incentive
Plan, as amended (the "2001 Plan"). In addition, options outside the option
plans have been granted. Due to expiration of the plan, no future grants of
options for the purchase of shares of our common stock are available under the
1992 Plan.
Our option plan activity is summarized as follows:
1992 Plan 2001 Plan Non Plan
--------------------------- --------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- ---------------------------------------------- ------------- ------------ ------------- ------------- ------------- -----------
Outstanding at December 31, 2005 38,164,531 $0.3917 399,359,850 $0.0204 423,864,000 $0.0402
Options granted - - -
Options exercised - - -
Options canceled, expired or forfeited - - (2,475,000) $0.1275
------------- ------------- -------------
Outstanding at June 30, 2006 38,164,531 $0.3917 399,359,850 $0.0204 421,389,000 $0.0397
============= ============= =============
Options exercisable at June 30, 2006 38,164,531 $0.3917 399,359,850 $0.0204 421,389,000 $0.0397
============= ============= =============
Options available for grant at June 30, 2006 - 218,520,150 -
============= ============= =============
Weighted average remaining
contractual life (in years) 1.9 6.0 2.8
============= ============= =============
Aggregate intrinsic value $ - $ - $ -
============= ============= =============
The aggregate intrinsic value in the table above represents the intrinsic value
(the aggregate difference between the closing stock price of our common stock on
June 30, 2006 and the exercise price for in-the-money options) that would have
been received by the optionees if all options had been exercised on June 30,
2006.
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:
8
(In thousands of dollars)
Cost Market Market
Basis Unrealized Value Unrealized Value
1/1/05 Gain (Loss) 12/31/05 Loss 6/30/06
------------ ------------- ------------ ------------ -------------
ITC $ 10 $ 2 $ 12 $ (1) $ 11
Teltran 14 (6) 8 (3) 5
------------ ------------- ------------ ------------ -------------
Totals $ 24 $ (4) $ 20 $ (4) $ 16
============ ============= ============ ============ =============
We review declines in the value of our investments 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 and
six months ended June 30, 2006, we did not recognize any other-than-temporary
decline in realizable value of our investments.
Accounts receivable comprise the following:
(In thousands of dollars)
December 31, June 30,
2005 2006
-------------- --------------
Technology license fees and royalties $ 533 $ 317
Joint ventures and affiliates 34 34
Other receivables 424 285
-------------- --------------
$ 991 $ 636
Allowance for doubtful accounts (351) (350)
-------------- --------------
Accounts receivable, net $ 640 $ 286
============== ==============
Inventories comprise the following:
(In thousands of dollars)
December 31, June 30,
2005 2006
-------------- --------------
Finished goods $ 248 $ 245
Components 206 202
-------------- --------------
$ 454 $ 447
Reserve for obsolete and slow moving inventory (201) (196)
-------------- --------------
Inventories, net $ 253 $ 251
============== ==============
Other current assets comprise the following:
(In thousands of dollars)
December 31, June 30,
2005 2006
-------------- --------------
Notes receivable $ 1,000 $ 1,000
Due from former officer 98 98
Advances and deposits 53 24
Other 181 179
-------------- --------------
$ 1,332 $ 1,301
Reserve for uncollectible amounts (a) (1,098) (1,098)
-------------- --------------
Other assets $ 234 $ 203
Less: other assets classified as long term 53 24
-------------- --------------
Other current assets $ 181 $ 179
============== ==============
9
Footnote:
- --------
(a) Includes full reserve for the $1.0 million of notes receivable and the
$98,000 due from a former officer. The $1.0 million of non-recourse,
non-interest bearing notes receivable due January 2, 2002 were partial
consideration for the January 9, 2001 6% convertible notes payable
(see Note 6). The note receivable from the former officer (plus
accrued interest) is the amount in excess of the amount owed to him.
Property and equipment comprise the following:
(In thousands of dollars)
December 31, June 30,
2005 2006
-------------- --------------
Machinery and equipment $ 946 $ 947
Furniture and fixtures 337 323
Tooling 491 572
Leasehold improvements 388 391
Other 402 403
-------------- --------------
$ 2,564 $ 2,636
Accumulated depreciation (1,715) (1,903)
-------------- --------------
Property and equipment, net $ 849 $ 733
============== ==============
Depreciation expense for each of the three and six months ended June 30,
2005 and 2006 was approximately $0.1 million and $0.2 million, respectively.
Accrued expenses comprise the following:
(In thousands of dollars)
December 31, June 30,
2005 2006
(As Restated)
-------------- --------------
Non-registration fees due to related parties $ 216 $ 308
Interest due to a stockholder 2,641 3,006
Consulting fees due to a stockholder - 85
Incentive compensation due to officers 792 749
-------------- --------------
Accrued expenses-related parties $ 3,649 $ 4,148
============== ==============
Non-registration fees $ 5,721 $ 6,358
Interest 2,136 2,517
Commissions payable 124 116
Other 3,830 3,281
-------------- --------------
Accrued expenses-other $ 11,811 $ 12,272
============== ==============
Other current liabilities comprise the following:
(In thousands of dollars)
December 31, June 30,
2005 2006
-------------- --------------
License reacquisition payable $ 4,000 $ 4,000
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 139 41
-------------- --------------
$ 7,125 $ 7,027
Less: other liabilities classified as long term 27 13
-------------- --------------
Other current liabilities $ 7,098 $ 7,014
============== ==============
10
Statements of Operations Information
Other (income) expense, net consisted of the following:
(In thousands of dollars)
Three months ended Six months ended
June 30, June 30,
--------------------------------- ---------------------------------
2005 2006 2005 2006
(As Restated) (As Restated)
--------------- --------------- --------------- ---------------
Finance costs associated with non-registration
of common shares $ 350 $ 367 $ 697 $ 729
Default penalties on stockholder convertible notes 301 1,728 2,942 8,865
Loss (gain) on change in fair value of derivatives 1,715 (2,436) (1,745) (7,174)
Costs associated with non-conversion of preferred stock(a) 1,183 - 2,442 -
Gain from sale of purchase option in Westport lease (Note 8) - (308) - (308)
Other 79 (1) 128 14
--------------- --------------- --------------- ---------------
Other (income) expense, net $ 3,628 $ (650) $ 4,464 $ 2,126
=============== =============== =============== ===============
Footnote:
- --------
(a) These costs were waived, and the expense was reversed, in the third
quarter of 2005.
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 Pro Tech borne by us for the six months ended June 30,
2005 and 2006 were less than $0.1 million and $0.4 million, respectively. Future
earnings of our majority-owned subsidiaries otherwise attributable to minority
shareholders' interests will be allocated again to minority shareholders only
upon additional investments or after future earnings are sufficient to recover
the cumulative losses previously absorbed by us (approximately $3.1 million at
June 30, 2006).
Supplemental Cash Flow Information
(In thousands of dollars)
Six months ended June 30,
---------------------------------
2005 2006
(As Restated)
--------------- ---------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 9 $ 7
=============== ===============
Supplemental disclosures of non-cash investing and financing activities:
Unrealized holding gain (loss) on available-for-sale securities $ 2 $ (4)
=============== ===============
Finance costs associated with non-registration of common shares $ 2,404 $ -
=============== ===============
Finance costs associated with non-conversion of preferred stock $ 2,344 $ -
=============== ===============
Issuance of series I preferred stock $ 976 $ -
=============== ===============
Property and equipment financed through notes payable $ 18 $ -
=============== ===============
Principal on stockholder convertible notes exchanged for new notes $ 29,417 $ 78,649
=============== ===============
Interest on stockholder convertible notes exchanged for new notes $ 1,279 $ 3,632
=============== ===============
Default penalty on stockholder convertible notes exchanged for new notes $ 2,942 $ 8,865
=============== ===============
11
4. Capital Deficit:
The changes in capital deficit during the six months ended June 30, 2006 were as follows:
Series I
Convertible
Preferred Stock Common Stock Additional
-------------------- ----------------------- Paid-in
(In thousands of dollars and shares) Shares Amount Shares Amount Capital
--------- --------- ----------- ---------- -----------
Balance at December 31, 2005 (As Restated) 1 $ 510 838,984 $ 8,389 $ 233,079
Conversion of series H preferred stock - - 74,735 748 248
Dividend and amortization of discounts on beneficial
conversion feature to subsidiary preferred shareholders - - - - (160)
Net loss - - - - -
Change in valuation of available-for-sale marketable securities - - - - -
Foreign currency translation adjustment - - - - -
--------- --------- ----------- ---------- -----------
Balance at June 30, 2006 1 $ 510 913,719 $ 9,137 $ 233,167
========= ========= =========== ========== ===========
Accumulated
Other
Accumu- Compre-
lated hensive
(In thousands of dollars and shares) Deficit income Total
------------ ------------- ------------
Balance at December 31, 2005 (As Restated) $ (389,572) $ 280 $ (147,314)
Conversion of series H preferred stock - - 996
Dividend and amortization of discounts on beneficial
conversion feature to subsidiary preferred shareholders - - (160)
Net loss (22,128) - (22,128)
Change in valuation of available-for-sale marketable securities - (4) (4)
Foreign currency translation adjustment - 65 65
------------ ------------- ------------
Balance at June 30, 2006 $ (411,700) $ 341 $ (168,545)
============ ============= ============
12
5. Notes Payable:
(In thousands of dollars)
December 31, June 30,
2005 2006
------------- -------------
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 14 6
Interest at 12% per annum; monthly payments (including interest) of $1.5
from November 2005 through September 2006, remainder matures October 15,
2006.
Note due former employee (a) 100 100
$100 bears interest at 8.25% per annum, compounded annually;
past due.
Other financings 77 62
Interest ranging from 7% to 9% per annum;
$35 due July 15, 2003 (a); $27 due November 1, 2007.
------------- -------------
Notes Payable $ 576 $ 553
============= =============
Footnote:
- --------
(a) Notes payable are in default due to nonpayment.
6. Convertible Notes Payable:
(In thousands of dollars)
December 31, June 30,
2005 2006
(As Restated)
Stockholder Convertible Notes ------------- -------------
Issued to Carole Salkind - (a) (see Note 10) $ 83,649 $ 106,287
Weighted average effective interest rate of 58.1% per annum; accrues
interest at 8% per annum, except $6,001 and $7,467 at 12%; collateralized by
substantially all of the assets of NCT; convertible into NCT common stock
at prices of the greater of par value (currently $0.01) or of prices ranging
from $0.0018 - $0.0166 or exchangeable for common stock of NCT
subsidiaries except for Pro Tech; maturing by quarter as follows:
2005 2006
--------------------------------
Past due $ 576 $ -
Demand notes (b) 375 6,575
March 31, 2006 69,841 -
June 30, 2006 7,857 -
September 30, 2006 - 76,444
December 31, 2006 - 18,268
December 31, 2009 5,000 5,000
Less: unamortized debt discounts (5,538) (4,163)
------------- -------------
$ 78,111 $ 102,124
Less: amounts classified as long-term (5,000) (5,000)
------------- -------------
Stockholder Convertible Notes $ 73,111 $ 97,124
============= =============
13
(In thousands of dollars)
December 31, June 30,
Convertible Notes: 2005 2006
------------- -------------
8% Convertible Notes (c) $ 2,626 $ 2,626
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; past due, except
July 2004 notes matured July 2006; issued as follows:
Issue Date 2005 2006
- ---------- --------------------------------
March 14, 2001 $ 17 $ 17
April 12, 2001 9 9
January 10, 2002 550 550
March 11, 2002 400 400
April 22, 2003 235 235
September 4, 2003 440 440
July 23, 2004 975 975
6% Convertible Notes (in default) 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; issued as follows:
Issue Date 2005 2006
- ---------- --------------------------------
January 9, 2001 $ 818 $ 818
April 4, 2001 325 325
May 25, 2001 81 81
June 29, 2001 1,250 1,250
------------- -------------
$ 5,100 $ 5,100
Less: unamortized debt discounts (216) (22)
------------- -------------
Current maturities of convertible notes $ 4,884 $ 5,078
============= =============
Footnotes:
- ---------
(a) We have issued convertible notes collateralized by substantially all
of our assets to Carole Salkind, a stockholder and spouse of a former
director of NCT. During the six months ended June 30, 2006, we issued
an aggregate of $101.3 million of convertible notes ($98.8 million of
8% notes and $2.5 million of 12% notes). Consideration for these notes
was $3.9 million in cash, refinancing of $78.6 million in principal
for matured notes, $3.6 million of interest, $8.9 million of default
penalties (including interest default penalties aggregating $1.0
million) and $6.3 million of original issue discounts ("OIDs") ($2.7
million arising from cash consideration in an amount less than the
face value of the related notes and $3.6 million arising from
refinanced notes). In addition to the $6.3 million in OIDs, we
recorded OIDs of $2.9 million to the notes based upon the fair value
of warrants granted to Ms. Salkind (see Note 9). These discounts are
being amortized over the term of the related notes. There were no
beneficial conversion features recorded as a discount to the notes
during the six months ended June 30, 2006. For the three and six
months ended June 30, 2006, $3.7 million and $10.6 million,
respectively, of amortization of current and prior year OIDs and
beneficial conversion features were classified as interest expense on
our condensed consolidated statements of operations. Unamortized
discounts of $5.5 million and $4.2 million have been reflected as a
reduction to the stockholder convertible notes on our condensed
consolidated balance sheets at December 31, 2005 and June 30, 2006,
respectively. The default provisions in these notes impose a penalty
of 10% of the principal in default and default interest from the date
of default at the stated interest rate plus 5%. Further, the five-year
$5.0 million note issued to Ms. Salkind in December 2004 imposes an
interest default penalty (10% of the then outstanding principal of
this note) each time a quarterly interest installment is not paid when
due. Because we had defaulted on repayment of all of the notes as they
matured during the six months ended June 30, 2006, aggregate default
penalty expense of $1.7 million and $8.9 million for the three and six
months ended June 30, 2006, respectively, has been reflected in other
(income) expense, net on our condensed consolidated statements of
operations.
(b) Due upon the earlier of demand or six months from the respective dates
of issuance.
14
(c) We are in default on convertible notes aggregating $1.6 million due to
a cross-default provision and non-payment. We are also in default on
convertible notes aggregating $1.0 million dated July 23, 2004 due to
our failure to register for resale the shares of our common stock
issuable upon conversion of these notes. These notes were not repaid
when due on July 23, 2006.
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 $0.7 million on our condensed consolidated balance sheet at June
30, 2006, which is comprised of $0.6 million fair value of the preferred shares
plus accrued dividends thereon of approximately $0.1 million. We have the option
to settle the accrued dividends in cash or common stock. If the holder elected
to exchange the stated value of the preferred stock, along with accrued
dividends, for NCT common stock as of June 30, 2006, we would have been required
to issue approximately 55.1 million shares (calculated at a $0.01 conversion
price, our current par value). 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 December 31, 2005 and June 30, 2006, there were no shares of Pro Tech
series A preferred stock outstanding and 460 shares of Pro Tech series B
preferred stock outstanding. For the three and six months ended June 30, 2006,
the 4% dividends earned by the holder of the Pro Tech series B preferred stock
were approximately $5,000 and $9,000, respectively. These amounts are included
in interest expense on our condensed consolidated statements of operations.
8. Commitments and Contingencies:
In July 2005, we entered into a second amended and restated private equity
credit agreement with Crammer Road LLC ("Crammer Road"), a Cayman Islands
limited liability company, that supersedes and replaces our amended and restated
private equity credit agreement dated as of September 30, 2004, which in turn
replaced a similar agreement dated as of July 25, 2002. The new credit agreement
provides that we must put to Crammer Road shares of our common stock having an
aggregate value of at least $5.0 million (the minimum commitment amount) and may
put to Crammer Road shares of our common stock having an aggregate value of up
to $50.0 million (the maximum commitment amount). The purchase price of the
shares will equal 93% of the average of the three lowest closing bid prices of
our common stock during the ten-day trading period immediately following the
date of our notice to Crammer Road of our election to put shares. The maximum
amount that we can put to Crammer Road in any single transaction is equal to, at
the time of our election, the lesser of (a) $2.0 million or (b) 500% of the
daily weighted average volume of shares of our common stock for the 15 trading
days immediately preceding the date of the put, provided that the maximum amount
is no less than $0.5 million. Through June 30, 2006, we have sold a total of
18,756,756 shares of our common stock to Crammer Road pursuant to our private
equity credit agreement for gross proceeds of approximately $0.1 million.
Delaware law restricts sales of unissued shares of common stock at a price
less than the par value of the common stock. We have put shares under the
private equity credit agreement which were issued below par value. In the
future, we do not intend to sell shares pursuant to the private equity credit
agreement when the purchase price of such shares would be less than the par
value per share. We also will not honor conversion requests of preferred stock
or convertible notes or exercise of warrants or options if that would require us
to issue shares of our common stock when the issuance price of such shares would
be less than the par value per share.
In May 2006, we amended the lease on our principal executive offices and
corporate headquarters located in Westport, Connecticut. Pursuant to this
amendment, we released our option to purchase the real estate under the lease
and agreed to reduce the term of the lease to now terminate on March 31, 2007.
In exchange, we are no longer required to pay base rent through March 31, 2007
in the aggregate amount of approximately $0.3 million, and our current landlord
has agreed to pay us $0.2 million upon our vacating the building on or before
March 31, 2007, but not sooner than January 1, 2007. The total value of the base
rent for the period from June 2006 through March 2007 has been recorded as a
gain from the sale of the purchase option in the Westport lease in other
(income) expense, with a corresponding charge to prepaid rent. The rent is being
expensed over the remaining term of the amended lease. The cash payment will be
recognized when earned.
15
9. Capital Stock:
Common Shares Available for Future Issuance
At June 30, 2006, we were required to reserve for issuance approximately
22.0 billion shares of our common stock based on the minimum issue price of $.01
per share, the current par value of our common stock. Delaware law restricts
sales of unissued shares of common stock at a price less than the par value of
the common stock. The number of shares issuable upon conversion or exchange of
several of our outstanding convertible and exchangeable securities varies as a
function of the market price of our common stock. At June 30, 2006, the number
of shares we are required to reserve exceeded the number of authorized but
unissued shares of our common stock.
NCT Group, Inc. Preferred Stock
At June 30, 2006, we had two series of preferred stock issued and
outstanding, our series H convertible preferred stock, classified as a current
liability, consisting of 2,100 designated shares, and our series I convertible
preferred stock, consisting of 1,000 designated shares. At June 30, 2006,
1,590.5 shares of series H preferred stock were issued and outstanding. The
series H preferred stock carries a cumulative dividend of 4% per annum on the
stated value ($10,000 per share) payable upon conversion in either cash or
common stock, at our election. 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 in the case of our liquidation, dissolution or winding up. The
holder of our series H preferred stock (Crammer Road) has no voting rights
(except as may be required by law). Each share of series H preferred stock is
convertible into shares of our common stock at 75% of the average closing bid
price of our common stock for the five-day trading period immediately preceding
conversion. If the holder elected to convert the stated value of the preferred
stock, along with accrued dividends, into our common stock as of June 30, 2006,
we would be required to issue approximately 1.8 billion shares (calculated at a
$0.01 conversion price, our current par value). The holder of our series H
preferred stock 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 preferred stock 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). Because
of the conversion terms of other outstanding convertible instruments, we are not
assured of having sufficient shares available to honor all potential exchange,
conversion and exercise requests. As a result, our series H preferred stock,
including accrued dividends, is classified as a liability on our consolidated
balance sheets under the caption "Preferred stock subject to conversion into a
variable number of shares." At June 30, 2006, the monetary value of the series H
preferred stock was approximately $24.6 million (comprised of approximately
$21.2 million fair value of the preferred shares plus approximately $3.4 million
fair value of the accrued dividends thereon). For the six months ended June 30,
2005 and 2006, we have included approximately $0.4 million and $0.3 million of
series H preferred stock dividends in interest expense on our condensed
consolidated statements of operations.
During the six months ended June 30, 2006, Crammer Road converted 65 shares
of series H preferred stock into 74,735,671 shares of our common stock (see Note
14 for transactions subsequent to June 30, 2006).
Pursuant to the terms of a registration rights agreement with Crammer Road,
we were obligated to file a registration statement covering the shares of our
common stock issuable upon conversion of the 27 shares of our series H preferred
stock issued in May 2004 no later than August 28, 2004. Because we did not have
a sufficient number of authorized shares of our common stock to issue these
shares, we were not 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 these 27 shares of our outstanding series H preferred stock. For each
of the six months ended June 30, 2005 and 2006, these liquidated damages were
less than $0.1 million and are included in other (income) expense, net on our
condensed consolidated statement of operations.
We had received a request to convert 189 shares (approximately $1.9 million
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 was
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 elected to purchase on the
open market the number of our common shares it should have been issued upon
conversion of the series H shares, Crammer Road was entitled to a
16
payment equal to the excess, if any, of the open market price over the
conversion price. For the six months ended June 30, 2005, we recorded charges,
classified as other (income) expense, net, of $2.3 million for non-conversion of
series H into our common stock. On July 19, 2005, Crammer Road irrevocably
waived, rescinded and voided any and all outstanding demands with respect to the
requested conversion of the 189 shares of series H preferred stock into shares
of our common stock.
At June 30, 2006, 510 shares of our series I preferred stock were issued
and outstanding and held by 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 holder of our series I
preferred stock has 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 510 issued and
outstanding shares of our series I preferred stock are convertible into
24,285,714 shares of our common stock.
Artera Group, Inc. Preferred Stock
At June 30, 2006, there were 8,299 shares of Artera Group series A
preferred stock outstanding, 271 of which are held by us. Each share of series A
convertible preferred stock is convertible into shares of Artera Group common
stock at a conversion price equal to the average "final trading price" of Artera
Group common stock for the five trading days prior to the conversion date. The
"final trading price" of Artera Group common stock is currently equal to the
greater of (i) the net book value per share or (ii) the value attributable to
the common stock based on any financing occurring within the prior nine months.
If Artera Group common stock is ever listed for trading on a securities trading
market anywhere in the world, the "final trading price" will be the closing
price of Artera Group common stock on such market. We entered into an exchange
rights agreement in 2001 with ten accredited investors who hold 4,276 shares
with $4.3 million in aggregate stated value of Artera Group series A preferred
stock. Each of the ten holders received the right to exchange their series A
preferred stock for shares of NCT's 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 surrendered the right to convert
into Artera Group common stock. We are obligated to register for resale shares
of our common stock issuable upon the exchange of these 4,276 shares of series A
preferred stock. For each of the three and six months ended June 30, 2005 and
2006, we incurred charges of approximately $0.4 million and $0.7 million,
respectively, for non-registration of the underlying shares of our common stock,
classified as other (income) expense, net. Pursuant to the 2001 exchange rights
agreement, we have the option at any time to redeem the shares of 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 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. For each of the three-month periods ended June
30, 2005 and 2006, the 4% preferred stock dividends were approximately $0.1
million and for each of the six-month periods ended June 30, 2005 and 2006, were
approximately $0.2 million, and are included in the calculation of net loss
attributable to common stockholders on the condensed consolidated statements of
operations. During the six months ended June 30, 2005, 271 series A preferred
shares (stated value of approximately $0.3 million) along with accrued dividends
(less than $0.1 million) were exchanged for 160 shares of our series I preferred
stock.
Warrants
During the six months ended June 30, 2006, in conjunction with the issuance
of convertible notes, we issued warrants to Carole Salkind to acquire an
aggregate of 1,492,000,000 shares of our common stock at exercise prices of the
greater of par value (currently $0.01) or of prices ranging from $0.0020 to
$0.0037 per share. We estimated the fair value of the warrants at the dates of
issuance was $2.9 million utilizing the Black-Scholes option pricing model.
Based upon an allocation of a portion of the proceeds to the fair values of the
warrants, we recorded a discount to the convertible notes issued to Carole
Salkind of $2.9 million during the six months ended June 30, 2006.
17
10. Related Parties:
Carole Salkind and Affiliates
During the six months ended June 30, 2006, we issued twenty-two 8%
convertible notes in aggregate principal amount of $98.8 million and three 12%
convertible notes in aggregate principal amount of $2.5 million, along with
five-year warrants as outlined above (see Note 9). Of these notes, $94.7 million
mature six months from the respective dates of issuance and $6.6 million are due
upon the earlier of demand or six months from the respective dates of issuance
(see Note 6). 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 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 costs to provide this automobile are approximately $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, Carole Salkind's son, in exchange for an aggregate of
accrued consulting fees of approximately $0.5 million including amounts accrued
through June 12, 2005, representing all consulting fees payable in cash to
various entities affiliated with Carole Salkind pursuant to expired or expiring
consulting agreements (but not to Morton Salkind personally pursuant to his
January 2005 agreement). These consulting fees had previously been assigned to
Steven Salkind by these entities.
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 $0.3
million, $0.1 million and $0.2 million for our Chief Executive Officer,
President and Chief Financial Officer, respectively. Further, the payment of a
portion of their remaining bonus amounts is subject to certain limitations. In
addition, effective January 1, 2005, this bonus arrangement was revised to
calculate bonuses based on certain actual cash inflows. Bonuses based on equity
or financing cash inflows ceased effective September 30, 2005. Effective
September 30, 2005, bonuses are calculated based on a percentage of product
sales, licenses, royalties and similar revenue.
Spyder Technologies Group, LLC
On December 16, 2005, we, Artera Group and Spyder Technologies Group, LLC,
a company in which our Chairman and Chief Executive Officer, Michael Parrella,
and members of his family have interests, entered into a consulting agreement,
pursuant to which, among other things:
o Spyder serves as a consultant to Artera Group and performs
certain computer and data processing services for which Spyder
receives a cash consulting fee of $365 per day;
o Spyder assigned to Artera Group any and all of Spyder's rights in
certain intellectual property developed by Spyder prior to the
date of the consulting agreement, for which Spyder will receive a
fee of 2% of the net revenue received by Artera Group from its
"Rev the Web" service; and
o Spyder assigned to Artera Group any and all of Spyder's rights in
certain intellectual property developed by Spyder from and after
the date of the consulting agreement.
For the three and six months ended June 30, 2006, Spyder earned technical
consulting fees of $23,360 and $46,060, respectively.
18
11. Litigation:
Founding Midcore Shareholder Litigation
In April 2004, Jerrold Metcoff and David Wilson filed a complaint against
us and Michael Parrella, our Chairman and Chief Executive Officer, in
Connecticut state court, which complaint was subsequently amended to add Carole
Salkind and her spouse, Morton Salkind, as defendants. 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, 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
plaintiffs also allege that we and Mr. Parrella engaged in intentional and/or
negligent misrepresentations, fraudulent transfers of intellectual property and
other company assets, unfair trade practices and breaches of an implied covenant
of good faith and fair dealing. The complaint, as amended, seeks damages,
punitive damages, interest and attorneys' fees, and seeks a declaration that the
intellectual property acquired from the plaintiffs by the corporation that
became Midcore Software, Inc. (which intellectual property is currently used in
our Artera Turbo service offerings) is held in trust for the benefit of the
plaintiffs. The damages, punitive damages, interest and attorneys' fees sought
in the substitute complaint are all for unspecified amounts, but in other court
filings in the case, the plaintiffs have alleged that the total cash amount they
are owed exceeds $4.2 million. Mr. Parrella has told us that he intends to deny
the material allegations against him.
On January 4, 2006, the plaintiffs filed a second revised complaint. On
January 27, 2006, we filed a motion to strike six counts set forth in the
plaintiffs' second revised complaint, including certain claims of breach of
contract and breach of contractual representation and warranties against various
corporate defendants and claims of breach of fiduciary duty against Mr.
Parrella. On April 28, 2006, the court struck four of the six claims, including
two claims against Mr. Parrella on the basis that these two claims could not be
properly joined in this lawsuit. On June 19, 2006, the plaintiffs filed a
request to file a second substitute complaint, and on June 30, 2006, we filed an
objection to this request. This motion is currently pending before the court.
Discovery in the case is ongoing.
In November 2005, Messrs. Metcoff and Wilson filed a separate complaint
against John McCloy, Sam Oolie, Irene Lebovics, our President, and Cy Hammond,
our Chief Financial Officer (all current or former members of our Board of
Directors), in Connecticut state court asserting claims against them for
breaches of fiduciary duty and unfair trade practices in connection with the
transactions relating to the August 29, 2000 Agreement and Plan of Merger. The
damages, punitive damages, interest and attorneys' fees sought in the complaint
are for unspecified amounts. Messrs. McCloy, Oolie and Hammond and Ms. Lebovics
have indicated to us that they intend to deny the allegations against them. On
December 5, 2005, Metcoff and Wilson filed an amended complaint. On May 19,
2006, the plaintiffs filed a motion to add Mr. Parrella as an additional
defendant and to further amend their amended complaint, primarily to add to this
lawsuit the two claims against Mr. Parrella that were struck by the court in the
first lawsuit. On June 9, 2006, the plaintiffs filed a second amended complaint,
which included Mr. Parrella as an additional defendant. On August 4, 2006, the
five defendants in this action filed a request to revise the second amended
complaint. This motion is currently pending before the court.
We have agreed to indemnify Messrs. Parrella, McCloy, Oolie and Hammond and
Ms. Lebovics, to the extent permitted by our certificate of incorporation and
applicable law, for any liabilities (including legal fees) they may incur as a
result of the claims against them in these actions. We submitted the claims
against Messrs. Parrella, McCloy, Oolie and Hammond and Ms. Lebovics in the
cases to our director and officer indemnification insurance carrier, which has
denied coverage of all of the claims against Messrs. Parrella, McCloy, Oolie and
Hammond and Ms. Lebovics.
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 the action against her. Through June 30, 2006, Ms. Salkind incurred
approximately $0.1 million in legal fees, of which we have paid approximately
half. At June 30, 2006, our accrued liability for these legal fees was less than
$0.1 million.
Reference is made to our Annual Report on Form 10-K, as amended, for the
year ended December 31, 2005, 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, as amended, that could
have a material adverse effect on our financial position and results of
operations.
19
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
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 and expense.
During the three and six months ended June 30, 2006, 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. Revenue from our discontinued operations (Note 13) has been
reclassified and is, therefore, not included in the revenue amounts presented
below.
Reportable segment data for the three and six months ended June 30, 2005
and June 30, 2006, is as follows:
(In thousands)
For the three months ended Communi- Reportable Other Consoli- Grand
June 30, 2005 (As Restated) cations Media Technology Segments Corporate dating Total
- -------------------------------------- --------- --------- ------------- ------------- ---------- ---------- -----------
License Fees and Royalties - External $ 259 $ - $ 69 $ 328 $ 3 $ (3) $ 328
Other Revenue - External 513 3 - 516 - - 516
Revenue - Other Operating Segments (243) - - (243) 4 239 -
Net (Loss) Income (3,188) (1,681) 146 (4,723) (17,111) 595 (21,239)
Segment Assets 14,104 21,887 758 36,749 2,253 (33,977) 5,025
(In thousands)
For the three months ended Communi- Reportable Other Consoli- Grand
June 30, 2006 cations Media Technology Segments Corporate dating Total
- -------------------------------------- --------- --------- ------------- ------------- ---------- ---------- -----------
License Fees and Royalties - External $ 27 $ - $ 30 $ 57 $ 4 $ (5) $ 56
Other Revenue - External 471 2 - 473 - - 473
Revenue - Other Operating Segments 227 - - 227 5 (232) -
Net (Loss) Income (4,111) (1,900) 194 (5,817) 2,932 (5,267) (8,152)
Segment Assets 12,051 20,157 692 32,900 2,796 (31,877) 3,819
(In thousands)
For the six months ended Communi- Reportable Other Consoli- Grand
June 30, 2005 (As Restated) cations Media Technology Segments Corporate dating Total
- -------------------------------------- --------- --------- ------------- ------------- ---------- ---------- -----------
License Fees and Royalties - External $ 889 $ 535 $ 69 $ 1,493 $ 9 $ (9) $ 1,493
Other Revenue - External 983 5 - 988 - - 988
Revenue - Other Operating Segments 28 - - 28 9 (37) -
Net (Loss) Income (5,869) (2,704) 220 (8,353) (54,744) 22,030 (41,067)
Segment Assets 14,104 21,887 758 36,749 2,253 (33,977) 5,025
(In thousands)
For the six months ended Communi- Reportable Other Consoli- Grand
June 30, 2006 cations Media Technology Segments Corporate dating Total
- -------------------------------------- --------- --------- ------------- ------------- ---------- ---------- -----------
License Fees and Royalties - External $ 457 $ - $ 57 $ 514 $ 223 $ (224) $ 513
Other Revenue - External 970 4 - 974 - - 974
Revenue - Other Operating Segments 485 - - 485 9 (494) -
Net (Loss) Income (7,643) (3,721) 353 (11,011) 20,757 (31,874) (22,128)
Segment Assets 12,051 20,157 692 32,900 2,796 (31,877) 3,819
20
13. Discontinued Operations:
In September 2005, we decided to modify the business model for our Hospital
Radio Network ("HRN") business. Beginning October 1, 2005, instead of continuing
to directly operate this business, under our modified business model, we are
licensing our proprietary technology used in this business to third parties. In
exchange, we will receive a percentage of the advertising revenue generated by
these third parties through existing and new installations of our Sight & Sound
systems in health care facilities. Our initial licensee is a company whose
president is a former operations manager of HRN.
This modification of the business model meets the criteria established for
recognition as discontinued operations under SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." HRN represents a component of our
media segment comprised of operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest
of the segment. At December 31, 2005, HRN was classified as discontinued
operations and its results of operations are separately reported for all periods
presented.
The results of operations from this business are reflected in the
statements of operations as "Loss from discontinued operations" and are
summarized as follows:
(In thousands of dollars)
Three months Six months
ended ended
June 30, 2005 June 30, 2005
--------------- ---------------
Net revenue $12 $48
--------------- ---------------
Cost of sales 1 2
Selling, general and administrative expense 15 30
Research and development expense 66 132
--------------- ---------------
Costs and expenses 82 164
--------------- ---------------
Loss from discontinued operations ($70) ($116)
=============== ===============
14. Subsequent Events:
On July 10, 2006, we issued Carole Salkind an 8% convertible note in the
principal amount of $1.1 million for which Ms. Salkind paid us $0.5 million in
cash. This note is due upon demand, but in no event later than six months from
the date of issuance. Also on July 10, 2006, we issued Carole Salkind a 12%
convertible note in the principal amount of $0.7 million to cure our default on
payment of the quarterly interest installment due under the $5.0 million note
dated December 22, 2004. The principal amount of this note represents the
interest installment due July 1, 2006 (approximately $0.2 million), default
interest thereon of less than $0.1 million and interest default penalty (10% of
the then outstanding principal) of $0.5 million. This note matures six months
from the date of issuance. On July 31, 2006, we issued Carole Salkind an 8%
convertible note in the principal amount of $0.6 million for which Ms. Salkind
paid us $0.3 million in cash. This note is due upon demand, but in no event
later than six months from the date of issuance. Also on July 31, 2006, we
issued Carole Salkind an 8% convertible note in the principal amount of $0.8
million to cure our default under a note dated January 11, 2006. The principal
amount of this note represents the aggregate principal rolled over
(approximately $0.4 million), default penalty (10% of the principal in default)
of less than $0.1 million, accrued interest of less than $0.1 million and an
original issue discount of approximately $0.4 million. On August 2, 2006, we
issued Carole Salkind an 8% convertible note in the principal amount of $0.8
million to cure our default under a note dated January 24, 2006. The principal
amount of this note represents the aggregate principal rolled over
(approximately $0.4 million), default penalty (10% of the principal in default)
of less than $0.1 million, accrued interest of less than $0.01 million and an
original issue discount of approximately $0.4 million. These latter two notes
mature six months from the respective dates of issuance. On August 16, 2006, we
issued Carole Salkind an 8% convertible note in the principal amount of $0.6
million for which Ms. Salkind paid us $0.3 million in cash. This note is due
upon demand, but in no event later than six months from the date of issuance.
21
The convertible notes are secured by substantially all of our assets. The
notes bear interest at the stated rate until the due date of the notes, or until
demand is made for repayment of the $1.1 million or the two $0.6 million notes,
and bear interest at a default rate equal to the stated rate of interest plus 5%
on any amount of principal or interest that is not paid when due or upon demand.
Interest is payable upon maturity of the notes or upon demand for repayment of
the $1.1 million or the two $0.6 million notes. At the election of Ms. Salkind,
the July 10, July 31, and August 2, 2006 notes may be converted into shares of
our common stock at a conversion price per share equal to the greater of (i)
$0.0019 or (ii) the par value of our common stock on the date of conversion, and
the August 16, 2006 note may be converted into shares of our common stock at a
conversion price per share equal to the greater of (i) $0.0022 or (ii) the par
value of our common stock on the date of conversion. At the election of Ms.
Salkind, the notes may be 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). The notes contain events of default, any one of
which (if not cured) triggers a default penalty of 10% of the then outstanding
principal. If triggered, the default penalty, along with the outstanding
principal and accrued interest, becomes immediately due and payable. Events of
default include the failure to pay principal and interest when due and the
failure to issue shares of common stock upon exercise of conversion rights.
As of August 16, 2006, we were in default of an aggregate of $75.4 million
of secured convertible notes issued to Carole Salkind (consisting of four 8%
convertible notes in the aggregate principal amount of $74.7 million and one 12%
convertible note in the principal amount of $0.7 million). One 8% convertible
note in the principal amount of $31.6 million has been in default for more than
30 days. Since January 2001, we generally have defaulted on the repayment of
obligations owed to Ms. Salkind as they become due and have refinanced the
matured notes, along with accrued interest and penalties, into new notes within
a short time after default. We expect to refinance all of the existing matured
notes as well, and we are currently negotiating with Ms. Salkind the refinancing
of substantially all of our indebtedness to her, not just the notes currently in
default. However, we can give no assurances with respect to the terms or any
such refinancing or whether such a refinancing will occur.
In July 2006, Crammer Road converted 15 shares of our series H preferred
stock (stated value of $150,000) along with accrued dividends thereon into
17,455,890 shares of our common stock.
22
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 revenue to sustain our current
level of operations and to execute our business plan;
o our ability to obtain additional financing 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, as
amended, for the year ended December 31, 2005 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 consists primarily
of technology licensing fees and royalties and product sales. Operating revenue
for the six months ended June 30, 2006 consisted of approximately 34.5% in
technology licensing fees and royalties, 65.2% in product sales and 0.3% in
other revenue. 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.
Going Concern Risks
Since inception, we have experienced substantial recurring losses, which
amounted to $411.7 million on a cumulative basis through June 30, 2006.
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 and product sales to generate significant
cash for our operations is critical to our long-term success. We cannot predict
whether we will be successful in obtaining market acceptance of our new products
or technologies or in completing our current licensing agreement negotiations.
To the extent our internally generated funds are not adequate, we believe that
we will need to obtain additional working capital through equity and/or debt
financings.
23
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 additional amendments to our
certificate of incorporation to sufficiently increase the number of authorized
shares of our common stock and to reduce or eliminate the par value of our
common stock. However, we can give no assurance that our stockholders would
approve either or both of these amendments.
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. At June 30, 2006, our cash and cash equivalents amounted to
$0.3 million and our working capital deficit was $157.5 million. We have been
able to continue our operations by raising additional working capital through
the sale of convertible notes. We have been primarily dependent upon funding
from Carole Salkind for the past several years. 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
June 30, 2006 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 following discussion of our financial condition and results of
operations is based on the condensed consolidated financial statements included
in this Form 10-Q, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenue and expenses, and the related
disclosures of contingencies. We base these 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 for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. On an ongoing basis, we evaluate our estimates, including those
related to amortization and potential impairment of intangible assets and
goodwill. 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. During the six months ended June 30, 2006, there were no significant
changes to the critical accounting policies and estimates that we disclosed in
Management's Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on Form 10-K, as amended, for the year ended
December 31, 2005, except our impairment of intangible assets as discussed below
and our required adoption of SFAS No. 123(R), "Share-Based Payment".
The methods, estimates and judgments we use in applying our accounting
policies have a significant impact on the results we report in our financial
statements, which we discuss under the heading "Results of Operations" below.
Some of our accounting policies require us to make difficult and subjective
judgments, often as a result of the need to make estimates of matters that are
inherently uncertain. Below, we discuss the critical policies that required us
to make difficult or subjective assumptions or estimates regarding our condensed
consolidated financial statements included in this quarterly report. We also
have other policies that we consider key accounting policies, such as policies
for revenue recognition, including the deferral of revenue; however, these
policies do not require us to make estimates or judgments that are difficult or
subjective.
24
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, 2005, we
evaluated the goodwill allocated to our Advancel reporting unit and our NCT
Hearing reporting unit and determined no impairment existed for Advancel or NCT
Hearing. At June 30, 2006, our goodwill consisting of the Advancel and NCT
Hearing reporting units was $1.3 million. Our next annual evaluation is planned
for December 31, 2006.
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 six months ended June 30, 2005 and 2006 was less than
$0.1 million. At June 30, 2006, our patent rights and other intangibles, net
were $0.7 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 affect 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. Our results of operations would be impacted whether we
impair assets or accelerate their amortization. In light of our continuing
losses, a potential indicator of impairment, we test our patent rights and other
intangible assets with finite useful lives for impairment at each reporting
period.
Based on an evaluation as of June 30, 2006, our subsidiary, Pro Tech
Communications, Inc., determined an impairment was present with respect to our
license granted to Pro Tech. The impairment charge to Pro Tech, on its
accounting records, was $1.5 million. After consolidation of Pro Tech's results
of operations in our financial statements, the resulting impairment was
approximately $0.2 million, representing the minority shareholders' portion of
Pro Tech's impairment recognized in our condensed consolidated statements of
operations for the three months and six months ended June 30, 2006. Our next
evaluation is planned for our next reporting date.
Accounting for Derivative Instruments
We have issued and outstanding convertible debt, options, warrants and
certain convertible equity instruments with embedded derivative features which
we analyze in accordance with SFAS No. 133 and EITF No. 00-19, to determine the
proper accounting classification for these instruments. Under EITF No. 00-19,
instruments containing an embedded derivative on the date of sale or issuance
are recorded as liabilities based on their fair value utilizing an appropriate
valuation model. The instrument is classified as a liability and is
marked-to-market and adjusted to fair value at each reporting date and the
change in fair value is recorded in other income (expense). In addition,
freestanding warrants and non-employee options are accounted for as equity
instruments or liabilities in accordance with the provisions of EITF No. 00-19.
Because, as of June 30, 2006, we did not have a sufficient number of available
and authorized shares for the conversion or exercise of all outstanding
instruments, certain convertible equity instruments and all freestanding
warrants and non-employee options are recorded at fair value, marked-to-market
at each reporting date, and are carried on a separate line of the accompanying
balance sheet.
25
Stock-Based Compensation
Effective January 1, 2006, we adopted SFAS No. 123(R). We elected to use
the modified prospective transition method, and accordingly, prior period
results were not restated to reflect the impact of SFAS No. 123(R). Prior to the
adoption of SFAS No. 123(R), stock-based compensation expense related to stock
options was not recognized in the results of operations if the exercise price
was at least equal to the market value of the common stock on the grant date, in
accordance with APB Opinion No. 25. As a result, the recognition of employee
stock-based compensation expense was generally limited to the expense attributed
to restricted stock awards and stock option modifications, if any.
As of June 30, 2006, there was no unrecognized stock compensation related
to unvested awards (net of estimated forfeitures) expected to be recognized over
future periods because all awards were vested at December 31, 2005.
Results of Operations
Three months ended June 30, 2006 compared to three months ended June 30, 2005
Revenue. Total revenue for the three months ended June 30, 2006 was $0.5
million compared to $0.8 million for same period in 2005, a decrease of $0.3
million, or 37.5%, resulting primarily from a decline in our royalties. Total
revenue for the three months ended June 30, 2006 consisted of approximately
10.6% in technology licensing fees and royalties, 89.2% in product sales and
0.2% in other revenue compared to the three months ended June 30, 2005 of
approximately 38.9% in technology licensing fees and royalties, 61.0% in product
sales and 0.1% of other revenue.
Technology licensing fees and royalties were $0.1 million for the three
months ended June 30, 2006 compared to $0.3 million for the same period in 2005,
a decrease of $0.2 million, or 66.7%. This decrease was due primarily to an
expected decline in royalties received from Sharp Corporation. In May 2005, we
learned that our ClearSpeech algorithm would not be incorporated by Sharp in its
next generation product. We believe that royalties received in the three months
ended June 30, 2006 were the final royalties to be received from Sharp with
respect to this algorithm. Our revenue from Sharp for the three months ended
June 30, 2006 was less than $0.1 million compared to $0.2 million for the same
period in 2005.
Product sales were $0.5 million for each of the three months ended June 30,
2006 and 2005. Gross profit on product sales, as a percentage of product sales,
for the three months ended June 30, 2006 and 2005 was 49.4% and 50.3%,
respectively. For each of the three months ended June 30, 2006 and 2005, in
excess of 99% 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 June 30, 2006 included 63.7% of Pro Tech products and 17.3%
of Artera Turbo subscriptions, whereas the same period in the prior year
included 66.8% of Pro Tech products and 17.3% of Artera Turbo subscriptions. Our
subscriber base that generated the Artera Turbo product sales for the three
months ended June 30, 2006 and 2005 consisted of residential and small business
users.
Costs and expenses. Total costs and expenses for the three months ended
June 30, 2006 were $8.7 million compared to $22.0 million for the same period in
2005, a decrease of $13.3 million, or 60.5%, due to a $8.9 million decrease in
interest expense, a $4.2 million decrease in non-operating other (income)
expense, net, a $0.3 million decrease in selling, general and administrative
expenses, and a $0.1 million decrease in research and development expenses.
For the three months ended June 30, 2006, selling, general and
administrative expenses totaled $1.7 million compared to $2.0 million for the
three months ended June 30, 2005, a decrease of $0.3 million, or 15.0%. The
decline in selling, general and administrative expenses reflected lower
compensation costs (attributable to fewer personnel as well as revised bonus
arrangements), reduced outside consultant services, lower advertising and trade
show expenses and lower travel expenses.
Research and development expenses for the three months ended June 30, 2006
were $0.9 million compared to $1.0 million for the three months ended June 30,
2005, a decrease of $0.1 million, or 10.0%, primarily due to lower compensation
costs and patent expenses. Our research and development efforts are primarily
devoted to enhancing our Artea Turbo service offerings.
26
We incurred an impairment charge of approximately $0.2 million for the
three months ended June 30, 2006 as a result of an impairment in the value of
our license granted to our Pro Tech subsidiary. There was no similar charge for
the same three-month period in 2005.
For the three months ended June 30, 2006, other (income) expense, net
totaled ($0.6) million compared to $3.6 million for the three months ended June
30, 2005, a decrease in expense of $4.2 million, or 116.7%. The decrease was
primarily attributable to a $4.2 million gain resulting from the adjustment of
the fair value of outstanding options, warrants and certain convertible equity
instruments and $1.2 million in costs associated with non-conversion of
preferred stock incurred in 2005, but not in 2006 (subsequently waived and
reversed in the third quarter of 2005) by a preferred stockholder, partially
offset by an increase of $1.4 million in default penalties on stockholder
convertible notes.
For the three months ended June 30, 2006, interest expense, net totaled
$6.3 million compared to $15.2 million for the three months ended June 30, 2005,
a decrease of $8.9 million, or 58.6%. The decrease in interest expense was
primarily attributable to a decrease in the amortization of beneficial
conversion features ($6.9 million) and original issue discounts ($2.7 million),
partially offset by an increase in the interest incurred on our debt ($0.8
million) due to an increase in our outstanding indebtedness. The original issue
discounts and beneficial conversion features arising from the allocation of
proceeds to the fair value of warrants was lower in the three months ended June
30, 2006 compared to the same period in 2005 because, although our stock price
traded lower than in 2005, we used our par value as the exercise or conversion
price in the calculation of fair value for instruments with exercise or
conversion prices below par due to legal restrictions on issuance of shares at a
price less than par value. Interest expense for the three months ended June 30,
2006 included amortization of original issue discounts of $3.6 million,
amortization of beneficial conversion features of $0.3 million and interest
accrued on our outstanding debt of $2.3 million. Interest expense for the three
months ended June 30, 2005 included amortization of original issue discounts of
$6.3 million, amortization of beneficial conversion features of $7.2 million and
interest incurred on our outstanding debt of $1.5 million. In addition, each of
the three months ended June 30, 2006 and 2005 included $0.2 million interest
expense attributable to dividends on preferred stock and subsidiary preferred
stock classified as liabilities.
For the three months ended June 30, 2005, the consolidated net loss
included a loss from discontinued operations of less than $0.1 million. The loss
was the result of modifying the business model for operating our Hospital Radio
Network business in September 2005 such that instead of continuing to directly
operate this business, we are licensing our proprietary technology used in this
business to third parties. In exchange, we will receive a percentage of the
advertising revenue generated by these third parties through existing and new
installations of our Sight & Sound systems in health care facilities.
Six months ended June 30, 2006 compared to six months ended June 30, 2005
Revenue. Total revenue for the six months ended June 30, 2006 was $1.5
million compared to $2.5 million for same period in 2005, a decrease of $1.0
million, or 40.0%, primarily the result of having fully recognized the remaining
$0.5 million of revenue from the New Transducers Ltd. ("NXT") license in the six
months ended June 30, 2005. We also experienced a decline of approximately $0.5
million in our royalties, including a decline of $0.2 million from Sharp
Corporation during the six months ended June 30, 2006. Total revenue for the six
months ended June 30, 2006 consisted of approximately 34.5% in technology
licensing fees and royalties, 65.2% in product sales and 0.3% in other revenue
compared to the six months ended June 30, 2005 of approximately 60.2% in
technology licensing fees and royalties, 39.8% in product sales and zero of
other revenue.
Technology licensing fees and royalties were $0.5 million for the six
months ended June 30, 2006 compared to $1.5 million for the same period in 2005,
a decrease of $1.0 million, or 66.7%. This decrease was due primarily to having
fully recognized revenue from the NXT license in 2005 and having experienced the
expected decline in royalties received from Sharp in 2006. In May 2005, we
learned that our ClearSpeech algorithm would not be incorporated by Sharp in its
next generation product. We believe that royalties received in the six months
ended June 30, 2006 were the final royalties to be received from Sharp with
respect to this algorithm. Our revenue from Sharp for the six months ended June
30, 2006 was $0.2 million compared to $0.4 million for the same period in 2005.
Product sales were $1.0 million for each of the six months ended June 30,
2006 and 2005. Gross profit on product sales, as a percentage of product sales,
for the six months ended June 30, 2006 and 2005 was 51.5% and 56.9%,
respectively. The decline in the gross profit margin was primarily due to the
increase in discounted sales to distributors in our consumer audio market. For
each of the six months ended June 30, 2006 and 2005, in excess of 99% of our
product sales were attributable to our communications segment. The mix of our
product sales within the
27
communications segment for the six months ended June 30, 2006 included 63.2% of
Pro Tech products and 16.5% of Artera Turbo subscriptions, whereas the same
period in the prior year included 64.6% of Pro Tech products and 18.2% of Artera
Turbo subscriptions. Our subscriber base that generated the Artera Turbo product
sales for the six months ended June 30, 2006 and 2005 consisted of residential
and small business users.
Costs and expenses. Total costs and expenses for the six months ended June
30, 2006 were $23.6 million compared to $43.4 million for the same period in
2005, a decrease of $19.8 million, or 45.6%, due primarily to a $17.8 million
decrease in interest expense and a $2.3 million decrease in other (income)
expense, net.
For the six months ended June 30, 2006, selling, general and administrative
expenses totaled $3.4 million compared to $3.2 million for the six months ended
June 30, 2005, an increase of $0.2 million, or 6.3%. This increase was due
primarily to the waiver in 2005 by three executives of a portion of their
incentive bonus earned in years before 2005. The bonus amounts waived in 2005
were approximately $0.3 million, $0.1 million and $0.2 million for our Chief
Executive Officer, President and Chief Financial Officer, respectively.
Excluding the effect of this waiver, our selling, general and administrative
expenses in the six months ended June 30, 2006 compared to the same 2005 period
reflected decreased compensation-related costs, promotional expenses and outside
consultant expenses.
Research and development expenses for the six months ended June 30, 2006
were $1.8 million compared to $2.1 million for the six months ended June 30,
2005, a decrease of $0.3 million, or 14.3%, primarily due to completion of
development projects. Our research and development efforts are primarily devoted
to enhancing our Artera Turbo service offerings.
We incurred an impairment charge of approximately $0.2 million for the six
months ended June 30, 2006 as a result of an impairment in the value of our
license granted to our Pro Tech subsidiary. There was no similar charge for the
same six-month period in 2005.
For the six months ended June 30, 2006, other (income) expense, net totaled
$2.1 million compared to $4.4 million for the six months ended June 30, 2005, a
decrease in expenses of $2.3 million, or 52.3%. The decrease was primarily
attributable to a $5.4 million gain resulting from the adjustment of the fair
value of outstanding options, warrants and certain convertible equity
instruments and $2.4 million in costs associated with non-conversion of
preferred stock incurred in 2005, but not in 2006 (subsequently waived and
reversed in the third quarter of 2005) by a preferred stockholder, partially
offset by an increase of $5.9 million in default penalties on stockholder
convertible notes.
For the six months ended June 30, 2006, interest expense, net totaled $15.5
million compared to $33.3 million for the six months ended June 30, 2005, an
decrease of $17.8 million, or 53.5%. The decrease in interest expense was
primarily attributable to a decrease in the amortization of beneficial
conversion features ($13.4 million) and original issue discounts ($5.8 million),
partially offset by an increase in the interest incurred on our debt ($1.4
million) due to an increase in our outstanding indebtedness. The original issue
discounts and beneficial conversion features arising from the allocation of
proceeds to the fair value of warrants was lower in the six months ended June
30, 2006 compared to the same period in 2005 because, although our stock price
traded lower than in 2005, we used our par value as the exercise or conversion
price in the calculation of fair value for instruments with exercise or
conversion prices below par due to legal restrictions on issuance of shares at a
price less than par value. Interest expense for the six months ended June 30,
2006 included amortization of original issue discounts of $8.2 million,
amortization of beneficial conversion features of $2.6 million and interest
accrued on our outstanding debt of $4.4 million. Interest expense for the six
months ended June 30, 2005 included amortization of original issue discounts of
$14.0 million, amortization of beneficial conversion features of $16.0 million
and interest incurred on our outstanding debt of $3.0 million. In addition, the
six months ended June 30, 2006 and 2005 included $0.3 million and $0.4 million,
respectively, of interest expense attributable to dividends on preferred stock
and subsidiary preferred stock classified as liabilities.
For the six months ended June 30, 2005, the consolidated net loss included
a loss from discontinued operations of $0.1 million. The loss was the result of
modifying the business model for operating our Hospital Radio Network business
in September 2005 such that instead of continuing to directly operate this
business, we are licensing our proprietary technology used in this business to
third parties. In exchange, we will receive a percentage of the advertising
revenue generated by these third parties through existing and new installations
of our Sight & Sound systems in health care facilities.
28
Liquidity and Capital Resources
We have experienced substantial losses since inception, which have been
recurring and amounted to $411.7 million on a cumulative basis through June 30,
2006. 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;
o royalties;
o product sales; and
o other revenue.
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 revenue derived from
technology licensing fees and royalties and product sales. Our ability to
continue as a going concern is substantially dependent upon future levels of
funding from our revenue sources, which are currently uncertain. Since 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. At our 2005 annual meeting of stockholders, held on June 28, 2005,
our stockholders approved an amendment to our certificate of incorporation to
increase the number of authorized shares of our common stock to 5.622 billion
shares. This increase in the number of our authorized shares of common stock,
however, is not sufficient for us to satisfy potential requests for conversions
and exchanges of our and our subsidiaries' derivative securities. 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
June 30, 2006 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 six months ended June 30,
2006 are described in the notes to the condensed consolidated financial
statements. In 2006, 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 2004, 2005 and to date in 2006 despite our failure to repay
her notes as they 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 during each of the six months ended June
30, 2005 and 2006 was $0.7 million. 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 approximate 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, $0.6 million is
used currently 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 June 30, 2006, our cash and cash equivalents aggregated $0.3 million and
our working capital deficit was $157.5 million, compared to a deficit of $136.8
million at December 31, 2005, a $20.7 million deterioration. Our current assets
were $1.1 million at June 30, 2006 compared to $1.5 million at December 31,
2005. Our current liabilities were $158.5 million at June 30, 2006 compared to
$138.4 million at December 31, 2005. The $20.1 million increase in current
liabilities was due primarily to increased indebtedness to Carole Salkind of
$24.0 million (net of discounts) and an increase in accrued expenses of $1.0
million, partially offset by decreases in derivative liabilities of $4.2 million
and preferred stock subject to conversion into a variable number of shares of
$0.6 million. At June 30, 2006, our current liabilities consisted of
indebtedness ($102.8 million), accrued liabilities ($16.4 million), other
current liabilities ($7.0 million), preferred stock subject to conversion into a
variable number of shares of common stock ($24.6 million), derivative
liabilities ($3.7 million), accounts payable ($3.0 million), deferred revenue
($0.4 million) and shares of subsidiary subject to exchange rights ($0.7
million). Most of our
29
indebtedness (and accrued interest thereon) is convertible into shares of our
common stock and may be converted to the extent we have sufficient shares of
authorized but unissued common stock.
At June 30, 2006, 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 June 30, 2006:
(In millions)
New Defaults
Indebtedness Defaults Cured Indebtedness
In Default during during In Default
12/31/05 the Period the Period 6/30/06
------------- -------------- ------------- ----------------
Notes Payable:
Former Employees / Other $ 0.5 (a) $ - $ - $ 0.5 (a)
Convertible Notes:
Carole Salkind Notes 0.6 (a) 78.0 (a) (78.6) -
8% Notes 2.6 (a,b) - 2.6 (a,b)
6% Notes 2.5 (a) - 2.5 (a)
------------- -------------- ------------- ----------------
Subtotal 5.7 78.0 (78.6) 5.1
------------- -------------- ------------- ----------------
Grand Total $ 6.2 $ 78.0 $ (78.6) $ 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 six months ended June 30,
2006 was $3.9 million due primarily to the 2006 net loss of $22.1 million, as
adjusted to reconcile to net cash.
Our deferred revenue balance at June 30, 2006 was $0.4 million. No
additional cash will be realized from our deferred revenue balance.
Net cash provided by financing activities was $3.8 million for the six
months ended June 30, 2006 and was primarily due to the proceeds from issuance
of convertible notes to Ms. Salkind for cash consideration of $3.9 million. The
cash proceeds from debt issued in the six months ended June 30, 2006 was
primarily used for working capital purposes.
At June 30, 2006, our short-term debt was $102.8 million (comprised of
$106.4 million face value of outstanding convertible notes payable and $0.6
million of outstanding notes payable), shown net of discounts of approximately
$4.2 million on our condensed consolidated balance sheet, compared to $78.6
million of short-term debt, net at December 31, 2005, an increase of $24.2
million due primarily to debt issued to Carole Salkind.
During the six months ended June 30, 2006, we issued an aggregate of $101.3
million of convertible notes (twenty-two 8% notes in the aggregate principal
amount of $98.8 million and three 12% notes in the aggregate principal amount of
$2.5 million). Of these notes, $94.7 million mature six months from the
respective dates of issuance and $6.6 million mature upon the earlier of demand
or six months from the respective dates of issuance. Consideration for these
notes was $3.9 million in cash, refinancing of $78.6 million in principal for
matured notes, $3.6 million of interest, $8.9 million of default penalties
(including interest default penalties aggregating $1.0 million) and $6.3 million
of original issue discounts ($2.7 million arising from cash consideration in an
amount less than the face value of the related notes and $3.6 million arising
from refinanced notes). 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.
We believe that the level of financial resources available to us is
critical to our ability to continue as a going concern. We will need to raise
additional capital through equity or debt financing in order to sustain our
operations or capitalize upon business opportunities and market conditions. 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 2006 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.
30
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 be able to access 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.
In July 2005, we entered into a second amended and restated private equity
credit agreement with Crammer Road that superseded and replaced our amended and
restated private equity credit agreement dated as of September 30, 2004. The new
credit agreement gives us the right to sell to Crammer Road shares of our common
stock having an aggregate value of up to $50.0 million pursuant to puts made by
us. The agreement requires us to sell to Crammer Road at least an aggregate of
$5.0 million of our common stock at a 7% discount from the market value of our
common stock determined at the time of a put. Through June 30, 2006, we have
sold a total of 18,756,756 shares of our common stock to Crammer Road pursuant
to our private equity credit agreement for gross proceeds of $0.1 million, at
prices determined pursuant to the provisions of the agreement, which prices were
less than $0.01 per share, the current par value of our common stock. Delaware
law restricts sales of unissued shares of common stock at a price less than the
par value of the common stock. We do not intend to sell shares pursuant to the
private equity credit agreement when the purchase price of such shares would be
less than the par value of our common stock.
Because the purchase price of our common stock under the private equity
credit agreement currently would be less than the par value of our common stock,
we are currently unable to sell shares under the agreement. If and when
available to us, we intend to use the 2005 private equity credit agreement to
raise additional cash. However, the equity credit line may not be a reliable
source of new cash capital for us. We must maintain an active trading market
able to absorb large quantities of traded shares of our common stock. If the
market for our common stock has an insufficient volume of shares traded, large
quantities of shares of our common stock sold by Crammer Road to satisfy our
puts may drive the price of our common stock lower due to lack of demand for
those shares. In addition, the shares to be issued to Crammer Road under the
private equity credit agreement will be issued at a 7% discount to the average
of the three lowest closing bid prices for the ten trading days immediately
following the notice date of a put. Based on this discount, Crammer Road has an
incentive to sell immediately to realize the gain on the 7% discount. These
discounted sales could cause our stock price to decline. A significant downward
pressure on the price of our common stock caused by the sale of material amounts
of common stock under the private equity credit agreement could encourage short
sales by third parties. These sales could place additional downward pressure on
the price of our common stock by increasing the number of shares being sold.
We have no lines of credit with banks or other lending institutions and,
therefore, have no unused borrowing capacity.
Capital Expenditures
There were no material commitments for capital expenditures as of June 30,
2006 and no material commitments are expected in the near future. In connection
with our industrial safety earmuff, we have expended 25% of the $0.1 million in
tooling costs and accrued the remaining tooling costs.
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.
31
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 Exchange Act
of 1934, as amended) as of June 30, 2006. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures as of June 30, 2006 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 June 30, 2006 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
32
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a discussion of recent developments involving material legal
proceedings, see "Note 11 - Litigation" included in the notes to the condensed
consolidated financial statements herein.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors previously
disclosed in our Annual Report on Form 10-K, as amended, for the year ended
December 31, 2005.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As of August 16, 2006, we were in default of an aggregate of $75.4 million
of secured convertible notes issued to Carole Salkind (consisting of four 8%
convertible notes in the aggregate principal amount of $74.7 million and one 12%
convertible note in the principal amount of $0.7 million). One 8% convertible
note in the principal amount of $31.6 million has been in default for more than
30 days. Since January 2001, we generally have defaulted on the repayment of
obligations owed to Ms. Salkind as they become due and have refinanced the
matured notes, along with accrued interest and penalties, into new notes within
a short time after default. We expect to refinance all of the existing matured
notes as well, and we are currently negotiating with Ms. Salkind the refinancing
of substantially all of our indebtedness to her, not just the notes currently in
default. However, we can give no assurances with respect to the terms or any
such refinancing or whether such a refinancing will occur.
ITEM 6. EXHIBITS
10.1(a) Form of Secured Convertible Note (demand) issued by NCT Group, Inc. to
Carole Salkind (incorporated by reference to Exhibit 10.1(a) of the
registrant's Current Report on Form 8-K dated December 22, 2005 (File
No. 0-18267)).
10.1(b) Schedule of Secured Convertible Notes (demand) issued by NCT Group,
Inc. to Carole Salkind during the three months ended June 30, 2006.
10.2(a) Form of Secured Convertible Note (refinancings after October 31, 2005)
issued by NCT Group, Inc. to Carole Salkind (incorporated by reference
to Exhibit 10.2(a) of the registrant's Current Report on Form 8-K
dated December 7, 2005 (File No. 0-18267)).
10.2(b) Schedule of Secured Convertible Notes (refinancings after October 31,
2005) issued by NCT Group, Inc. to Carole Salkind during the three
months ended June 30, 2006.
10.3(a) Form of Warrant (new financing after October 31, 2005) issued by NCT
Group, Inc. to Carole Salkind (incorporated by reference to Exhibit
10.3(a) of the registrant's Current Report on Form 8-K dated December
7, 2005 (File No. 0-18267)).
10.3(b) Schedule of Warrants (new financings after October 31, 2005) issued by
NCT Group, Inc. to Carole Salkind during the three months ended June
30, 2006.
10.4(a) Form of Warrant (refinancings after October 31, 2005) issued by NCT
Group, Inc. to Carole Salkind (incorporated by reference to Exhibit
10.4(a) of the registrant's Current Report on Form 8-K dated December
7, 2005 (File No. 0-18267)).
10.4(b) Schedule of Warrants (refinancings after October 31, 2005) issued by
NCT Group, Inc. to Carole Salkind during the three months ended June
30, 2006.
10.5(a) Form of 12% Secured Convertible Note issued by NCT Group, Inc. to
Carole Salkind (incorporated by reference to Exhibit 10.11(a) to the
registrant's Annual Report on Form 10-K for the year ended December
31, 2005 (File No. 0-18267).
10.5(b) Schedule of 12% Secured Convertible Notes issued by NCT Group, Inc. to
Carole Salkind during the three months ended June 30, 2006.
33
10.6(a) Form of 12% Secured Convertible Note (refinancings) issued by NCT
Group, Inc. to Carole Salkind (incorporated by reference to Exhibit
10.4(a) of the registrant's Current Report on Form 8-K dated April 25,
2006).
10.6(b) Schedule of 12% Secured Convertible Note (refinancings) issued by NCT
Group, Inc. to Carole Salkind during the three months ended June 30,
2006.
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 and Chief Financial Officer
pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934
and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
34
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 and Treasurer
Dated: August 18, 2006
35