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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED October 31, 2000
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Commission File Number:
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PRO TECH COMMUNICATIONS, INC.
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(Exact name of registrant as specified in its charter)
FLORIDA 59-3281593
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(State or other jurisdiction of (I.R.S. Employer or
incorporation organization) Identification No.)
3311 Industrial 25th Street, Fort Pierce, Florida. 34946
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(Address of principal executive offices) (Zip Code)
(561) 464-5100
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12 (g) of the Act: Common Stock, $.001
par value.
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /_/
The aggregate market value of the Registrant's voting stock held by
nonaffiliates of the Registrant was $13.0 million as of February 12, 2001.
The number of shares outstanding of the Registrant's common stock is 29,800,391
asof February 12, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information contained in the Proxy Statement for the Annual Meeting of
Stockholders of Registrant to be filed with the Securities and Exchange
Commission on or before February 28, 2001, is incorporated by
reference into Part III of this Form 10-K.
PART I
ITEM 1. BUSINESS
A. General Business Developments
Pro Tech Communications, Inc. (the "Company") was incorporated in the State of
Florida on October 5, 1994. From August 30, 1991 to October 31, 1994, the
Company's business was conducted by Pro Tech Systems, a limited partnership
organized under the laws of the State of California. Keith Larkin, the Chairman
of the Board, Chief Executive Officer and Treasurer of the Company, was general
partner of Pro Tech Systems and there were 12 limited partners in the limited
partnership. From the formation of Pro Tech Systems in August 1991 until June
1993, the limited partnership was involved in engineering and designing
lightweight telecommunications headsets as well as preliminary marketing efforts
for the product. From June 1993 until October 1994, Pro Tech Systems was engaged
in limited manufacturing and marketing activities for its product. On November
1, 1994, all of the assets of Pro Tech Systems were transferred to the Company
as consideration for the issuance of 2,000,000 shares of the Company's common
stock, par value $.001 per share, which were subsequently distributed on a pro
rata basis to each of the partners of the partnership. Effective December 13,
1994, Pro Tech Systems was formally dissolved. On September 13, 2000, the
Company completed a transaction whereby it sold 23,702,750 shares of its common
stock , representing approximately 83% of its outstanding common stock, to NCT
Hearing Products, Inc. ("NCT Hearing"), a wholly-owned subsidiary of NCT Group,
Inc. ("NCT"), in exchange for exclusive rights to certain NCT technologies for
use in lightweight cellular, multimedia and telephony headsets.
The Company presently designs, develops, manufactures and markets lightweight
telecommunications headsets. The Company's headsets employ new concepts in
advanced lightweight design and marketing strategies involving the sale of the
Company's product directly to the commercial headset market as a replacement for
its competitors' products. The Company presently sells its first design for the
commercial headset market comprised of fast food companies and other large
quantity users of headset systems, and is in the process of completing
development of several other headsets for the telephone user market, to include
telephone operating companies, government agencies, business offices, and
professional telephone centers. The Company's products include:
o ProCom Headset
o A-10 Amplifier (telephone)
o Apex Headset
o Trinity Headset
o A-27 Amplifier
In addition, the Company will continue to concentrate its efforts on the
production of that portion of the telephone headset that the user wears. There
are two components to a complete telephone headset. The first is the headset
component that the user wears, consisting of a speaker and a microphone. The
second is the electronic amplifier which is relatively more complex, time
consuming and costly to produce as its requires many variations to interface
with the wide variety of telephone systems in the market and generates higher
labor and material costs. The electronic amplifier also generally offers lower
profit margins than the headset component. As a result, the Company presently
has sourced the first of several amplifiers engineered to the Company's
specifications.
The Company will also continue to concentrate its efforts on the production and
distribution of new headset designs having the capability of connecting to and
interfacing with various electronic amplifiers and telephone systems currently
in use. The Company has adopted a co-engineering product development strategy
through the use of joint engineering agreements with companies with
complimentary engineering patents. The Company projects that this strategy will
greatly increase the product development cycle while offering far superior
products to its customers. The Company has continued to make investments in
technology and had incurred development costs with respect to engineering
prototypes, pre-production models and field testing of several new products.
Management believes that the Company's investment in technology will result in
the improvement of the functionality, speed and cost of components and products.
B. Industry Background
The lightweight telephone headset industry is highly competitive and
characterized by a few dominant manufacturers. The Company is aware of several
companies who manufacture telephone headsets, each of which possesses greater
financial, manufacturing, marketing and other resources than the Company.
Primary among the Company's competitors is Plantronics, Inc. ("Plantronics"),
the world's largest manufacturer of lightweight telephone headsets. Plantronics
was founded by Mr. Larkin. The Company estimates Plantronics' share of the
market to be approximately 46% worldwide. Plantronics reported net sales from
all of its products (including electronic amplifiers and other headset
accessories and services) were approximately $320 million for the fiscal year
2000. Other competitors include GN Netcom, Inc. and Hello Direct. In 1997, GN
NetCom, Inc. purchased both UNEX Corporation and ACS Wireless in an attempt to
grow its market share through acquisitions and recently announced the potential
acquisition of Hello Direct. ACS Wireless was founded by Mr. Larkin. The Company
believes GN Netcom, Inc. has a market share of approximately 29% worldwide.
Designed specifically for air traffic controllers and other aerospace
applications, the first headsets were intended as a replacement for the heavy,
bulky headsets in use. While lightweight telephone headsets continue to be used
for such purposes. Today telephone headsets are predominantly used as a
substitute to telephone handsets used by a wide variety of users, including
telephone operating companies and telephone call centers (such as airline
reservations, catalog sales and credit collection operations) and to a lessor
extent, by business persons and other professionals whose occupations require
extensive, though not constant, use of the telephone. In comparison to
speakerphones, telephone headsets provide greater communications clarity and
security. The Company believes that these advantages will lead to increased
demand for telephone headsets.
Telephone headsets also have commercial applications, primarily two-way radio
communication systems, such as those used by fast food attendants to communicate
with patrons and other personnel. Personal computer applications for telephone
headsets include audio input and output via voice command, voice dictation and
integrated voice telephone functions.
The Company believes that in selecting telephone headsets, users primarily
consider price, product quality, reliability, product design and features, and
warranty terms. The Company believes that its headsets are superior in design
and construction and substantially lower in price than the models currently
available from the Company's competitors. No assurances can be given, however,
that the Company's products will be perceived by users and distributors as
providing a competitive advantage over competing headsets. In addition, no
assurance can be given that competing technologies will not become available
which are superior, less costly or marketed by better known companies. Also,
certain customers may prefer to do business with companies with substantially
greater resources than the Company.
In addition to direct competition from other companies offering lightweight
telephone headsets, the Company may face indirect competition in its industry
from technological advances such as interactive voice response systems which
require no human operators for certain applications such as account balance
inquiries or airplane flight information. The Company believes that this
competition will be more than offset by increased demand for headsets as voice
telecommunication applications expand.
C. Existing Products
The ProCom.
The Company's initial entry into the lightweight fast-food headset market is the
"ProCom." Weighing less than 2 ounces, the ProCom is worn by users over the head
by means of a springsteel wire headband and a cushioned earphone. Attached to
the earphone, which may be worn over either ear, is an adjustable boom, which
connects to the ProCom's microphone. The ProCom headset connects to the wireless
belt-pack system with the use of various plug types offered by the wireless
belt-pack providers sold in many fast-food franchises around the world. See
"BUSINESS -- Competition." The Company is presently selling the ProCom to
distributors at prices ranging from $20.00 to $49.00 per headset, and the
product is sold by the Company to retailers for $54.00 per headset.
The Freedom.
The Freedom is an adaptation of the ProCom headset to allow for it to be worn
without a headband and is currently being sold in the fast-food market. Through
the use of a Company engineered clip, this headset attaches to the standard hat
or visor being worn in the fast-food franchise. The electronics in the Freedom
are virtually the same as the ProCom headset providing the same market
acceptance. Through its own research, the Company found the need for user
comfort from the use of headsets over very long time periods. The Company
introduced this product in April 1998.
The Manager's Headset.
The manager's headset is a lightweight over-the-ear fast-food headset which
provides improved comfort to the fast-food store manager monitoring drive-thru
activity. It was introduced and favorably received in February of this fiscal
year and the Company will continue to offer this headset in the Company's
fast-food product line for the fiscal year 2001. The Company sells this headset
in a range from $24.50 to $46.00 depending on volumes purchased.
The APEX.
The Company introduced the APEX headset for sale in the second quarter of 1999.
After conducting its own market research, the Company determined that there is a
demand for a headset which combines both over-the-head and over-the-ear
features. As a result, the Company designed the APEX to incorporate both of
these features, which should enhance the Company's ability to market the product
to cellular, personal computer and small office telephone users. The Company had
offered the headset version initially, followed by the interchangeable version.
The APEX is a commercial adaptation of the headset that the Company has designed
for use by the National Aeronautics and Space Administration ("NASA"). Boeing
Defense and Space Group ("Boeing") is a prime contractor for NASA, and as such
has the responsibility to choose certain components and products used in NASA's
space program. The Company was chosen by The Boeing Corporation as a supplier of
telephone headsets for NASA projects after the Company provided Boeing with
product specifications which met NASA's requirements for the product. Boeing
also subjected the Company's product to various tests in order to ensure that
the product would function under conditions for space travel. See BUSINESS--
Marketing and Sales". The APEX is a smaller design of the Trinity, with
components reduced by 20% in order to create a lightweight headset. The speaker
and microphone positioning can be easily adjusted by the user for the headset
thereby allowing the product to fit numerous head and ear sizes. In addition,
the APEX has a detachable headband allowing the users the choice of wearing the
headset over the head or over the ear. The Company presently sells the APEX to
distributors at prices ranging from $40.00 to $62.00 per headset. The APEX is
being sold by distributors and directly by the Company to end-users for $99.00
per headset.
The ASTRA.
The Company introduced the Astra headset for sale in the fourth quarter of 1999.
The Astra headset is a variation of the Apex headset in that it has been adapted
for use directly in non-amplified phone systems. A preamplifier circuit has been
inserted inside the headset to allow for a direct connection into an automatic
call distributor (ACD) or phone system that provides this required configuration
headset.
The A-10 Amplifier.
The A-10 amplifier is the first in a series of multi-line amplifiers being
offered with each of the Company's headsets. It is designed for the SOHO market
(small office/home office) and has been engineered to work with over 90% of all
existing phone systems in the world. The size is very small and engineered to
plug and play with most phone systems.
The A-27 Amplifier.
The A-27 amplifier is the first in a series of amplifiers specifically designed
for automatic control distributors (ACD) or phone systems which use the standard
PJ-237 2-prong plug as their interface. This amplifier will employ noise
suppression technology designed by the Company. Three patent applications were
filed in fiscal year 2000. The A-27 was introduced into the call-center market
in the 2nd quarter of fiscal year 2000. The Company presently sells the A-27
Amplifier to distributors at prices ranging from $67.00 to $89.00 per amplifier.
The A-27 Amplifier is being sold by distributors and directly by the Company to
end-users for $127.00 per amplifier.
The Active Series Headset.
The Active Series Headset was introduced in the 2nd quarter of fiscal year 2000.
These headsets are designed for the mobile headset user. Cellular phone users
and automobile hands-free kits will be the primary market focus of this product.
The Company presently sells the Active Series Headset to distributors at prices
ranging from $8.00 to $20.00 per headset. The Active Series headset is being
sold by distributors and directly by the Company to end-users for $25.00 per
headset.
The Trinity.
The Trinity has been designed for users in noisy environments. The Company
completed the development of this product early in the 2000 calendar year.
Unlike other headsets currently available, the Trinity will employ a light (1/2
ounce) "acoustical ear cup" which completely surrounds the user's ear. The
perimeter of this cup rests lightly in a broad area of contact around the ear,
rather than against or in the ear itself, which the Company believes will allow
the user to wear the Trinity in comfort for extended periods. Moreover, by
enclosing the ear, the acoustical ear cup reduces background noise, thereby
significantly improving the clarity and strength of reception from the earphone.
The Trinity has been designed as a comfortable and lightweight alternative to
the bulky commercial sound suppressant headsets, which are presently the only
headsets available to users operating in noisy office environments. The Trinity
headset can be worn in a single ear cup version or dual ear cup version. Like
the ProCom, the Trinity will be produced with a choice of adapters capable of
interfacing with the electronic amplifiers and telephone systems of most major
manufacturers. The Company presently sells the Trinity to distributors at prices
ranging from $42.00 to $54.00 per headset, and the product is sold by the
Company to retailers for $118.00 per headset.
The disparity in price between the cost to distributors and retailers for each
product described in this section is primarily a result of a shifting of direct
selling expenses from the Company to distributors. These expenses, averaging
approximately $11.23 of the individual unit retail price, have been accepted by
distributors in return for a lower average purchase price. The Company offers
lower prices for its products to distributors who purchase certain quantities of
products to increase sales and gain market share for the Company's products.
D. Marketing and Sales
The Company presently intends to market its product primarily through its
officers and staff, utilizing industry contacts and calling upon potential
purchasers. The Company plans on supplementing the marketing efforts of its
employees by using electronic commerce from the Company's web site along with
independent sales representatives and strategic marketing agreements.
The following summarizes the Company's key alliances:
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Date Initial
Relationship
Key Marketing Alliances Established Applications
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McDonalds Corporation April 1995 Aftermarket Fast Food Headsets
Hello Direct April 2000 Marketing Agreement
3M Corporation April 2000 Marketing Agreement
Muzak Corporation July 2000 Marketing Agreement
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The Company markets and will continue to market its headsets directly to the
commercial headset market as a replacement for its competitors' headsets.
Examples of such purchasers include fast food companies and franchisees and
other large quantity users of commercial headset systems. The Company entered
into a non-binding business relationship agreement with McDonalds Corp.
("McDonalds") which allows the Company to sell its products on a non-exclusive
basis to McDonalds' franchises and company-owned restaurants. Initial test sales
to McDonalds and its franchisees by the Company and Pro Tech Systems totaled
$424,300 in 1994, which included sales to more than 3,500 McDonalds'
restaurants. These numbers increased to more than 7,000 restaurants during
fiscal year 1995 and to more than 11,000 restaurants during fiscal year 2000.
The Company's sales of headsets increased in fiscal year 2000 by 45% as a result
of an increase in unit sales through its distribution channels to the existing
fast-food market along with the Company's decision to expand its presence into
the restaurant market through the resale of Motorola and Kenwood radios. The
sale of the Company's products to McDonalds'-owned restaurants and franchisee
restaurants represented approximately 12% and 14% of the Company's net sales for
the fiscal year 1999 and fiscal 2000, respectively.
As the Company expands, it will direct its marketing and sales efforts at: (i)
telephone operating companies; (ii) telephone system manufacturers; (iii)
personal computer manufacturers; and (iv) government agencies. In addition,
manufacturers of new telephone systems and other telecommunication equipment
that utilize headsets have been targeted by the Company as a developing market
for telephone headsets. The Company will also supplement the above strategies
with joint ventures and marketing agreements with companies with complementary
technologies. Although the Company presently intends to sell its products to
several large telephone users, there can be no assurance that the Company will
be successful in such efforts. Other potential large volume purchasers of
headsets are manufacturers of personal computers, especially when headsets
become a standard telephone accessory. In addition, the Company plans to market
its products to government agencies. The Company's headset has been approved for
sale to Boeing, a prime contractor of NASA, for use by astronauts in space
travel. To date, the Company has had $8,765 of sales to Boeing for prototype
headsets. While profits from government contracts are anticipated to be minimal,
such sales enhance the credibility and reputation of the selected headset and
its manufacturer, especially within the telephone industry.
Finally, the Company's directed marketing and sales efforts will be supplemented
by the distribution of the Company's products through established channels of
distribution. These include: (i) specialized headset distributors that derive a
majority of their revenues from the sale of headsets to both end users, and, to
a lessor extent, resellers; and (ii) large electronic wholesalers that offer
hundreds of products, including headsets. It is anticipated that a majority of
sales of the Company's headsets to commercial users such as credit card
companies and airlines will be through such distributors.
In addition to marketing its technology through its marketing alliances as
described above, as of October 31, 2000, the Company has an internal sales and
marketing force of 5 employees, 1 independent sales representative and its
executive officers and directors.
The Company does not have a significant foreign exchange transaction risk
because its non-U.S. revenue is denominated and settled in U.S. dollars.
E. Manufacturing
In fiscal year 1999, the Company made a major shift in its production by
completing the transition of its final assembly manufacturing process to a Far
East manufacturer. This transition was completed on August 1, 1999. This
decision was made as a result of major improvements in the quality of components
being provided to the Company from its principal suppliers along with major
savings in production costs. The Company is currently sourcing all components
from several Far East suppliers who build each component according to Company
specifications. However, as a result of a rapid expansion of sales to the fast
food market, the Company was forced to expand its U.S. manufacturing operations
to support the increase in sales for the year ended October 31, 2000.
Consequently, in spite of this increase, the Company will adhere to its past
cost reduction policy and is in the process of expanding its Far East
manufacturing operations to support the current and projected sales volumes. A
full migration of this production capacity from the Company's U.S. operations
offshore will be completed by the second quarter of 2001. An interruption in the
supply of a component for which the Company is unable to readily procure a
substitute source of supply could temporarily result in the Company's inability
to deliver products on a timely basis, which in turn could adversely affect its
operations. To date, the Company has not experienced any shortages of supplies.
In order to meet forecasted customer requirements the Company has multiple
suppliers for every component to reduce the risk in a disruption of the supply
chain. At October 31, 1999 and 2000, the amount of the Company's inventory was
$285,883 and $558,860, respectively. The increase in inventory level is
attributed to two factors. First, the Company benefited from an individual
headset component price reduction for larger purchases made from its suppliers.
Second, the Company made larger purchases of finished product in order to
benefit from a further reduction in costs from the manufacture of larger
quantities.
As a result of the move of all production to the Far East, all existing
production facilities in the principal offices in Fort Pierce, Florida are now
being used for storing inventory, engineering, and specialty headset production.
The Company believes that the Fort Pierce office presently does not possess
sufficient capacity for these uses and therefore plans to move to a 13,000
square foot facility in March 2001. In the event that purchase orders were to
exceed the capabilities of the Fort Pierce location or the Company's supply
chain from the Far East were to be disrupted, the Company would immediately
enter into subcontracting arrangements for the products with other third
parties. A delay in establishing such arrangements, if necessary, could
adversely affect the Company's ability to deliver products on a timely basis to
its customers, which in turn could adversely affect the Company's operations.
The Company, however, believes that subcontracting the manufacture of the
Company's products could be accomplished on short notice given the simple design
of the Company's products.
F. Concentrations of Credit Risk
The Company sells its products and services to distributors and end users in
various industries worldwide. As outlined below, the Company's two largest
customers accounted for approximately 34% of revenues during 2000 and 21% of
gross accounts receivable at October 31, 2000. The Company does not require
collateral or other security to support customer receivables.
As of October 31, 2000,
And for the year then ended
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Accounts Revenue
CUSTOMER Receivable
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Muzak $ 57,782 $ 315,159
McDonalds $32,827 205,167
All Other 330,763 $1,042,158
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Total $ 421,372 $1,562,484
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The Company regularly assesses the realizability of its accounts receivable and
performs a detailed analysis of its aged accounts receivable. When quantifying
the realizability of accounts receivable, the Company takes into consideration
the value of past due receivables and the collectibility of such receivables,
based on credit worthiness.
Financial instruments, which potentially subject the Company to concentration of
credit risk, consist principally of cash and cash equivalents and trade
receivables. The Company's cash equivalents consist of commercial paper and
other investments that are readily convertible into cash and have original
maturities of three months or less. The Company primarily maintains its cash and
cash equivalents in one bank.
G. Competition
The lightweight telephone headset industry is highly competitive and
characterized by a few dominant manufacturers. The Company is aware of several
companies who manufacture telephone headsets, each of which possesses greater
financial, manufacturing, marketing and other resources than the Company.
Primary among the Company's competitors is Plantronics, the world's largest
manufacturer of lightweight telephone headsets. Plantronics was founded by Mr.
Larkin. The Company estimates Plantronics share of the market to be
approximately 40% worldwide. Plantronics reported net sales from all of its
products (including electronic amplifiers and other headset accessories and
services) were approximately $320 million for the fiscal year 2000. Other
competitors include GN Netcom, Inc. and Hello Direct. In 1997, GN NetCom, Inc.
purchased both UNEX Corporation and ACS Wireless in an attempt to grow its
market share through acquisitions and recently announced the potential
acquisition of Hello Direct. ACS Wireless was founded by Mr. Larkin. The Company
estimates that GN Netcom, Inc. has approximately 29% market share worldwide.
These companies are well established and have substantially greater management,
technical, financial, marketing and product development resources than the
Company.
The Company believes that in selecting telephone headsets, users primarily
consider price, product quality, reliability, product design and features, and
warranty terms. The Company believes that its headsets are superior in design
and construction and substantially lower in price than the models currently
available from the Company's competitors. No assurances can be given, however,
that the Company's products will be perceived by users and distributors as
providing a competitive advantage over competing headsets. In addition, no
assurance can be given that competing technologies will not become available
which are superior, less costly or marketed by better known companies. Also,
certain customers may prefer to do business with companies with substantially
greater resources than the Company.
In addition to direct competition from other companies offering lightweight
telephone headsets, the Company may face indirect competition in its industry
from technological advances such as interactive voice response systems which
require no human operators for certain applications such as account balance
inquiries or airplane flight information. The Company believes that this
competition will be more than offset by increased demand for headsets as voice
telecommunication applications expand.
H. Government Contracts
The Company currently is the contract provider of headsets to the Boeing
Corporation, the prime contractor to NASA (National Aeronautical Space
Administration), for headsets to be used in the international space station.
Government contracts provide for cancellation at the government's sole
discretion, in which event the contractor or subcontractor may recover its
actual costs up to the date of cancellation, plus a specified profit percentage.
Governmental expenditures for defense are subject to the political process and
to rapidly changing world events, either or both of which may result in
significant reductions in such expenditures in the proximate future. Government
contracts or contracts with prime government contractors are not viewed as a
significant part of the Company's business.
I. Environmental Regulation Compliance
Compliance with Federal, state and local provisions regulating the discharge of
materials into the environment, or otherwise relating to the protection of the
environment, does not have any material effect upon the capital expenditures,
earnings or competitive position of the Company.
J. Proprietary Protection
The Company does not presently own any patents for any of its products or
technologies. In fiscal year 1999, the employment agreement of Keith Larkin, the
Company's Chairman of the Board and Treasurer was eliminated. Mr. Larkin also
resigned as President of the Company but remained the Company's Chairman of the
Board and Treasurer. Mr. Hennessey, the Company's Vice President was immediately
named as his successor as President, Secretary and COO. Mr. Larkin's focus will
continue to be in new product development and Mr. Hennessey now manages the
operation of the business. The Company intends to seek patent protection on its
inventions at the appropriate time in the future. The process of seeking patent
protection can be lengthy and expensive, and there can be no assurance that
patents will issue from any applications filed by the Company or that any patent
issued will be of sufficient scope or strength or provide meaningful protection
or any commercial advantage to the Company. The Company may be subjected to, or
may initiate, litigation or patent office interference proceedings, which may
require significant financial and management resources. The failure to obtain
necessary rights or the advent of litigation arising out of any such claims
could have a material adverse effect on the Company's operations.
Certain of the Company's employees involved in engineering are required to enter
into confidentially agreements as a condition of employment. The Company does
not currently own any registered trademarks, although the Company intends to
file trademark applications in the future with respect to distinguishing marks.
K. Employees
The Company currently has 21 full-time employees and 3 part-time employees,
including 5 persons in management, 5 persons in administration and shipping, 5
persons in marketing and 6 persons in assembly and production. The Company
intends to hire up to 3 additional employees within the next six months, one of
whom will work in engineering, 2 in marketing. None of the Company's employees
are represented by a collective bargaining unit, and the Company believes that
its relationship with its employees is good.
L. Business Segments
The Company operates in one business segment (lightweight headsets for
commercial use) predominantly within one geographic area (North America).
M. Available Information
We file annual, quarterly and special reports, proxy statements and other
information with the Securities Exchange Commission ("SEC"). You may read and
copy any document we file at the SEC's public reference rooms in Washington,
D.C., New York, New York, and Chicago, Illinois. Please call the SEC at
1-800-SEC-0330 for further information on the public reference rooms. Our SEC
filings are also available to the public from the SEC's Website at
"http://www.sec.gov."
ITEM 2. PROPERTIES
The Company's executive, sales and manufacturing offices occupy approximately
5,000 square feet of space located at 3309 and 3311 Industrial 25th Street, Fort
Pierce, Florida 34946, pursuant to three leases expiring on November 30, 2000.
The Company's aggregate monthly rent under all leases is $2,450. The Company has
leased its current space on a month to month basis until its new facility is
ready for occupancy.
In January 2001, the Company signed a lease for approximately 12,927 square feet
of new office and production space in Ft. Pierce, Florida. The lease is
effective March 1, 2001 and expires in February 2006 and provides for monthly
rental of approximately $5,000 increasing to approximately $8,000 over the
five-year term.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any legal proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of stockholders of the Company was held on August 11, 2000. At
the meeting, Keith Larkin and Richard Hennessey were elected directors, each to
serve until the next annual meeting of stockholders and until his successor is
elected and qualified. The stockholders also (1) approved an amendment of the
Company's Restated Certificate of Incorporation to increase the number of shares
of common stock authorized thereunder from 10,000,000 shares to 40,000,000
shares and (2) approved the amendment to the Company's 1998 Stock Incentive Plan
to increase the aggregate number of shares of the Company's reserved for awards
of restricted stock and for issuance upon the exercise of stock options granted
under the 1998 Plan from 500,000 shares to 2,000,000 shares. The vote taken at
such meeting was as follows:
(a) With respect to the election of the directors:
FOR WITHHELD
Larkin 3,780,388 223,500
Hennessey 3,780,388 223,500
(b) With respect to the proposal to approve the amendment of the Company's
Restated Certificate of Incorporation to increase the number of shares of
common stock authorized thereunder from 10,000,000 to 40,000,000 shares:
ABSTENTIONS AND
FOR AGAINST BROKER NON-VOTES
2,203,576 604,250 6,600
(c) With respect to the proposal to approve the amendment to the Company's 1998
Stock Incentive Plan to increase the aggregate number of shares of the
Company's reserved for awards of restricted stock and for the issuance upon
the exercise of stock options under the 1998 Plan from 500,000 to 2,000,000
shares:
ABSTENTIONS AND
FOR AGAINST BROKER NON-VOTES
2,205,362 623,250 7,100
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock began trading on the NASD OTC Bulletin Board on March 22, 1996.
The Company's stock is currently being traded under the symbol "PCTU". The
following table sets forth the average high and low bid prices of the common
stock as reported by the NASD's OTC Bulletin Board for each of the fiscal
quarters during the Company's last two fiscal years and the interim period of
the current fiscal year. The market quotations reflect inter-dealer prices,
without retail mark-up, markdown, or commission and may not represent actual
transactions.
Year ended October 31, 1998 High Low
------------------------------- --------- --------
First Quarter $ 4.49 $ 4.20
Second Quarter $ 2.86 $ 2.60
Third Quarter $ 0.97 $ 0.94
Fourth Quarter $ 0.36 $ 0.26
Year ended October 31, 1999 High Low
-------------------------------- -------- --------
First Quarter $ 0.50 $ 0.38
Second Quarter $ 0.38 $ 0.27
Third Quarter $ 0.50 $ 0.31
Fourth Quarter $ 0.50 $ 0.19
Year ended October 31, 2000 High Low
-------------------------------- -------- --------
First Quarter $0.310 $0.299
Second Quarter $0.880 $0.788
Third Quarter $0.670 $0.625
Fourth Quarter $1.062 $0.625
On February 12, 2001, the last reported sale of the Company's common stock as
reported by the NASD OTC Bulletin Board was $0..437. As of February 12, 2001,
there were approximately 44 record holders of the common stock.
The Company has neither declared nor paid any dividends on its shares of common
stock since its incorporation in October 1994 and does not anticipate declaring
a cash dividend in the reasonably foreseeable future. Any decisions as to the
future payment of dividends will depend on the earnings and financial position
of the Company and such other factors as the Board of Directors deems relevant.
The Company anticipates that it will retain earnings, if any, in order to
finance expansion of its operations.
See Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Overview" for a description of the Company's sales of
unregistered securities during the year ended October 31, 2000.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data set forth below is derived from the
historical financial statements of the Company. The data set forth below is
qualified in its entirety by and should be read in conjunction with Item 8 -
"Financial Statements" and Item 7 -"Management's Discussion and Analysis of
Financial Condition and Results of Operations" that are included elsewhere in
this document.
Years Ended October 31,
---------------------------------------------------------------
1996 1997 1998 1999 2000
----------- --------- ------------ ----------- ------------
STATEMENTS OF OPERATIONS DATA:
Net sales 852,778 996,993 $1,142,482 $1,091,551 $ 1,562,484
Cost of goods sold 281,682 333,755 470,450 414,931 623,555
----------- --------- ------------ ----------- ------------
Gross profit 571,096 663,238 672,032 675,620 938,929
Selling, general and administrative 698,785 513,398 882,385 893,384 1,275,290
Provision for doubtful accounts (8,661) 3,924 38,835 3,771 7,990
----------- --------- ------------ ----------- ------------
Income (loss) from operations 66,359 (39,471) (249,188) (221,535) (344,351)
Other income (expense):
Interest (income) expense, net 13,800 28,688 24,719 9,181 (31,715)
Miscellaneous income 107 58 89 697 1,726
Loss on disposal of fixed assets - (1,116) - (964) -
----------- --------- ------------ ----------- ------------
Income (loss) before income taxes 1,194 (11,841) (224,380) (221,065) (374,340)
----------- --------- ------------ ----------- ------------
Income tax expense (benefit) 1,715 400 (964) - -
----------- --------- ------------ ----------- ------------
Net loss (521) (12,241) $ (223,416) $ (221,065) $ (374,340)
Less:
Preferred stock beneficial conversion - - - - 3,569,000
Preferred stock dividend requirement - - - - 375,000
Accretion of difference between carrying - - - - 5,425
----------- --------- ------------ ----------- ------------
Net (loss) attributable to
common stockholders (521) (12,241) $ (223,416) $ (221,065) $(4,323,765)
=========== ========= ============ =========== ============
Basic and Diluted Net loss per share (0.00) (0.00) $ (0.05) $ (0.05) $ (0.57)
=========== ========= ============ =========== ============
Weighted average number of common
Shares outstanding(1) 3,414,000 4,122,795 4,254,000 4,254,000 7,537,855
=========== ========= ============ =========== ============
------------------------------------------------------------
October 31,
1996 1997 1998 1999 2000
----------- ---------- ---------- --------- ------------
BALANCE SHEET DATA:
Total assets $1,110,508 $1,239,143 $1,158,898 $ 945,377 $18,652,665
Total current liabilities 99,153 81,764 209,845 209,300 662,956
Long-term debt - - - 8,089 3,687
Retained earnings (Accumulated deficit) 43,438 31,197 (192,219) (413,284) (787,624)
Stockholders' equity(2) 1,011,355 1,157,469 949,053 727,988 17,986,022
Working capital 878,109 996,458 724,769 494,148 1,419,819
(1) Excludes shares issuable upon the exercise of outstanding stock options,
warrants and convertible preferred stock, since their effect would be
antidilutive.
(2) The Company has never declared nor paid cash dividends on its common stock.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and the notes thereto included herein.
A. Forward-Looking Statements
Statements in this Annual Report on Form 10-K which are not historical facts are
forward-looking statements which involve risks and uncertainties. The Company's
actual results in fiscal 2001 and beyond may differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. Important factors that could cause actual results to differ materially
include but are not limited to the Company's ability to: achieve profitability;
achieve a competitive position in design, development, licensing, production and
distribution of technologies and electronic systems; produce a cost effective
product that will gain acceptance in relevant consumer and other product
markets; increase revenues from products; realize funding from product sales,
and engineering and development services to sustain the Company's current level
of operation; timely introduce new products; continue its current level of
operations to maintain satisfactory relations with its customers; attract and
retain key personnel; maintain and expand its strategic alliances; and protect
Company know-how, inventions and other secret or unprotected intellectual
property.
B. Overview
Pro Tech Communications, Inc. (hereinafter referred to as "Pro Tech" or the
"Company") presently designs, develops, manufactures and markets lightweight
telecommunications headsets. The Company's headsets employ new concepts in
advanced lightweight design and marketing strategies involving the sale of the
Company's product directly to the commercial headset market as a replacement for
its competitors' products. The Company presently sells its first design for the
commercial headset market comprised of fast food companies and other large
quantity users of headset systems, and is in the process of completing
development of several other headsets for the telephone user market, to include
telephone operating companies, government agencies, business offices, and
professional telephone centers. The Company's products include:
o ProCom Headset
o A-10 Amplifier (telephone)
o Apex Headset
o Trinity Headset
o A-27 Amplifier
The Company's operating revenues are comprised of product sales. Operating
revenues for the fiscal year ended October 31, 2000 consisted of approximately
$1,562,000 in product sales.
The Company's business strategy is to continually offer lightweight headsets and
telephony products that employ cutting edge sound technologies with an emphasis
on price/performance. In addition, the Company will continue to concentrate its
efforts on the production of that portion of the telephone headset that the user
wears. There are two components to a complete telephone headset. The first is
the headset component that the user wears, consisting of a speaker and a
microphone. The second is the electronic amplifier which is relatively more
complex, time consuming and costly to produce as it requires many variations to
interface with the wide variety of telephone systems in the market and generates
higher labor and material costs. The electronic amplifier also generally offers
lower profit margins than the headset component. As a result, the Company
presently has out-sourced to Asian manufacturers the production of amplifiers
engineered to the Company's specifications.
The Company will also continue to concentrate its efforts on the production and
distribution of new headset designs having the capability of connecting to and
interfacing with various electronic amplifiers and telephone systems currently
in use. The Company has adopted a co-engineering product development strategy
through the use of joint engineering agreements with companies with
complimentary engineering patents. The Company projects that this strategy will
greatly accelerate the product development cycle while offering far superior
products to its customers. The Company has continued to make investments in
technology and has incurred development costs with respect to engineering
prototypes, pre-production models and field testing of several new products.
Management believes that the Company's investment in technology will result in
the improvement of the functionality, speed and cost of components and products.
As the Company establishes distribution channels and as consumer awareness of
its products increases, so, too, will its product sales. At the same time, the
Company continues to strive to lower the cost of its products and enhance their
technological performance.
Since its inception, the Company has incurred losses from operations which have
been recurring and amounted to $787,624 on a cumulative basis through October
31, 2000. These losses, which include the costs for development of products for
commercial use, have been funded primarily from (1) product sales and (2) the
sale of preferred stock convertible into common stock, (3) common stock and (4)
short-term financing arrangements.
C. RESULTS OF OPERATIONS
YEAR ENDED OCTOBER 31, 2000 AS COMPARED TO THE YEAR ENDED OCTOBER 31, 1999:
For the year ended October 31, 2000, the Company realized a net loss of $374,340
compared to a net loss of $221,065 for the year ended October 31, 1999. The
current reporting year loss was attributed to three factors: (1) The Company's
acquisition of certain intangible property from NCT Hearing Products, Inc.
required amortization expense of $78,000 during the month of October 2000, (2)
Due to acquisition of approximately 83% of the Company's common stock by NCT
Hearing Products, Inc., related to the intangible property acquired, there was
an overhead expense allocation incurred by the Company of approximately $101,000
for the period from September 12, 2000 to October 31, 2000 and (3) the result of
the growing competition in the Company's distributor selling channel in the
fast-food market causing a deterioration of gross margins.
Net sales generated during the year ended October 31, 2000 increased 43% to
$1,562,484 from $1,090,551 in fiscal year ended October 31, 1999. This increase
in sales was as a result of two factors: (1) The Company's ability to continue
to recoup fast-food headset market share lost during fiscal year ended 1999, (2)
Sales from the market introduction of several new telephone headsets and related
communication equipment.
The Company continued the sale of its products through distributors augmenting
these sales with direct sales from the Company's own outbound telemarketing
operation. At the completion of fiscal year 2000, the Company sold a total of
41,121 headsets, as compared to 27,641 headsets in the previous year. This
difference represents an increase in sales of 13,480 headsets or 49% more than
the comparable twelve-month period. Net unit sales of fast-food headsets
increased 33% primarily from the expansion of the Company's sales distribution
channel previously mentioned. Consistent with the Company's objectives, the
indirect distribution channel accounted for 73% of net revenues and 77% unit
volumes versus 64% of net revenues and 74% of unit volumes in the comparable
1999 period. The Company has successfully maintained its relationship with The
McDonald's Corporation and once again has been selected to be a part of
McDonald's International Owner Operator's trade show planned for April of fiscal
year 2002. Sales from outside the fast-food market were $250,000 as a result of
delays in the market introduction of the Company's telephone product line. These
delays were the result of the lack of working capital required to successfully
enter this market. On September 29, 2000, the Company received an initial
capital infusion of $1.5 million to support this working capital requirement,
with corresponding stock warrants to invest an additional $2.3 million. The
Company expects sales to dramatically increase from the telephone market as a
result of receiving this capital infusion. The market introductions of these new
products are planned in the 2nd and 3rd quarter of fiscal year 2001.
Gross margin percent decreased 1.86% to 60.09% versus 61.95% in comparable 1999
period as a result of the Company's desire to regain lost market share due to
price competition in the fast-food headset market as well as an increase in
manufacturing of certain of the Company's products domestically here in the U.S.
Selling, general and administrative expenses (SG&A) for the fiscal year were
$1,275,290 or 81.6% of revenues versus $893,384 or 89% in revenues in the
comparable 1999 period. This increase was the result of several factors. First,
due to the transaction resulting in the acquisition of the intangible property
from NCT Hearing Products, Inc the Company incurred approximately $78,000 of
amortization expense of such intangible property and an allocation of overhead
expense which amounted to approximately $101,000 for the period from September
12, 2000 to October 31, 2000. Second, the Company decreased its marketing and
advertising expenses to $54,424 from $98,738 in the comparable 1999 period as a
result of a reduction in expenses in marketing material from the use of
alternative source along with the decision to reduce the Company's attendance at
trade shows showing targeted return on investments. These trade shows allowed
the Company the opportunity to successfully present the new products planned for
market introduction in the 1st and 2nd quarter of fiscal year 2000 along with
the opportunity to perform needed market research necessary to have successful
product introductions in the future. The Company has continued its investment in
Research and Development and new product development accounting for investments
mold designs and component testing. Although this is the Company's intention
there is no formal agreements in place and no assurances that they will occur in
the future. The Company is also reviewing several possible alliances with
companies that have complimentary products, which could provide access into
several key accounts in the telephone market.
Net amortization and depreciation expenses increased to $128,658 or 8.2% of
revenues in the current fiscal year versus $45,222 or 4.1% of revenues in the
comparable 1999 period. This increase was as a result of the amortization of the
intangible property acquired in September 2000. Such amortization expense
amounted to approximately $78,000 for the year ended October 31, 2000.
The Company generated interest income of $4,877 for the year ended October 31,
2000 as compared to $10,202 for the comparable 1999 year. The interest income
resulted from the Company's investment of the net proceeds from the private
placement of securities into short-term certificates of deposits less cash
available for investment used in operations.
YEAR ENDED OCTOBER 31, 1999 AS COMPARED TO THE YEAR ENDED OCTOBER 31, 1998:
For the year ended October 31, 1999, the Company realized a net loss of $221,065
compared to a net loss of $223,416 for the year ended October 31, 1998. The 1999
reporting year loss was attributed to three factors: (1) The Company maintained
production of its products at the Company's Florida office for nine months of
this fiscal year corresponding with incurring one-time charges from the
transition of the Company's production operations to the Far East; (2) The
Company's revenues were negatively impacted late in the second half of this
fiscal year as a result of a competitors attempt to take away the Company's
distributor selling channel in the fast-food market; and (3) A five week delay
in the market introduction of the Company's telephone headsets as a result of
the Taiwan earthquake in the 4th quarter fiscal year 1999. For fiscal year 1998,
the loss is attributed to the following adjustments: (1) an additional accrued
warranty expense of $97,000, (2) the write-off of $36,062owed to the Company
from the closing of the Company's investment banker firm under retainer, (3) a
one time charge of $50,000 to the Company's production department. as a result
of a product re-call (4) the payment of $25,000 due to the result of a mediated
settlement with the Company's public relations firm.
Net sales generated during the year ended October 31, 1999 decreased 4.5% to
$1,090,551 from $1,142,482 in fiscal year ended October 31, 1998. This decrease
in sales was as a result of two factors: (1) Delays in the market introduction
of several telephone products resulting in very little sales benefit for the
current fiscal year. (2) The adoption of the Company's distributor sales
strategy from one of the Company's direct competitors in the fast food market.
This action from this competitor severely impacted the ability of the Company to
sell into this channel in the fourth quarter of the fiscal year 1999. This
channel represented 72% of the Company's sales volume for the fiscal year. The
Company, after realizing this competitive tactic, countered with increased
discounts of the Company's products. The result of this counter action has
allowed the Company to recoup approximately 30% of the revenues lost late in the
current fiscal year and the Company used the same tactics to win back business
lost during this period in fiscal year 2000.
The Company continued the sale of its products through distributors augmenting
these sales with direct sales from the Company's own outbound telemarketing
operation. At the completion of fiscal year 1999, the Company sold a total of
27,641 headsets, as compared to 29,673 headsets in the previous year. This
difference represents a decrease in sales of 2,032 headsets or 6.8% less than
the comparable twelve-month period. Net unit sales of fast-food headsets
decreased 6.7% primarily from the increase in competitive activity described in
the previous paragraph. Consistent with the Company's objectives, the indirect
distribution channel accounted for 64% of net revenues and 74% unit volumes
versus 64% of net revenues and 74% of unit volumes in the comparable 1998
period. The Company has successfully maintained its relationship with The
McDonald's Corporation and once again has been selected to be a part of
McDonald's International Owner Operator's trade show planned for April of fiscal
year 2000. In addition the Company was invited to present its products at KFC's
International trade show planned to be held in January of fiscal year 2000.
Sales from outside the fast-food market were negligible as a result of delays in
the market introduction of the Company's telephone product line. The Company
expects sales to dramatically increase upon the market introduction planned in
the 1st and 2nd quarter of fiscal year 2000.
Gross margin percent increased 3.13% to 61.95% versus 58.82% in comparable 1998
period as result of the fourth quarter cost savings from the transition of all
production offshore to the Far East. This action showed a 48% gain in cost of
goods produced through the Company's now established Far East manufacturing
partners. The Company plans to keep this same supply-chain in place for all
existing and new products planned for market introduction in the 1st and 2nd
quarter of fiscal year 2000.
Selling, general and administrative expenses (SG&A) for the fiscal year were
$893,384 or 81.9% of revenues versus $882,385 or 76% in revenues in the
comparable 1998 period. This increase was the result of several factors. First,
in fiscal year 1999, an unaffiliated investment-banking firm was retained in
order to proceed with the structuring of a potential investment of capital into
the Company. The capital would be used for new product development along with
the associated expansion of sales personnel developing the telephone market. For
the current fiscal year 1999, the Company's expenses to this firm were $35,000.
Second, the Company increased its marketing and advertising expenses to $98,738
from $43,143 in the comparable 1998 period to support several telephone trade
shows attended by the Companies marketing staff. These trade shows allowed the
Company the opportunity to successfully present the new products planned for
market introduction in the 1st and 2nd quarter of fiscal year 2000 along with
the opportunity to perform needed market research necessary to have successful
product introductions in the future. The Company has continued its investment in
Research and Development and new product development accounting for investments
mold designs and component testing. Although this is the Company's intention
there is no formal agreements in place and no assurances that they will occur in
the future. The Company is also reviewing several possible alliances with
companies that have complimentary products, which could provide access into
several key accounts in the telephone market. The Company was able to reduce its
accrued expenses associated with warranty charges for its product to $78,038 in
1999 from $152,503 in 1998. This change was as a result of major improvements
made in the quality and price of components used in the Company's products.
Net depreciation expenses increased to $45,222 or 4% of revenues in the current
fiscal year versus $38,783 or 3% of revenues in the comparable 1998 period. This
increase was as a result of an increased investment in production molding
associated with new product development along with investment in the improvement
of the Company's trade show marketing displays being used in call-center trade
shows.
The Company generated interest income of $10,202 for fiscal year 1999 as
compared to $24,719 for the comparable 1998 year. The interest income resulted
from the Company's investment of the net proceeds from the private placement of
securities into short-term certificates of deposits less cash available for
investment used in operations.
D. LIQUIDITY AND CAPITAL RESOURCES
The current ratio (current assets to current liabilities) of the Company was
3.14 to 1.00 at October 31, 2000, as compared to 3.36 to 1.00 for the same
comparable 1999 fiscal year. At October 31, 2000, the Company's current assets
exceeded its current liabilities by approximately $1,419,819.
During the current fiscal year ending October 31, 2000, the Company has funded
its working capital requirements with cash flow from operations, short-term
borrowings and the sale of convertible preferred stock. Management believes that
the Company has sufficient funds to meet the Company's anticipated working
capital requirements for the next 12 months. In addition the Company is
currently seeking a new asset-based lending agreement to further assist the
Company attain it's projected business growth in 2001. In December 2000, the
Company terminated its short-term factoring arrangement entered into in December
1999. Under this agreement the Company's obligations were collateralized by all
of the Company's account receivable, inventory, and equipment. During 2000,
under the expired factoring agreement the Company had obtained advances totaling
$339,440.
In addition, in order for the Company to maximize the potential of the telephone
user market and to enable the Company to expand into additional markets,
including government agencies and personal computers, the Company will require
additional capital. On March 27, 2000, the Company obtained a loan from Westek
Communications Inc. (a related party) for $150,000 payable in one year with an
interest rate of 8.5%. These funds were used to finance ongoing product
development along with the associated market introduction and promotion of these
new products. The Company will seek to raise additional financing as a result of
its relationship with NCT Hearing Products, Inc. and its parent company NCT
Group, Inc.
At October 31, 2000, cash and cash equivalents were $1,070,408. Such balance was
invested in interest bearing money market accounts.
The Company's working capital increased to $1,419,819 at October 31, 2000, from
$494,148 at October 31, 1999. This $925,671 increase was primarily due to the
receipt of net proceeds of $1,200,025 from the sale of $1,500,000 of the
Company's Series A Convertible Preferred stock in September 2000.
During 2000, the net cash used in operating activities was $511,558, compared to
$239,858 used in operating activities during 1999, an increase of $271,700. The
$511,558 net cash used in operating activities was primarily due to increased
interest expense on short-term borrowings made throughout 2000 along with
investments of $41,454 in R&D along with the hiring of a Vice-President of
Engineering. The remainder $470,013 was invested in SG&A in preparation of
several new product introductions planned for the fiscal year 2001.
Net inventory increased during 2000 by $272,977, due to the increase of its fast
food headset market and production of new products during 2000. The Company has
received individual unit cost benefits by extending its commitments to its Far
East suppliers beyond 6 months thus allowing for a further 27% reduction in the
Company's per unit costs.
The net cash provided by financing activities was $1,551,690 in 2000, primarily
due to the $1,200,025 net proceeds from the Series A Preferred Stock financings
(see note 6 - "Notes to the Financial Statements" for further details) and
$449,975 net proceeds from issuance of notes payable (see note 5 - "Notes to the
Financial Statements" for further details).
The Company has no lines of credit with banks or other lending institutions and
therefore has no unused borrowing capacity.
Due to the Company's need to fund new product development and increase it's
manufacturing capacity in order to meet new business demands in 2000 and 2001,
it was necessary for the Company to enter into certain transactions, which
provided additional funding as follows:
On June 7, and July 7, 2000, the Company obtained bridge financing of $299,975
through its relationship with NCT Group, Inc. in order to support existing
product development and working capital requirements.
On September 13, 2000, the Company entered into a Stock Purchase Agreement with
NCT's subsidiary, NCT Hearing, pursuant to which NCT Hearing granted an
exclusive license to the Company for rights to certain NCT technologies for use
in lightweight cellular, multimedia and telephony headsets. The license is
royalty free unless and until NCT Hearing owns less than 50% of the Company's
common stock on a fully diluted basis. If NCT Hearing's percentage ownership of
common stock is less than 50%, the Company will be required to pay NCT Hearing a
royalty of 6% of net sales. In consideration for this license, the Company
issued 23,702,750 shares of its common stock, representing approximately 83% of
its issued and outstanding common stock, to NCT Hearing. As a condition
precedent to the closing of the transaction, NCT arranged $1.5 million in equity
financing for the Company through the sale of the Company's convertible
preferred stock (see below).
On September 29, 2000, the Company entered into a Securities Purchase and
Supplemental Exchange Rights Agreement with Austost Anstalt Schaan, Balmore
Funds, S.A. and Zakeni Limited (The "Pro Tech Investors") and NCT to consummate
the $1.5 million financing arranged by NCT for the Company in connection with
its sale of Pro Tech Series A Convertible Preferred Stock ("Pro Tech Preferred")
to the Pro Tech Investors. The Pro Tech Preferred consists of 1,500 designated
shares, par value of $0.01 per share and a stated value of one thousand dollars
($1,000) per share with accretion of four percent (4%) per annum on the stated
value payable upon conversion or exchange in either cash or common stock at the
election of the Company. Under such agreement, the Pro Tech Investors may elect
to exchange their Pro Tech Preferred for shares of NCT common stock or convert
their Pro Tech Preferred for shares of the Company's common stock at a
conversion price which shall be the lesser of (i) the then lowest average of the
average closing bid price for a share of the Company's common stock as reported
on the NASD OTC Bulletin Board for any consecutive five day period out of
fifteen trading days preceding the date of such conversion, less a discount of
20%, subject to certain adjustments set forth in the Articles of Amendment to
Articles of Incorporation of the Company dated as of September 29, 2000; or (ii)
a fixed conversion price of $0.50 set forth in the Articles of Amendment to
Articles of Incorporation of the Company dated as of September 29, 2000.
In connection with the execution of the Securities Purchase and Supplemental
Exchange Rights Agreement on September 29, 2000, the Company issued warrants to
the Pro Tech Investors to acquire 4.5 million shares of the Company's common
stock. Such warrants are exercisable at $0.50 per share and expire on October
28, 2003. In addition, the Company has the right to require the warrant holders
to exercise upon a call from the Company. The warrants are callable as follows:
(i) one third of the warrants are callable by the Company if the closing bid
price of the common stock for each of the previous fifteen trading days equals
or exceeds $0.68 per share and the average daily trading volume during such
period is equal to or exceeds 150,000 shares; (ii) two thirds of the warrants
are callable by the Company if the closing bid price of the common stock for
each of the previous fifteen trading days equals or exceeds $0.94 per share and
the average daily trading volume during such period is equal to or exceeds
150,000 shares; and (iii) the warrants are callable in their entirety by the
Company if the closing bid price of the common stock for each of the previous
fifteen trading days equals or exceeds $1.135 per share and the average daily
trading volume during such period is equal to or exceeds 150,000 shares.
E. Capital Expenditures
There were no material commitments for capital expenditures as of October 31,
2000, and no other material commitments are anticipated in the near future.
ITEM 7A. QUANTITATIVE OR QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Pro Tech's primary market risk exposures are fluctuations in interest rates and
foreign exchange rates. The Company is exposed to short-term interest rate risk
on certain of its debts and trade accounts receivable sales. The Company does
not use derivative financial instruments to hedge cash flows for such
obligations. In the normal course of business, the Company employs established
policies and procedures to manage these risks.
Based upon a hypothetical 10 percent proportionate increase in interest rates
from the average level of interest rates during the last twelve months, and
taking into consideration expected investment positions, commissions paid to
selling agents, growth of new business and the expected borrowing level of
variable-rate debt the expected effect on net income related to our financial
instruments would be immaterial.
ITEM 8. FINANCIAL STATEMENTS
The Reports of the Independent Auditors Morgan, Jacoby, Thurn, Boyle &
Associates, P.A., and the financial statements and accompanying notes are
attached.
Page
Independent Auditors' Report F-1
Balance Sheets as of October 31, 1999 and 2000 F-2
Statements of Operations for the years ended October 31,
1998, 1999 and 2000 F-3
Statements of Stockholders' Equity for the years ended
October 31, 1998, 1999 and 2000 F-4
Statements of Cash Flows for the years ended October 31,
1998, 1999 and 2000 F-5
Notes to Financial Statements F-6
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
There have been no disagreements with independent accountants on accounting and
financial disclosure matters during the Company's two most recent fiscal years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages, positions and the offices held
by each of the executive officers and directors of the Company as of February
13, 2001.
Name Age Positions and Offices
--------------------- ----- ----------------------------------------------
Keith Larkin 76 Chairman of the Board, Chief Executive
Officer and Treasurer
Richard Hennessey 41 President, Director and Secretary
Michael J. Parrella 52 Director
Cy E. Hammond 46 Director
Irene Lebovics 47 Director
Keith Larkin is the founder, Chairman of the Board of Directors, Chief Executive
Officer and Treasurer of the Company. Mr. Larkin's 30-year professional career
has been devoted to designing, manufacturing and marketing his new designs in
lightweight telephone headsets. In 1961, Mr. Larkin founded Plantronics, the
current industry leader in lightweight telephone headsets with annual sales of
all its products (including the electronic amplifier) in 1999 of approximately
$286 million. From 1961 until he sold his interest in 1967, Mr. Larkin served as
the President and Chairman of Plantronics, during which Plantronics established
itself as the main source of lightweight telephone headsets to the telephone
industry and provided the headsets for NASA Mercury, Gemini and Apollo moon
flights. In the late 1970's, Mr. Larkin conceived, developed and patented a new
design in headsets to compete against Plantronics' headsets. With Mr. Larkin as
its President, ACS Wireless attained $1 million monthly sales figures to the
telephone market within three years of operation and replaced Plantronics'
headsets on the NASA Space Shuttle. In 1986, he left ACS Wireless to become
involved in Christian children's relief programs in Haiti and Honduras for a
period of three years. From January 1989 to August 1991, Mr. Larkin served as
the President of Advanced Recreational Technology, Inc., an engineering research
and development company owned by Mr. Larkin. In August 1991, Mr. Larkin founded
Pro Tech Systems, a California limited partnership that he managed as general
partner. Pro Tech Systems was formed to design, manufacture, and market
lightweight telephone headsets. Upon the transfer of all of the assets of Pro
Tech Systems to the Company in November 1994, Mr. Larkin became the Chairman of
the Board of Directors, Chief Executive Officer, President and Treasurer of the
Company, positions which he held until February 2, 1999, when he resigned as
President of the Company but retained his position as Chairman of the Board of
Directors, Chief Executive Officer and Treasurer.
Richard Hennessey joined the Company as Director of Marketing in August 1995 and
was appointed Vice President Marketing on June 10, 1996. On August 4, 1998, Mr.
Hennessey was appointed to Secretary and Director of the Company. On February 2,
1999 Mr. Hennessey was appointed President and Chief Operating Officer of the
Company. From 1982 through 1984, Mr. Hennessey was a salesman with the computer
sales division of Lanier Business Products located in Boston, Massachusetts.
From 1984 through April 1994, Mr. Hennessey held various new venture sales and
sales management positions with Digital Equipment Corporation. From January 1995
until Mr. Hennessey joined the Company, he was engaged in voluntary missionary
work.
Michael J. Parrella currently serves as a Director of the Company. Mr. Parrella
is Chairman of the Board of Directors and Chief Executive Officer of NCT. From
November 1994 to July 1995, Mr. Parrella served as Executive Vice President of
NCT. Prior to that, from February 1988 until November 1994, he served as
President and Chief Operating Officer of NCT. He initially became a director of
NCT in 1986 after evaluating the application potential of NCT's noise
cancellation technology. At that time, he formed an investment group to acquire
control of the Board of Directors and to raise new capital to restructure NCT
and its research and development efforts. Mr. Parrella also serves as Chief
Executive Officer and Acting President of NCT Audio Products, Inc. ("NCT
Audio"), a subsidiary of the Company, a position to which he was elected on
September 4, 1997. He became a director of NCT Audio on August 25, 1998. Mr.
Parrella is a director of Advancel Logic Corp. ("Advancel"), a subsidiary of
NCT, serves as Chairman of the Board of Distributed Media Corporation ("DMC"), a
subsidiary of NCT, serves as Chairman of the Board of NCT Hearing Products, Inc.
("NCT Hearing"), a subsidiary of NCT, and serves as Chairman of the Board of
Midcore Software, Inc., ("Midcore"), a subsidiary of NCT.
Cy E. Hammond currently serves as a Director of the Company. Mr. Hammond is
Senior Vice President, Chief Financial Officer, Treasurer and Assistant
Secretary of NCT. He joined NCT as Controller in January 1990 and was appointed
a Vice President in February 1994. Mr. Hammond also serves as Acting Chief
Financial Officer and Treasurer of NCT Audio, a position to which he was elected
on September 4, 1997, and Acting Chief Financial Officer, Treasurer and
Assistant Secretary for Advancel, a position to which he was elected on January
5, 2000. Mr. Hammond serves as a director of Midcore. During 1989, he was
Treasurer and Director of Finance for Alcolac, Inc., a multinational specialty
chemical producer. Prior to 1989 and from 1973, Mr. Hammond served in several
senior finance positions at the Research Division of W.R. Grace & Co., the last
of which included management of the division's worldwide financial operations.
Irene Lebovics currently serves as a Director of the Company. Ms. Lebovics is
President and Secretary of NCT and President of NCT Hearing. On January 5, 2000,
Ms. Lebovics was elected Acting Chief Marketing Officer and Secretary of
Advancel. She joined NCT as Vice President of NCT and President of NCT Medical
Systems ("NCTM") in July 1989. In March 1990, NCTM became part of NCT Personal
Quieting and Ms. Lebovics served as President. In January 1993, she was
appointed Senior Vice President of NCT. In November 1994, Ms. Lebovics became
President of NCT Hearing. From August 1, 1995, to May 1, 1996, she also served
as Secretary of NCT. Ms. Lebovics has held various positions in product
marketing with Bristol-Myers, a consumer products company, and in advertising
with McCaffrey and McCall. Ms. Lebovics serves as a director of DMC and Midcore.
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors, executive officers and persons who own more than 10% of a registered
class of the Company's equity securities to file with the Securities and
Exchange Commission (the "SEC") initial reports of ownership and reports of
changes in ownership in the Common Stock. Executive officers, directors and
persons who own more than 10% of a registered class of the Company's equity
securities are required by SEC regulation to furnish the Company with copies of
all Section 16(a) forms they file with the SEC.
To the Company's knowledge, based solely on review of the copies of such reports
furnished to the Company and representations that no other reports were
required, during the fiscal year ended October 31, 2000, all of such executive
officers, directors and persons who own more than 10% of a registered class of
the Company's equity securities complied with all Section 16(a) filing
requirements.
ITEM 11. EXECUTIVE COMPENSATION
Set forth below is certain information for the three fiscal years ended October
31, 1998, 1999 and 2000 relating to compensation received by the Company's Chief
Executive Officer and, if applicable, the other four most highly compensated
officers of the Company whose total annual salary and bonus for the fiscal year
ended October 31, 2000 exceeded $100,000.
Securities
Other Underlying All
Name and Principal Annual Options/Warrants Other
Position Year Salary ($) Bonus ($) Compensation ($) SARs (#) Compensation
- --------------------------- -------- ----------- ---------- ---------------- ---------------- -------------
Keith Larkin 2000 $22,500 $ - $ - - $ -
Chairman of the Board 1999 25,000 - - 540,000 -
Chief Executive Officer 1998 42,500 - - - -
and Treasurer
Compensation Arrangements with Certain Officers and Directors
The Company had an employment agreement with Keith Larkin, which was terminated
on February 2, 1999. The agreement provided for a maximum annual salary of
$90,000 with additional amounts added using the consumer price index as a
minimum. Mr. Larkin was eligible for the maximum annual salary during a given
year only if the Company generated annual sales of at least $2,000,000 and
pre-tax income equal to at least 20% of the Company's annual sales. Since the
Company did not meet the minimum requirements during fiscal years 1998, 1999 or
2000, the Board of Directors paid Mr. Larkin the compensation set forth in the
preceding table.
The Company has no set salary obligations to Mr. Larkin for his services for the
current or future fiscal years. Mr. Larkin, however, has agreed to assign to the
Company all of his rights, title and interest in and to any and all inventions,
discoveries, developments, improvements, processes, trade secrets, trademark,
copyright and patent rights of which he conceives during his tenure as Chairman
of the Board of Directors, Chief Executive Officer and Treasurer of the Company.
The Company does not have a written employment agreement with Richard Hennessey.
During each of the fiscal years ended October 31, 1998, 1999 and 2000, Mr.
Hennessey received a salary of $51,000, $51,000 and $76,621, respectively.
Messrs. Larkin and Hennessey did not receive any additional compensation for
serving as directors of the Company.
Compensation of Directors
No directors of the Company have received any fees for serving as a director.
Stock Option Plans
On November 28, 2000, the Company issued options to purchase 500,000 shares of
common stock at $0.4375 per share under the 1998 Stock Option Plan, which vest
as follows: 125,000 immediately, 125,000 on November 28, 2001, 125,000 on
November 28, 2002, and 125,000 on November 28, 2003. The options expire on
November 28, 2007.
2000 Aggregated Option and Warrant Exercises and
October 31, 2000 Option and Warrant Values
The following table sets forth certain information with respect to the exercise
of options and warrants to purchase common stock during the fiscal year ended
October 31, 2000, and the unexercised options and warrants held and the value
thereof at that date, by each of Mr. Larkin and Mr. Hennessey.
Number of shares
Number Underlying Value of Unexercised
of Unexercised Options In-the-Money Options
Shares and Warrants at and Warrants at
Acquired October 31, 2000 October 31, 2000
On Value --------------------------------- --------------------------
Name Exercise(#) Realized Exercisable (#) Unexercisable ($) Exercisable Unexercisable
- ------------------ ------------ ---------- --------------- ----------------- ----------- --------------
Keith Larkin - - 465,000 - $ 203,250 $ -
Richard Hennessey - - 300,000 300,000 $ 131,100 $ 131,1000
During fiscal year 2000, neither Mr. Larkin nor Mr. Hennessey exercised any
stock options. The fair market value of the Company's common stock as of October
31, 2000 was less than the exercise price for both Mr. Larkin's and Mr.
Hennessey's stock options. Accordingly, as of October 31, 2000, Mr. Larkin's and
Mr. Hennessey's unexercised stock options had no value.
1996 Stock Option Plan
On April 15, 1996, the Board of Directors of the Company adopted the Company's
1996 Stock Option Plan. The 1996 Plan provides for the grant by the Company of
options to purchase up to an aggregate of 590,000 of the Company's authorized
but unissued shares of common stock (subject to adjustment in certain cases
including stock splits, recapitalizations and reorganizations) to officers,
directors, consultants, and other persons rendering services to the Company.
The purposes of the 1996 Plan are to provide incentive to employees, including
officers, directors and consultants of the Company, to encourage such persons to
remain in the employ of the Company and to attract to the Company persons of
experience and ability. The 1996 Plan terminates on April 15, 2002.
Options granted under the 1996 Plan may be either incentive stock options within
the meaning of the Internal Revenue Code of 1986, as amended, or options that do
not qualify as incentive options. The exercise price of incentive options must
be at least equal to the fair market value of the shares of common stock on the
date of grant; provided, however, that the exercise price of any incentive
option granted to any person who, at the time of the grant of the option, owns
stock aggregating 10% or more of the total combined voting power of the Company
or any parent or subsidiary of the Company, must not be less than 110% of the
fair market value
On April 15, 1996, 540,000 and 50,000 shares were granted to the Company's then
president and officers, respectively, at an option price of $0.50 per share. The
stock option exercise price was the fair value at the date of the grant, which
was determined from the price paid per share during the Company's stock offering
carried out in 1996. The stock options are exercisable upon the grant date,
extending over a period of three years.
Prior to fiscal year 1998, the Company received $25,000 upon issuance of 50,000
shares of common stock upon the exercise of 50,000 options by the Company's
officers. On April 13, 1999 the remaining 540,000 options issued to the
Company's previous president were extended for 2 years to April 15, 2001.
1998 Stock Option Plan
On March 5, 1998, the Board of Directors adopted the 1998 Stock Option Plan for
the benefit of directors, officers, employees and consultants to the Company.
The 1998 Plan originally authorized the issuance of up to 500,000 shares of
common stock and was increased to 2,000,000 shares of common stock on August 11,
2000. On August 4, 1998, 200,000 and 100,000 shares were granted to the
Company's officers and employees, respectively, at an option price of $0.375 per
share. The stock option exercise price was the fair market value of a share of
common stock at the date of the grant. Options to purchase 150,000 shares of
common stock granted to Richard Hennessey vest and are exercisable as follows:
50,000 immediately, 50,000 on August 4, 1999 and 50,000 on August 4, 2000. The
remaining options vested immediately. All options are exercisable over a
three-year period from the date of vesting.
On April 13, 1999, the remaining 1998 Plan options to purchase 200,000 shares
were granted to Richard Hennessey at an option price of $0.38 per share. The
stock option exercise price was greater than the fair market value of a share of
common stock at the date of the grant. The options vest and are exercisable as
follows: 100,000 immediately; 50,000 on April 13, 2000; and 50,000 on April 13,
2001. The options expire April 13, 2004.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.
Information required under this item is contained in a definitive proxy
statement that the Registrant will file on or before February 28, 2001, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
PART IV
ITEM 14. Exhibits, Financial Statements Schedules and
Reports on Form 8-K.
(a) (1) Financial Statements. The following financial statements are filed
as part of this Form 10-K.
Independent Auditors' Report
Balance Sheets as of October 31, 1999 and October 31, 2000.
Statements of Operations for the years ended October 31, 1998, 1999 and 2000.
Statements of Stockholders' Equity for the years ended October 31, 1998, 1999
and 2000.
Statements of Cash Flows for the years ended October 31, 1998, 1999 and 2000.
Notes to Financial Statements.
(2) Financial Statements Schedules - Schedules are omitted as not
applicable or not required.
(a) (3) Exhibits including those Incorporated by Reference.
(b) No report on Form 8-K was filed during the last quarter of the year
covered by this Annual Report on Form 10-K.
* 3(a) Amended and Restated Articles of Incorporation of the Company
as filed with the Department of State of the State of Florida on
August 17, 2000, incorporated herein by reference to Exhibit 3(a)
to the Company's Quarterly Report on Form 10-QSB for the quarter
ended July 31, 2000.
** 3(b) Amended and Restated Articles of Incorporation of the Company
as filed with the Department of State of the State of Florida on
October 2, 2000.
** 3(c) Bylaws of the Company.
** 4(a) Warrant to purchase 1,125,000 shares of common stock of the
Company at a purchase price of $0.50 per share issued to Austost
Anstalt Schaan.
** 4(b) Warrant to purchase 1,125,000 shares of common stock of the
Company at a purchase price of $0.50 per share issued to Balmore
Funds S.A.
** 4(c) Warrant to purchase 2,250,000 shares of common stock of the
Company at a purchase price of $0.50 per share issued to Zakeni
Limited.
* 10(a) 1996 Stock Option Plan. (1)
** 10(b) 1998 Stock Option Plan (1); incorporated herein by reference
to Exhibit 10.1 to the Company's Registration Statement on Form S-8
filed on August 3, 1998.
* 10(c) Stock Option, dated April 15, 1996, issued by the Company to Keith
Larkin. (1)
** 10(d) Stock Option, dated August 4, 1998, issued by the Company to Richard
Hennessey. (1)
** 10(e) Stock Option, dated April 13, 1999, issued by the Company to
Richard Hennessey. (1)
** 10(f) Promissory Note, dated March 27, 2000 issued by the Company
to Westek Communications.
** 10(g) Stock Purchase Agreement between the Company and NCT Hearing
Products, Inc., dated September 13, 2000, incorporated herein by
reference to Exhibit 10(an) to the Pre-Effective Amendment No. 2 to
Form S-1 of NCT Group, inc. filed with the SEC on December 3, 2000.
** 10(h) License Agreement between the Company and NCT Hearing Products,
Inc., dated September 12, 2000.
** 10(i) Securities Purchase and Supplemental Exchange Rights Agreement,
dated as of September 29, 2000, among the Company, NCT Group, Inc.,
Austost Anstalt Schaan, Balmore Funds S.A. and Zakeni Limited.
** 10(j) Registration Rights Agreement, dated as of September 29, 2000,
among the Company, NCT Group, Inc., Austost Anstalt Schaan,
Balmore Funds S.A. and Zakeni Limited.
** 10(k) Consulting Agreement with Union Atlantic LC dated March 15, 1999.
** 10(l) Amendment No. 1 to Consulting Agreement between the Company and
Union Atlantic LC dated June 1, 1999.
** 10(m) Modification to Consulting Agreement between the Company and
Union Atlantic LC dated July 29, 1999.
10(n) Shareholder's Agreement dated September 13, 2000 by and between the
Company and NCT Hearing Products, Inc.
** 23(a) Consent of Morgan, Jacoby, Thurn, Boyle & Associates, P.A.
27 Financial Data Schedule.
- -----------------------
* Incorporated by reference to the initial filing with the SEC of the Company's
Form 10-KSB on July 5, 1996.
** Incorporated herein by reference to Registration Statement on Form S-1 filed
with the SEC November 3, 2000.
(1) Denotes a management contract or compensatory plan or arrangement.
(b) No report on Form 8-K was filed during the last quarter of the year
covered by this Annual Report on Form 10-K.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on February 13, 2001.
PRO TECH COMMUNICATIONS, INC.
(Registrant)
By: /s/ RICHARD HENNESSEY
---------------------------------
Richard Hennessey, President
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant in the
capacities and on the dates indicated.
Signature Capacity Date
----------------------------------------------------------------------
/s/ RICHARD HENNESSEY Director, Secretary and February 13, 2001
------------------------President
Richard Hennessey
/s/ KEITH LARKIN Chief Executive Officer, February 13, 2001
------------------------Treasurer and Chairman of
Keith Larkin the Board (Principal
Executive, Financial and
Accounting Officer)
/s/ MICHAEL J. PARRELLA Director February 13, 2001
------------------------
Michael J. Parrella
/s/ CY E. HAMMOND Director February 13, 2001
------------------------
Cy E. Hammond
/s/ IRENE LEBOVICS Director February 13, 2001
------------------------
Irene Lebovics
Independent Auditors' Report
--------------------------
The Board of Directors
Pro Tech Communications, Inc.:
We have audited the accompanying balance sheets of Pro Tech Communications, Inc.
as of October 31, 1999 and 2000 and the related statements of operations,
stockholders' equity and cash flows for each of the years in the three-year
period ended October 31, 2000. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pro Tech Communications, Inc.
as of October 31, 1999 and 2000, and the results of its operations and its cash
flows for each of the years in the three-year period ended October 31, 2000 in
conformity with accounting principles generally accepted in the United States of
America.
Vero Beach, Florida
December 22, 2000,
except for note 12,
as to which the date is
January 26, 2001
PRO TECH COMMUNICATIONS, INC.
BALANCE SHEETS
OCTOBER 31,
1999 2000
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 160,428 $ 1,070,408
Accounts receivable, less allowance for doubtful accounts of
$18,661 and $26,557, respectively (note 5) 205,923 421,372
Inventories, net of reserves (note 2) 285,883 558,860
Due from officers and employees 14,298 365
Other current assets 36,916 31,770
---------------- ----------------
Total current assets 703,448 2,082,775
Property and equipment, net 196,747 278,805
Intangible assets, net of accumulated amortization of $77,655 (note 6) - 16,229,837
Due from officer (note 10) 43,743 56,824
Other assets 1,439 4,424
---------------- ----------------
$ 945,377 $ 18,652,665
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 100,104 $ 216,807
Accrued expenses(note 4) 100,388 102,165
Current portion of capital lease obligations (note 8) 8,808 6,757
Other liabilities (note 10) - 101,057
Notes Payable(note 5) - 236,170
---------------- ----------------
Total current liabilities 209,300 662,956
Capital lease obligations(note 8) 8,089 3,687
---------------- ----------------
Total liabilities 217,389 666,643
Commitments (note 8)
Stockholders' equity(notes 6 and 7):
Preferred stock, $.01 par value, authorized 998.500 shares, none issued
and outstanding - -
Series A Convertible Preferred stock, $.01 par value, $1,000 stated value,
authorized, issu-d and outstan1,505,4250 shares
Common stock, $.001 par value, authorized 40,000,000 shares, issued and
outstanding 4,24,2540 and 28,248,43828,248s, respectively
Additional paid-in-capital 1,137,018 17,239,973
Accumulated deficit (413,284) (787,624)
---------------- ----------------
Total stockholders' equity 727,988 17,986,022
---------------- ----------------
$ 945,377 $ 18,652,665
================ ================
The accompanying notes are an integral part of the financial statements.
PRO TECH COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
For the Years
Ended October 31,
-------------------------------------------
1998 1999 2000
------------ ------------ -------------
Net sales $ 1,142,482 $ 1,090,551 $ 1,562,484
Cost of goods sold 470,450 414,931 623,555
------------ ------------ -------------
Gross profit 672,032 675,620 938,929
Selling, general and administrative 882,385 893,384 1,275,290
Provision for doubtful accounts 38,835 3,771 7,990
------------ ------------ -------------
Loss from operations (249,188) (221,535) (344,351)
Other income (expense) :
Interest income 24,719 10,202 4,877
Interest expense - (1,021) (36,592)
Miscellaneous expense 89 697 1,726
Loss on disposal of fixed assets - (9,408) -
------------ ------------ -------------
Loss before income taxes (224,380) (221,065) (374,340)
Income tax expense (benefit)(note 9) (964) - -
------------ ------------ -------------
NET LOSS $ (223,416) $ (221,065) $ (374,340)
============ ============ =============
Adjustments attributable to preferred stock(note 6):
Preferred stock beneficial conversion feature $ - $ - $ 3,569,000
Preferred stock dividend requirement - - 375,000
Accretion of difference between carrying amount
and redemption amount of redeemable
preferred stock - - 5,425
------------ ------------ -------------
NET LOSS ATTRIBUTABLE TO
COMMON STOCKHOLDERS $ (223,416) $ (221,065) $ (4,323,765)
============ ============ =============
Basic and diluted income/(loss) per share $ (0.05) $ (0.05) $ (0.57)
============ ============ =============
Weighted average common shares outstanding -
basic and diluted 4,254,000 4,254,000 7,537,855
============ ============ =============
PRO TECH COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
For the years
Ended October 31,
-------------------------------------------
1998 1999 2000
------------ ------------ -------------
NET LOSS $ (223,416) $ (221,065) $ (374,340)
Other comprehensive income:
Currency translation adjustment - - -
Unrealized loss on marketable securities - - -
------------ ------------ -------------
COMPREHENSIVE LOSS $ (223,416) $ (221,065) $ (374,340)
============ ============ =============
The accompanying notes are an integral part of the financial statements.
PRO TECH COMMUNICATIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended October 31, 1998, 1999 and 2000
Retained
Series A Earnings
Common Preferred Additional (Accumulated)
Stock Stock Paid in Capital (Deficit) Total
------------ ------------ ----------------- ------------- ------------
Balance, October 31, 1997 $ 4,254 $ - $ 1,122,018 $ 31,197 $ 1,157,469
Executive compensation
contributed by an officer (note 6) 15,000 15,000
Net loss (223,416) (223,416)
------------ ------------ ----------------- ------------- ------------
Balance, October 31, 1998 4,254 - 1,137,018 (192,219) 949,053
Net loss - - - (221,065) (221,065)
------------ ------------ ----------------- ------------- ------------
Balance, October 31, 1999 4,254 - 1,137,018 (413,284) 727,988
Issuance of 12,000 shares of
common stock under stock
option plans(note 7) 12 - 4,548 - 4,560
Issuance of 23,982,438 shares
of common stock in exchange for certain
intangible assets including 279,688 shares
issued as issuance costs, net of related
issuance costs of $179,678 (note 6) 23,982 - 16,103,832 - 16,127,814
Issuance of 1,500,000 of preferred stock (note 6) - 1,500,000 - - 1,500,000
Accretion dividend of preferred stock - 5,425 (5,425) - -
Net loss - - - (374,350) (374,350)
------------ ------------ ----------------- ------------- ------------
Balance, October 31, 2000 $ 28,248 $ 1,505,425 $ 17,239,973 $ (787,634) $ 17,986,012
============ ============ ================= ============= ============
The accompanying notes are an integral part of the financial statements.
PRO TECH COMMUNICATIONS, INC.
STATEMENTS OF Cash Flows
Years ended October 31,
------------ ------------ -------------
1998 1999 2000
------------ ------------ -------------
Cash flows from operating activities:
Net (loss) $ (223,416) $ (221,065) $ (374,340)
Adjustments to reconcile net loss to net cash
(used in) operating activities:
Depreciation and amortization 38,783 45,222 128,658
Common stock options and warrants issued
as consideration for:
Compensation - -
Operating expenses - -
Provision for doubtful accounts 2,773 3,771 7,990
Loss on disposition of fixed assets - 9,408 -
Executive compensation contributed by an officer 15,000 - -
Beneficial conversion feature on convertible note (Note 8) - -
Changes in operating assets and liabilities: -
(Increase) decrease in accounts receivable 27,746 (9,459) (223,439)
(Increase) decrease in inventories, net (85,001) (40,273) (272,977)
Increase in receivable from officers and employees (22,033) (590) 852
(Increase) decrease in other assets 21,553 (17,519) 2,161
Increase(decrease) in accounts payable 13,641 63,724 116,703
Increase (decrease) in accrued expenses 114,530 (73,077) 1,777
Increase in due to parent - - 101,057
------------ ------------ -------------
Net cash (used in) operating activities $ (96,424) $ (239,858) $ (511,558)
------------ ------------ -------------
Cash flows from investing activities:
Capital expenditures (64,497) (49,482) (130,152)
Purchase of short-term investments (523,905) - -
Proceeds on maturity of short-term investments 527,296 254,545 -
------------ ------------ -------------
Net cash (used in) investing activities $ (61,106) $ 205,063 $ (130,152)
------------ ------------ -------------
Cash flows from financing activities:
Proceeds from:
Convertible notes (net) (Note8) - - -
Notes payable - - 536,145
Sale of preferred stock (net) (Note 12) - - 1,020,347
Sale of common stock (net) - - 4,560
Repayment of:
Capital lease obligations - (3,574) (9,362)
------------ ------------ -------------
Net cash provided by financing activities $ - $ (3,574) $ 1,551,690
------------ ------------ -------------
Net increase (decrease) in cash and cash equivalents $ (157,530) $ (38,369) $ 909,980
Cash and cash equivalents - beginning of period 356,327 198,797 -
------------ ------------ -------------
Cash and cash equivalents - end of period $ 198,797 $ 160,428 $ 909,980
============ ============ =============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ - $ - $ -
============ ============ =============
Supplemental disclosures of non-cash investing and financing activities:
During 1999 and 2000, the Company acquired $20,471 and $2,909, respectively, of
equipment through capital leases.
During 2000, the Company acquired licenses and patent rights through the
issuance of 23,982,438 shares of common stock valued at $16,307,492.
During 2000, the Company issued Series A Convertible Preferred Stock in exchange
for the satisfaction of notes payable amounting to $299,975.
During 2000, the Company adjusted the carrying value of preferred stock and
additional paid-in capital for the 4% accretion totaling $5,425.
PRO TECH COMMUNICATIONS, INC.
Notes to Financial Statements
(1) Organization and Summary of Significant Accounting Policies
(a) Organization
Pro Tech Communications, Inc. (the "Company") was organized and
incorporated under the laws of the State of Florida for the purpose
of designing, developing, producing and marketing lightweight
telephone headsets. The Company presently manufactures and markets
its headsets primarily for fast food companies and other large
quantity users of headset systems. The Company is in the process of
completing the development of several designs for the telephone user
market, which includes telephone operating companies, government
agencies and business offices. The Company's business strategy is to
offer lightweight headsets with design emphasis on performance and
durability at a cost below that of its competitors.
As a result of the issuance of common stock on September 12, 2000, as
discussed in note 6, the Company became a subsidiary of NCT Hearing
Products, Inc., a wholly owned subsidiary of NCT Group, Inc. As of
October 31, 2000, NCT Hearing Products, Inc. owned approximately
82.9% of the outstanding common stock of the Company.
On December 28, 2000, the Company decided to change its year-end to
conform with NCT Group, Inc., which is December 31. Accordingly, the
Company will report on the two-month transition period in its Form
10-K as of December 31, 2000.
(b) Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents.
(c) Inventory
Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out (FIFO) method.
(d) Revenue and Cost Recognition
The Company recognizes revenues as products are shipped. Each headset
carries a one to two year warranty, depending on the model. The
Company provides, by a current charge to income, an amount it
estimates that will be needed to cover future warranty obligations
for products sold during the year. The accrued liability for warranty
costs is included in accrued expenses in the balance sheet.
(e) Property and Equipment
Property and equipment is carried at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the
assets, which are generally 5-10 years. Repair and maintenance costs
are charged to expense when incurred.
(e) Intangible Assets
Intangible assets consist of licensing rights of certain technologies
acquired from NCT Hearing Products, Inc. through the issuance of
common stock (see note 6). Amortization is computed using the
straight-line method over the estimated useful lives of the assets of
17.5 years. Intangible assets are periodically reviewed by the
Company for impairments where the fair value is less than the
carrying value. Amortization expense was $77,655 for the year ended
October 31, 2000.
(f) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets or
liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(g) Advertising
The costs of advertising, promotion and marketing programs are
charged to operations in the year incurred. Advertising costs were
$43,143, $98,738 and $54,424 for the years ended October 31, 1998,
1999 and 2000, respectively, and were included in selling, general
and administrative expenses in the accompanying statements of
operations.
(h) Research and Development
Research and development costs are expensed when incurred and are
included in selling, general and administrative expenses. The amount
charged to expense for the years ended October 31, 1998, 1999 and
2000 was $40,815, $70,809 and $41,554, respectively.
(i) Fair Value of Financial Instruments
The estimated fair values of the Company's cash and cash equivalents,
accounts receivable and current liabilities approximate the carrying
amount due to the short-term nature of such financial instruments.
(j) Use of Estimates
The preparation of the Company's financial statements in conformity
with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses and contingent assets and
liabilities. Actual results could differ from those estimates.
(k) Loss Per Common Share
The Company reports loss per common share in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share." Generally, the per share effects of potential
common shares such as warrants, options, convertible debt and
convertible preferred stock have not been included, as the effect
would be antidilutive (see note 6). However, when preferred stock
will be convertible to common stock at a conversion rate that is at a
discount from the common stock market price at the time of issuance,
the discounted amount is an assured incremental yield, the
"beneficial conversion feature," to the preferred shareholders and is
accounted for as an embedded dividend to preferred shareholders. The
Company has reflected such beneficial conversion feature as a
preferred stock dividend and as an adjustment to the net loss
attributable to common stockholders.
(l) Stock Options
The Company has adopted the disclosure only provisions of Statement
of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, and continues to apply Accounting
Principles Board Opinion No. 25 and related interpretations in
accounting for its stock-based compensation plans.
(m) Long-Lived Assets
Long-lived assets and certain identifiable intangibles are reviewed
for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs
to sell. There were no such impairments for the years ending October
31, 1999 and 2000.
(n) Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist of cash and cash equivalents
and trade receivables. The Company maintains cash and cash
equivalents in accounts with various financial institutions in
amounts, which at times, may be in excess of the FDIC insurance
limit. As of October 31, 2000, the Company's cash and cash equivalent
balances exceeded the FDIC insurance limit by $948,749. The Company
has not experienced any losses on such accounts and does not believe
it is exposed to any significant risk with respect to cash and cash
equivalents.
The Company sells its products and services to distributors and end
users in various industries worldwide. The Company regularly assesses
the realizability of accounts receivable and takes into consideration
the value of past due receivables and the collectibility of such
receivables, based on credit worthiness. The Company does not require
collateral or other security to support customer receivables.
The Company is currently sourcing all components from several Far
East suppliers who build each component to the Company's
specifications. An interruption in the supply of a component for
which the Company is unable to readily procure a substitute source of
supply could temporarily result in the Company's ability to deliver
products on a timely basis, which in turn could adversely affect its
operations. To date, the Company has not experienced any shortages of
supplies.
(o) Recent Accounting Standards
In June 1997, the Financial Standards Accounting Board (FASB) issued
Statement No. 130, Reporting Comprehensive Income (Statement 130),
which establishes standards for reporting and display of
comprehensive income and its components in a financial statement
having the same prominence as other financial statements. Statement
130 is effective for years beginning after December 15, 1997 (fiscal
year 1999 for the Company). As of October 31, 2000, the Company had
no components considered to be other comprehensive income.
In June 1999, the FASB issued Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities (Statement 133), which
establishes accounting and reporting standards for derivative
instruments and hedging activities. Statement 133 requires
recognizing derivatives as assets or liabilities at fair value and
defines certain conditions when such derivatives may be considered
hedges. In addition, the FASB issued Statement No. 138, which amends
Statement 133. Statement 133, as amended by Statements 137 and 138,
is effective for fiscal years beginning after June 15, 2000 (fiscal
year 2001 for the Company). As of October 31, 2000, the Company had
no such derivatives.
In September 2000, the FASB issued Statement No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities - a replacement of FASB Statement No. 125. This statement
replaced Statement No. 125 and is effective for transfers and
servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. Statement 140 is effective for
recognition and disclosures of certain securitization transactions
for fiscal years ending after December 15, 2000.
The Company does not expect these new pronouncements will have a
significant impact on the reporting of its financial results.
(2) Inventory
Inventory at October 31, 1999 and 2000 consists of the following:
1999 2000
------------- ------------
Raw materials 96,015 180,347
Work in process 70,560 77,766
Finished goods 119,308 300,747
------------- ------------
$285,883 $558,860
============= ============
(3) Net Property and Equipment
The following is a summary of property and equipment at October 31, 1999
and 2000:
1999 2000
------------- ------------
Production molds $184,430 $ 295,621
Office equipment 63,957 36,049
Production equipment 35,049 66,918
Leased equipment 20,471 23,380
Leasehold improvements 14,577 29,577
Vehicles 5,557 5,557
Marketing displays 16,160 16,160
------------- ------------
Total cost 340,201 473,262
Less accumulated depreciation and
amortization 143,454 194,457
------------- ------------
Total $196,747 $ 278,805
============= ============
Total depreciation and amortization expense was $38,628, $45,067 and
$51,546 for the years ended October 31, 1998, 1999 and 2000, respectively.
(4) Accrued Expenses
Accrued expenses consisted of the following at October 31, 1999 and 2000:
1999 2000
-------------- -------------
Accrued warranty expense $ 78,038 $ 78,879
Other accrued expenses 22,350 23,286
-------------- -------------
$ 100,388 $ 102,165
============== =============
(5) Notes Payable and Other Financing Arrangements
On March 27, 2000, the Company received a loan of $150,000 from a
stockholder of the Company. The loan matures on March 27, 2001 and bears
interest at 8.5% per annum, payable at maturity.
On December 22, 1999, the Company entered into a short-term factoring
arrangement providing for advances of up to $300,000, based on 80% of
selected accounts receivable factored under the agreement on a recourse
basis. The Company is charged a factoring fee of 1% on each advance, plus
2% per month on advances outstanding. In addition, the minimum fee charged
per month is 1% of the total factoring plan, or $3,000, during the life of
the agreement, which is for six months and automatically renewable for
additional six month terms, unless terminated by the Company with 30 days
notice. The Company's obligations are collateralized by all of the
Company's account receivable, inventory, and equipment.
At October 31, 2000, accounts receivable factored under this agreement and
still outstanding was $103,223, of which, $86,170 had been received under
the borrowing arrangement and is classified as note payable to finance
company in the accompanying balance sheet. Total fees incurred under this
arrangement amounted to $25,167 during the year ended October 31, 2000 and
have been classified as interest expense in the accompanying statement of
operations. The Company terminated this arrangement in December 2000.
(6) Capital Stock
On August 11, 2000, the Company's shareholders approved an amendment to the
Company's Articles of Incorporation to increase the number of authorized
shares of common stock from 10,000,000 to 40,000,000 and to authorize the
creation of 1,000,000 shares of non-voting, blank check preferred stock.
Series A Convertible Preferred Stock
On September 29, 2000, the Company's Board of Directors designated the
Series A Convertible Preferred Stock with 1,500 authorized shares, a par
value of $0.01 per share, and a stated value of $1,000 per share. The
Series A preferred stock has an accretion of 4% per annum on the stated
value payable upon conversion or exchange in either cash or common stock.
Each share of stock is convertible into the Company's common stock based on
a conversion price that is the lower of: the lowest average closing bid
price for a five day consecutive period out of fifteen trading days, less a
discount of 20%, subject to certain adjustments as set forth in the
Articles of Amendment to Articles of Incorporation of the Company dated as
of September 29, 2000; or a fixed price of $0.50 subject to certain
adjustments as set forth in the Articles of Amendment to Articles of
Incorporation of the Company dated as of September 29, 2000. In addition,
the stock is exchangeable for common stock of NCT Group, Inc. Any
outstanding shares will be manditorily converted on March 31, 2005.
The Company, at its option, may redeem up to $500,000 of the Series A
preferred stock if the closing bid price is less than $0.50 per share. The
redemption price is equal to 125% of the stated value plus 100% of the
cumulative 4% accretion. The stock may be redeemed at the holders' option
if the holders of at least two-thirds of the Series A Preferred Shares then
outstanding require such redemption upon certain events of noncompliance
with the terms of the Series A Preferred Stock Purchase Agreement or
Registration Rights Agreement.
On September 29, 2000, the Company entered into an agreement to issue 1,500
shares of Series A Convertible Preferred Stock for $1,500,000. The Company
received $1,200,025 cash and satisfied $299,975 of notes payable in
exchange for the preferred stock. In addition, under the agreement, the
Company provided warrants to purchase 4,500,000 shares of the Company's
common stock. The warrants are exercisable at $0.50 per share and expire on
October 28, 2003. The Company has the right to require the warrant holders
to exercise upon a call by the Company under the following conditions: one
third of the warrants are callable if the closing bid price of the common
stock for each of the previous fifteen days equals or exceeds $0.68 per
share and the average daily trading volume during such period is at least
150,000 shares; two thirds of the warrants are callable if the closing bid
price of the common stock for each of the previous fifteen days equals or
exceeds $0.94 per share and the average daily trading volume during such
period is at least 150,000 shares; and, all of the warrants are callable if
the closing bid price of the common stock for each of the previous fifteen
days equals or exceeds $1.135 per share and the average daily trading
volume during such period is at least 150,000 shares.
The following table summarizes warrants to purchase common stock during the
years ended October 31, 1998 and 2000 (no warrants were outstanding during
the year ended October 31, 1999):
1998 2000
------------------------ -----------------------
Weighted Weighted
Average Average
Shares Exercise Shares Exercise
Price Price
--------- ------------- ---------- -----------
Warrants outstanding,
beginning of year 1,000,000 $ 1.50 - $ -
Warrants granted - - 4,500,000 0.50
Warrants terminated 1,000,000 1.50 - -
---------- ------------- ---------- -----------
Warrants outstanding and
exercisable, end of year - $ - 4,500,000 $ 0.50
---------- ------------- ---------- -----------
As of October 31, 2000, the Company's outstanding warrants have a weighted
average remaining contractual life of approximately 2.9 years.
Common Stock
On September 12, 2000, the Company acquired licensing rights for certain
technologies from NCT Hearing Products, Inc. through the issuance of
23,982,438 shares of common stock, including 279,688 shares of common stock
for costs of issuance. The intangible assets received in the exchange were
valued at the fair value of the Company's stock, which was $16,307,492.
At October 31, 1999 and 2000, $4,000 was held in escrow for the benefit of
the Company pending completion of the subscription agreements by two
investors for 4,000 shares each. These receivables are netted against
additional paid-in capital.
For purposes of determining earnings per share per common stockholder, the
Company estimated the value of the warrants issued during the year ended
October 31, 2000 to be $3,569,000 using the Black-Scholes valuation method
prescribed by SFAS No. 123, with the following assumptions: dividend yield
of 0%; expected volatility of 100%; risk-free interest rate of 5.97%; and
expected lives of three years. In addition, the value of the discounted
conversion price as of October 31, 2000 was $375,000 based on the average
closing bid price of approximately $0.96. Total accretion on the Series A
Convertible Preferred Stock as of October 31, 2000 amounted to $5,425.
As of October 31, 2000, the number of shares of common stock required to be
reserved for the conversion of preferred stock and for the exercise of
options and warrants, was 8,802,981 shares.
During the year ended October 31, 1998, the Company's president was paid a
salary in cash of $30,000. In addition, the Company recorded compensation
expense of $15,000, with a corresponding credit to additional paid-in
capital, to reflect the estimated fair value of the unpaid services
provided by the president to the Company.
(7) Stock Option Plans
On April 15, 1996, the Board of Directors adopted The 1996 Stock Option
Plan (the 1996 Plan), for the benefit of directors, officers, employees and
consultants to the Company. The Plan authorized the issuance of up to
590,000 shares of common stock. On April 15, 1996, 540,000 and 50,000
shares were granted to the Company's President and officers, respectively,
at an option price of $0.50 per share. The stock option exercise price was
the fair value at the date of the grant. On April 13, 1999, the original
expiration date of the options, the Company extended the options to April
15, 2001.
On March 5, 1998, the Board of Directors adopted the 1998 Stock Option Plan
for the benefit of directors, officers, employees and consultants to the
Company. This plan originally authorized the issuance of up to 500,000
shares of common stock and was increased to 2,000,000 shares of common
stock on August 11, 2000. On August 4, 1998, 200,000 and 100,000 shares
were granted to the Company's officers and employees, respectively, at an
option price of $0.375 per share. The stock option exercise price was the
fair market value of a share of common stock at the date of the grant.
Options to purchase 150,000 shares of common stock vest and are exercisable
as follows: 50,000 immediately; 50,000 on August 4, 1999; and 50,000 on
August 4, 2000. The remaining options vested immediately. All options are
exercisable over a three-year period from the date of vesting.
During March and April 2000, options to purchase 12,000 shares of common
stock at $0.375 per share were exercised. Total proceeds received by the
Company amounted to $4,560.
On April 13, 1999, the remaining 1998 Plan options to purchase 200,000
shares were granted to Company officer, at an option price of $0.38 per
share. The stock option exercise price was greater than the fair market
value of a share of common stock at the date of the grant. The options vest
and are exercisable as follows: 100,000 immediately; 50,000 on April 13,
2000; and 50,000 on April 13, 2001. The options expire on April 13, 2004.
The following table summarizes stock option activity:
1998 1999 2000
-------------------- -------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------- --------- --------- --------- --------- ----------
Options outstanding
beginning of year 540,000 $ 0.500 840,000 $ 0.455 1,040,000 $ 0.441
Options granted 300,000 0.375 200,000 0.380 - -
Options exercised - - - - (12,000) (0.380)
Options expired - - - - - -
-------- --------- --------- --------- --------- ----------
Options outstanding
end of year 840,000 $ 0.455 1,040,000 $ 0.441 1,028,000 $ 0.442
======== ========= ========= ========= ========= ==========
Options exercisable
end of year 740,000 $ 0.466 890,000 $ 0.451 978,000 $ 0.445
======== ========= ========= ========= ========= ==========
As of October 31, 2000, the Company's outstanding stock options have
exercise prices ranging from $0.375 to $0.50 and a weighted average
remaining contractual life of approximately 1.3 years.
No compensation expense was recorded during 1998, 1999 and 2000 for the
options issued to the Company's officers and employees, in accordance with
APB 25. Had compensation expense been determined on the fair value at the
date of grant in accordance with the provisions of Statement 123, the
Company's net loss and loss per share attributable to common stockholders
would have been adjusted to the pro forma amounts indicated below:
1998 1999 2000
------------ ------------ ------------
Net loss:
As reported $(223,416) $(221,065) $(4,323,765)
============ ============ ============
Pro forma $(278,280) (369,295) (4,341,632)
============ ============ ============
Loss per share:
As reported $ (0.05) $ (0.05) $ (0.57)
============ ============ ============
Pro forma $ (0.06) $ (0.09) $ (0.58)
============ ============ ============
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1999: dividend yield of 0%; expected
volatility of 141%; risk-free interest rate of 5.76%; and, expected lives
ranging from three to five years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1998: dividend yield of 0%; expected
volatility of 150%; risk-free interest rate of 5.45%; and, expected lives
of three years.
(8) Commitments
Future minimum lease payments under noncancelable operating leases for
buildings and equipment and the present value of future minimum capital
lease payments as of October 31, 2000 are:
Year ended October 31 Capital Leases Operating Leases
------------------------------ ---------------- -------------------
2001 $7,964 2,789
2002 3,676 -
2003 390 -
Total minimum lease payments 12,030 2,789
================ ===================
Less amount representing interest 1,586
---------------- -------------------
Present value of net minimum
capital lease payments 10,444
Less current installments 6,757
---------------- -------------------
Obligations under capital
leases, excluding current
installments $ 3,687
---------------- -------------------
Rent expense under lease agreements totaled $24,637, $32,559 and $41,696
for the years ended October 31, 1998, 1999 and 2000, respectively.
(9) Income Taxes
There was no provision for income taxes for the years ended October 31,
1999 and 2000 due to operating losses incurred. Income tax expense
(benefit) consisted of the following for the year ended October 31, 1998:
Current Deferred Total
---------- ------------ -----------
1998:
Federal $(6,264) $ 3,800 $ (2,464)
State - 1,500 1,500
---------- ------------ -----------
$(6,264) $ 5,300 $ (964)
========== ============ ===========
The actual expense (benefit) differs from the "expected" amount computed by
applying the U.S. Federal corporate income tax rate of 34% to loss before
income taxes as follows:
1998 1999 2000
---------- ------------ -----------
Computed "expected" tax benefit $(75,961) $(75,162) $(127,276)
Increase (reduction) in income
taxes resulting from:
Net operating loss not
currently utilizable 70,001 75,016 100,873
Nondeductible amortization - - 26,403
Other nondeductible expenses 4,996 146 -
---------- ------------ -----------
$ (964) $ - $ -
========== ============ ===========
The exercise of stock options in 1997 and 2000, which had been granted
under the Company's 1996 and 1998 Stock Option Plans (see note 7), gave
rise to compensation totaling $225,000 and $8,952, respectively, that is
includable in the taxable income of the employees and deductible by the
Company for federal and state income tax purposes. Such compensation
resulted from increases in the fair market value of the Company's common
stock subsequent to the date of grant of the applicable exercised stock
options and, accordingly, in accordance with APB 25, such compensation was
not recognized as an expense for financial reporting purposes. The related
tax benefits will be reflected as contributions to additional paid-in
capital in the periods in which the compensation deduction is utilized by
the Company and, in accordance with APB 25 and Statement 109, such
compensation deductions are not considered to be temporary differences.
Such deductions have not been utilized by the Company due to the net
operating losses generated in 1999 and 2000.
The Company has net operating loss carryforwards for federal and state
income tax purposes amounting to $846,000 and $927,000, respectively, which
expire through the year 2020. In accordance with Internal Revenue Code
Section 382, the Company's net operating loss carryforwards are subject to
certain limitations resulting from the issuance of common stock to NCT
Hearing Products, Inc., as discussed in note 6.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
period in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected
future taxable income and tax planning strategies in making this
assessment.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities
are as follows:
1999 2000
---------- ----------
Accounts receivable principally due to
allowance for doubtful accounts $ 3,700 $ 5,200
Accrued warranty expense 15,400 15,400
Net operating loss carryforwards 70,000 124,900
Contribution carryforwards 400 500
---------- ----------
89,500 146,000
Less valuation allowance 81,700 139,200
---------- ----------
Total deferred tax assets 7,800 6,800
Plant and equipment principally due to
differences in depreciation 7,800 6,800
---------- ----------
Total deferred tax liabilities 7,800 6,800
---------- ----------
Net deferred taxes $ - $ -
---------- ----------
(10) Related Party Transactions
During fiscal year 1996, the Company loaned $28,882 to its Chairman.
Outstanding principal and interest, at 5% per annum, are due August 2,
2003. During the year ended October 31, 1998, the Company loaned an
additional $3,650 to its Chairman, which is due October 31, 2002, with
interest at 5% per annum. Outstanding principal and interest amounted to
$43,743 and $56,824 as of October 31, 1999 and 2000, respectively.
The Company had an employment agreement with its former President, which
was terminated during 1999. The agreement provided for a maximum annual
salary of $90,000 with additional amounts added using the consumer price
index as a minimum. The President was eligible for the maximum annual
salary during a given year only if the Company generated annual sales of at
least $2,000,000 and pre-tax income equal to at least 20% of the Company's
annual sales. Since the Company had not met the minimum requirements noted
above, the Board determined the President's compensation accordingly.
As of October 31, 2000, the Company owed $101,057 to NCT Hearing Products,
Inc., its parent company, for various administrative and accounting
services provided to the Company.
(11) Major Customers
During 1998, one customer accounted for approximately 27% of net sales
generated during the year. During 1999, two customers accounted for
approximately 30% of net sales generated during the year. During 2000, two
customers accounted for approximately 34% of net sales generated during the
year.
(12) Fourth Quarter Adjustment
During the fourth quarter of the year ended October 31, 2000, the Company
recorded a decrease to inventory and an increase to cost of goods sold for
approximately $75,000 to correct an error that occurred during the second
quarter of the year ended October 31, 2000.
(13) Subsequent Events
On November 28, 2000, the Company issued options to purchase 500,000 shares
of common stock at $0.4375 per share under the 1998 Stock Option Plan,
which vest as follows: 125,000 immediately, 125,000 on November 28, 2001,
125,000 on November 28, 2002, and 125,000 on November 28, 2003. The options
expire on November 28, 2007
On January 4, 2001, 330 shares of convertible preferred stock were
converted in exchange for 1,336,170 shares of the Company's common stock.
On January 16, 2001, 20 shares of convertible preferred stock were
converted in exchange for 73,725 shares of common stock. On January 19,
2001, 40 shares of convertible preferred stock were converted in exchange
for 142,058 shares of common stock.
On January 26, 2001, the Company entered into an agreement to lease new
office and production space, effective March 1, 2001. The lease provides
for monthly payments increasing from $5,395 to $8,092 over a five-year
term.