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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________
FORM 10-K
_____________
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2004
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ____________
Commission file number: 0-28602
PRO TECH COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Florida 59-3281593
- ------------------------------- ---------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4492 Okeechobee Road, Fort Pierce, Florida 34947
(Address of principal executive offices, including Zip Code)
Registrant's telephone number, including area code: (772) 464-5100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of class)
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. /_/
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). /_/ Yes /X/ No
The aggregate market value of the outstanding common stock of the registrant
held by non-affiliates of the registrant as of June 30, 2004 was approximately
$0.4 million.
Number of shares of common stock outstanding as of March 24, 2005: 73,390,133
Table of Contents
Page
----
PART I
Item 1. Business 3
Item 2. Properties 7
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 18
Item 8. Financial Statements and Supplementary Data 18
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 18
Item 9A. Controls and Procedures 18
Item 9B. Other Information 18
PART III
Item 10. Directors and Executive Officers of the Registrant 19
Item 11. Executive Compensation 20
Item 12. Security Ownership of Certain Beneficial Owners and Management 22
Item 13. Certain Relationships and Related Transactions 23
Item 14. Principal Accounting Fees and Services 24
PART IV
Item 15. Exhibits, Financial Statement Schedules 25
Signatures S-1
2
PART I
This Annual Report on Form 10-K contains forward-looking statements that
reflect our current estimates, expectations and projections about our future
results, performance, prospects and opportunities. Forward-looking statements
include all statements that are not historical facts. These statements are often
identified by words such as "anticipate," "believe," "could," "estimate,"
"expect," "intend," "plan," "may," "should," "will," "would" and similar
expressions. These forward-looking statements are based on information currently
available to us and are subject to numerous risks and uncertainties that could
cause our actual results, performance, prospects or opportunities to differ
materially from those expressed in, or implied by, the forward-looking
statements we make in this Annual Report. We have included important factors in
the cautionary statements included in this Annual Report, particularly in the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Factors That May Affect Our Future Results," that
could cause our actual results to differ materially from the results referred to
in the forward-looking statements we make in this Annual Report. You should not
place undue reliance on any forward-looking statements. Except as otherwise
required by federal securities laws, we undertake no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events, changed circumstances or any other reason after the
date of this Annual Report.
"Pro Tech" (which may be referred to as "we," "us," or "our") means Pro
Tech Communications, Inc.
All trademarks, service marks or trade names referred to in this Annual
Report are the property of their respective owners.
ITEM 1. BUSINESS
General
Pro Tech Communications, Inc. develops, manufactures and distributes
headphone and communications headset products and systems into the contact
center, quick service restaurant, cellular/mobile telephone and consumer audio
markets. Our products include:
o Apollo headsets and amplifiers for use in contact centers;
o ProCom headsets for use in quick-service restaurants; and
o NoiseBuster active noise reduction consumer audio headphones.
We were incorporated in Florida in 1994. Our principal executive offices
are located at 4492 Okeechobee Road, Fort Pierce, Florida 34947, our telephone
number is (772) 464-5100 and our Internet address is
www.protechcommunications.com. The information on our Internet website is not
incorporated into this Annual Report. We are a majority-owned, indirect
subsidiary of NCT Group, Inc., a publicly traded company that designs products
and develops and licenses technologies based upon its portfolio of patents and
related rights and extensive know-how and non-patented technologies.
Operations
Currently, we operate our business through two divisions: products and
telecommunications systems integration. Formerly, we also operated a call center
business division. Please see Note 15 to the Notes to Financial Statements
contained elsewhere in this Annual Report for additional information regarding
our business divisions. All of our operations are predominantly within North
America.
Products
Our products division develops, manufactures and distributes headphone and
communications headset products and systems into the contact center, quick
service restaurant, cellular/mobile telephone and consumer audio markets. In
September 2004, we introduced the next generation NoiseBuster active noise
reduction headphone into the consumer audio market.
3
We intend to continue to pursue new product development. Under a license
agreement with our parent company, NCT Hearing Products, Inc., we have access to
over 50 patents, patents pending and innovations relating to active noise
reduction and noise and echo cancellation. Though a recent expansion of this
license, we now have the ability to address additional markets of opportunity,
including personal hearing protection, spectator racing, two-way radio
communications, aviation and military. We intend to enter many of these markets
through the introduction of an extensive new ProActive line of active noise
reduction products as well as passive products designed for higher noise
settings. The first of these products is expected to be ProActive safety
earmuff. This earmuff will provide industrial hearing protection for use in
high-noise environments by combining passive hearing protection with advanced
active noise reduction technology. We expect to commercially introduce this
product during the first half of 2005.
Headsets
Our headsets include the following products:
o Apollo: Advanced, lightweight headsets designed for use by telephone
users in contact centers and other dynamic business environments;
o Apollo Freedom: Headsets designed to plug directly into phones with
built-in amplifiers;
o Trinity: Closed back headsets designed for use in loud environments,
such as very noisy contact centers; and
o ProCom: Highly durable, lightweight headsets designed for use in
drive-through quick service restaurants.
Amplifiers
Our amplifiers include the following products:
o Apollo: Multimedia amplifier engineered for simultaneous use of the
telephone and multimedia applications, including computer training,
Voice over Internet Protocol and voice recognition programs;
o A-10: Multi-line amplifier designed for small office and home office
use that has been engineered to work with over 90% of all existing
phone systems in the world; and
o A-27: Amplifier designed for automatic control distributors or phone
systems that use the standard PJ-237 2-prong plug as their interface.
Headphones
Our headphone product is the NoiseBuster personal active noise reduction
headphones that reduces low frequency background noise electronically using
active noise reduction technology, while leaving speech and music clearly
audible.
Hearing Protection
Our hearing protection products currently under development are the
ProActive active noise reduction industrial hearing protection earmuffs and
closed back communications headsets that are designed for use in higher-noise
environments consisting largely of low-frequency noise that cannot easily be
reduced with passive methods. Low frequency noise often masks the
intelligibility of speech and warning signals, which can be hazardous.
Telecommunications Systems Integration
Our telecommunications systems integration division sells and installs
simple to sophisticated analog, digital and Internet Protocol phone systems that
provide telecommunications systems integration support to small office and large
corporate call center clients.
4
Technology and Proprietary Information
Under a license agreement with our parent company, NCT Hearing, we have
access to over 50 patents, patents pending and innovations relating to active
noise reduction and noise and echo cancellation. These technologies are
instrumental in improving the clarity of communications delivered by many of our
products.
Active Noise Reduction. Active noise reduction technology minimizes low
frequency acoustical noise, or rumbling sounds. Active noise reduction
electronically couples a sound wave with its exact mirror image wave, called
anti-noise, resulting in a significant reduction of the offensive noise before
it reaches the user's ears. This technology is particularly effective against
low frequency noise, such as noise generated by computer fans, HVAC systems and
motor or engine-driven equipment. Reduction of this type of noise is especially
important for intelligible communications.
Noise and Echo Cancellation. Our technology license from NCT Hearing
includes the ClearSpeech suite of algorithms designed to remove background noise
and echo from a speech signal. This technology improves communications clarity
and intelligibility. The ClearSpeech Adaptive Speech Filter noise cancellation
algorithm removes up to 95% of stationary, or constant, noise from a signal
containing noise and speech. The ClearSpeech Acoustic Echo Cancellation is an
algorithm designed to continuously and adaptively remove acoustic echo from
speech. Acoustic echoes are produced by the open-air acoustic path between the
loudspeaker and the microphone in hands-free full-duplex communication systems.
By continuously tracking changes in this acoustic path, the acoustic echo
cancellation effectively eliminates the echo, improving the clarity of the
communication system.
We rely on a combination of patent, trademark, copyright and trade secret
laws in the U.S. and elsewhere as well as confidentiality procedures and
contractual provisions to protect our proprietary information, including
information licensed to us by NCT Hearing. We also enter into confidentiality
and invention assignment agreements with our employees and confidentiality
agreements with our consultants and other third parties.
Marketing and Sales
We market and sell our products primarily through direct sales. We also
supplement the sales efforts of our employees through the use of electronic
commerce, independent sales representatives and strategic marketing agreements.
Our marketing and sales efforts are currently focused on the sale of our headset
products to the commercial headset market, including quick service restaurant
companies and franchisees, contact centers and other large quantity users of
commercial headset systems. For example, we have an agreement with the
McDonald's Corporation that allows us to sell our products on a non-exclusive
basis to McDonald's franchisees and company-owned restaurants. As of December
31, 2004, we had an internal sales and marketing force of four employees, in
addition to some of our executive officers and directors who also participate in
our direct sales efforts.
Competition
The lightweight telephone and commercial audio headset industries are
highly competitive and dominated by a few manufacturers. The primary competitors
for our lightweight telephone headsets are Plantronics and GN Netcom. In
addition, in the lightweight telephone headset market, we may face indirect
competition from companies offering interactive voice response systems that
eliminate or reduce the need for human operators for certain applications, such
as account balance inquiries and airline flight information. The primary
competitors for our NoiseBuster headphones are Bose and Sony. The primary
competitors for our pending ProActive earmuff are expected to be Aearo and
Bacou.
Our current competitors and many of our potential competitors are
well-established companies that have substantially greater financial, technical,
production, sales and marketing, and product development resources than we do.
We believe that the competitive advantages for our products and services include
high performance resulting from our proprietary technology, superior design and
construction, and low cost, but that our competitive disadvantages include
limited name recognition, limited marketing and distribution resources and long
production lead times.
5
Manufacturing
Our manufacturing operations currently consist of assembly and testing, all
of which occurs at our Fort Pierce, Florida facilities. We purchase the majority
of our components for our products from several suppliers in Asia, who build
each component based on our specifications. The majority of our components and
subassemblies used in our manufacturing operations are obtained, or are
reasonably available from multiple suppliers currently under contract. We
procure materials to meet forecasted customer requirements. We maintain minimum
levels of finished goods based on market demand in addition to inventories of
work in progress, subassemblies and components. However, our management believes
that the assembly of our products by third parties will be cost effective to our
future operations. Therefore, we intend to discontinue the majority of our
assembly and testing operations at our Fort Pierce, Florida facilities during
2005.
Environmental Matters
We are subject to various federal, state and local environmental laws and
regulations, including those governing the use, discharge and disposal of
hazardous substances in the ordinary course of our manufacturing process. We
believe that our current manufacturing operations comply in all material
respects with applicable environmental laws and regulations and that our
compliance with these laws and regulations does not have a material effect on
our capital expenditures, earnings or competitive position.
Backlog
Our backlog of unfilled orders was approximately $44,000 on each of
December 31, 2004 and December 31, 2003. We do not believe that our backlog as
of any particular date is indicative of actual sales for any future period, and
therefore should not be used as an indication of future revenue.
Employees
As of December 31, 2004, we had eight full-time and six part-time
employees, including five employees in administration and shipping, four in
sales and marketing and five in assembly and production. None of our employees
is covered by a collective bargaining agreement. We believe our employee
relationships are good.
Available Information
We file reports, proxy statements and other documents with the Securities
and Exchange Commission ("SEC"). You may read and copy any document we file at
the SEC's public reference room at Judiciary Plaza Building, 450 Fifth Street,
N.W., Room 1024, Washington, D.C. 20549. You should call 1-800-SEC-0330 for more
information on the public reference room. Our SEC filings are also available to
you on the SEC's Internet site at http://www.sec.gov.
We maintain an Internet website at www.protechcommunications.com. Our
periodic reports filed with the SEC (including annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and Section 16
reports) are available free of charge on our Investor Information website at
www.protechcommunications.com/ptcinvest as soon as reasonably practicable after
these reports are electronically filed with the SEC. The information posted on
our website is not incorporated into this Annual Report.
6
ITEM 2. PROPERTIES
Our principal executive, sales and manufacturing facilities are located in
Fort Pierce, Florida where we lease approximately 13,000 square feet pursuant to
a lease that expires in February 2006. We believe these facilities provide us
with adequate space for the near term consistent with our current business
plans.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any legal proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of our stockholders, through the
solicitation of proxies or otherwise, during the fourth quarter of 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock currently trades on the NASD OTC Bulletin Board under the
symbol "PCTU." The following table sets forth the high and low sales prices of
our common stock, as reported on the NASD OTC Bulletin Board, for each of the
periods listed.
2003 2004
---------------------- ----------------------
High Low High Low
-------- --------- --------- ---------
1st Quarter $0.015 $0.005 $0.050 $0.013
2nd Quarter $0.018 $0.007 $0.150 $0.022
3rd Quarter $0.015 $0.008 $0.055 $0.013
4th Quarter $0.018 $0.009 $0.090 $0.025
As of February 28, 2005, we had 61 holders of record of our common stock
representing approximately 500 beneficial owners.
Dividends
We have never declared or paid any cash dividends on our common stock. We
currently anticipate that we will retain any future earnings for the
development, operation and expansion of our business. Accordingly, we do not
anticipate declaring or paying any cash dividends on our common stock in the
foreseeable future. Our board of directors will have discretion in determining
whether to declare or pay dividends, which will depend upon our financial
condition, operating results, capital requirements and such other factors as the
board of directors deems relevant. In addition, provisions of our series A and B
convertible preferred stock restrict our ability to pay cash dividends on our
common stock.
7
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is derived from our historical
financial statements and should be read in conjunction with our financial
statements and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" that are included elsewhere in this Annual
Report.
For the Year For the Two For the Year
Ended Months Ended Ended
October 31, December 31, December 31,
------------ ------------ -----------------------------------------------------
2000 2000 2001 2002 2003 2004
------------ ------------ ------------ ------------- ------------ -------------
STATEMENTS OF OPERATIONS DATA:
Net sales $ 1,562,484 $ 307,902 $ 2,175,306 $ 1,648,949 $ 1,178,535 $ 1,194,756
Cost of goods sold 623,555 129,378 920,127 774,316 364,413 518,340
------------ ------------ ------------ ------------- ------------ -------------
Gross profit 938,929 178,524 1,255,179 874,633 814,122 676,416
Selling, general and administrative 1,275,290 545,586 3,655,711 2,703,425 1,694,363 1,946,990
Impairment charge on intangible assets - - - 11,500,000 - -
Provision for doubtful accounts 7,990 1,574 9,958 29,800 6,591 14,621
------------ ------------ ------------ ------------- ------------ -------------
Loss from operations (344,351) (368,636) (2,410,490) (13,358,592) (886,832) (1,285,195)
Other income (expense):
Interest income (expense), net (31,715) (8,713) (20,262) (51,290) (90,966) (115,356)
Miscellaneous income 1,726 1,029 4,305 5,004 3,352 10,396
Loss on disposal of fixed assets - - (2,945) - - -
------------ ------------ ------------ ------------- ------------ -------------
Net loss (374,340) (376,320) (2,429,392) (13,404,878) (974,446) (1,390,155)
Less:
Preferred stock beneficial conversion 3,569,000 - 79,190 45,810 - -
Preferred stock embedded dividend 375,000 - 62,661 - - -
Dividend accretion on preferred stock 5,425 10,027 24,085 22,000 10,911 -
------------ ------------ ------------ ------------- ------------ -------------
Net loss attributable to common
stockholders - as previously reported (4,323,765) (386,347) (2,595,328) (13,472,688) (985,357) (1,390,155)
Adjustment of beneficial conversion (1) 2,444,000 - - - - -
------------ ------------ ------------ ------------- ------------ -------------
Net loss attributable to common
stockholders - as adjusted $(1,879,765) $ (386,347) $(2,595,328) $(13,472,688) $ (985,357) $ (1,390,155)
============ ============ ============ ============= ============ =============
Basic and diluted net loss per share attributable
to common stockholders - as previously reported (0.57) (0.01) (0.08) (0.41) (0.03) (0.02)
Adjustment of beneficial conversion (1) 0.32 - - - - -
------------ ------------ ------------ ------------- ------------ -------------
Basic and diluted net loss per share attributable
to common stockholders - as adjusted $ (0.25) $ (0.01) $ (0.08) $ (0.41) $ (0.03) $ (0.02)
============ ============ ============ ============= ============ =============
Weighted average number
of common shares outstanding (2) 7,537,855 28,248,438 32,281,034 33,200,311 33,200,311 62,377,398
============ ============ ============ ============= ============ =============
October 31, December 31,
------------ --------------------------------------------------------------------
2000 2000 2001 2002 2003 2004
------------ ------------ ------------ ------------- ------------ -------------
BALANCE SHEET DATA:
Total assets $18,652,665 $18,264,130 $17,184,920 $ 4,163,492 $ 3,673,036 $ 3,499,047
Total current liabilities 662,956 651,313 1,541,386 866,537 1,334,879 1,212,614
Long-term debt 3,687 3,115 44,632 1,102,931 1,849,949 2,218,526
Accumulated deficit (787,624) (1,163,944) (3,593,336) (16,998,214) (17,972,660) (19,362,815)
Stockholders' equity (3) 17,986,022 17,609,702 14,965,464 1,540,586 488,208 67,907
Working capital/(deficit) 1,419,819 1,205,686 (320,525) (19,543) (647,747) (630,388)
(1) Adjustment to reflect the allocation of proceeds to multiple equity
instruments (series A preferred stock and warrants) and to adjust the
beneficial conversion feature.
(2) Excludes shares issuable upon the exercise or conversion of outstanding
stock options, warrants and convertible preferred stock, since their effect
would be antidilutive.
(3) We have never declared nor paid cash dividends on our common stock.
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
We develop, manufacture and distribute headphone and communications headset
products and systems into the contact center, quick service restaurant,
cellular/mobile telephone and consumer audio markets. Our products include:
o Apollo headsets and amplifiers for use in contact centers;
o ProCom headsets for use in quick-service restaurants; and
o NoiseBuster active noise reduction consumer audio headphones.
We intend to continue to pursue new product development. Under a license
agreement with our parent company, NCT Hearing, we have access to over 50
patents, patents pending and innovations relating to active noise reduction and
noise and echo cancellation. Though a recent expansion of this license, we now
have the ability to address additional markets of opportunity including personal
hearing protection, spectator racing, two-way radio communications, aviation and
military. We intend to enter many of these markets through the introduction of
an extensive new ProActive line of active noise reduction products as well as
passive products designed for higher noise settings.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires our management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of contingent assets
and liabilities. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis of making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting
estimate to be made based upon assumptions about matters that are highly
uncertain at the time the estimate is made, and if different estimates that
reasonably could have been used, or changes in the accounting estimates that are
reasonably likely to occur periodically, could materially impact the financial
statements. Management believes the following critical accounting policies
reflect its more significant estimates and assumptions used in the preparation
of the financial statements.
Revenue Recognition
We recognize net sales from product sales upon shipment provided title and
risk of loss have been transferred to the customer, persuasive evidence of an
arrangement exists, fees are fixed or determinable and collection is reasonably
assured. We generally have no obligations to customers after the date that
product is shipped other than for warranty obligations. Returns and customer
credits are infrequent and recorded as a reduction to sales. Discounts from list
prices are recorded as a reduction to sales at the time of sale. We also
maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate resulting in an impairment of
their ability to make payments, additional allowances might be required.
Impairment of Long-Lived Assets and Identifiable Intangible Assets
We record impairment losses on long-lived assets and identifiable
intangible assets used in operations when events and circumstances indicate the
assets might be impaired or the remaining useful life has changed and the
undiscounted cash flows estimated to be generated by those assets are less than
their carrying amounts. The amount of the impairment loss recognized is the
amount by which the carrying amounts of the assets exceed the estimated fair
values. In order to evaluate potential impairment as required by Statement of
Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," we estimate future cash
9
flows based upon assumptions for projected future operating results, projected
future capital expenditures and other material factors that may affect the
continuity or the usefulness of the asset. The carrying amount of intangible
assets at December 31, 2004 and 2003 was approximately $2,610,000 and
$2,530,000, respectively.
Inventory and Reserves for Excess and Obsolescence
We value inventory at the lower of cost (first-in, first-out method) or
market. We regularly review inventory quantities on hand and record a provision
to write down inventory to its estimated net realizable value, if less than
cost. This estimate is based upon management's assumptions of future material
usage and obsolescence, which are a result of future demand and market
conditions. If actual market conditions become less favorable than those
projected by management, additional inventory provisions may be required. If
inventory is written down to its net realizable value and subsequently there is
an increased demand for the inventory at a higher value, the increased value of
the inventory is not realized until the inventory is sold, which will result in
improved margins in the period in which the product is sold. The inventory
reserve at December 31, 2004 and 2003 was approximately $119,000 and $5,000,
respectively.
Product Warranties
Accruals for estimated expenses related to warranties are made at the time
products are sold or services are rendered. These accruals are established using
historical information on the nature, frequency and average cost of warranty
claims and estimates of future costs. Management believes the warranty accruals
are adequate; however, actual warranty expenses could differ from estimated
amounts for any significant increase in material and workmanship defects rates,
which in turn could have a material adverse impact on our operating results. The
accrual for product warranties at December 31, 2004 and 2003 was $28,000 and
$42,000, respectively.
A summary of our significant accounting policies can be found in Notes to
Financial Statements: Note 1 - Organization and Summary of Significant
Accounting Policies.
Recently Issued Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 151, "Inventory Costs--an amendment of ARB No. 43," which is the result
of its efforts to converge U.S. accounting standards for inventories with
International Accounting Standards. SFAS No. 151 requires idle facility
expenses, freight, handling cost and wasted material (spoilage) costs to be
recognized as current-period charges. It also requires that allocation of fixed
production overhead to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 will be effective for inventory costs
incurred for us beginning January 1, 2006. We are evaluating the impact of this
standard on our financial statements.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based
Payment." This standard replaces SFAS No. 123, "Accounting for Stock-Based
Compensation" and supercedes Accounting Principals Board Opinion 25, "Accounting
for Stock Issued to Employees." It requires that the compensation cost of
share-based payment transactions be recognized in financial statements based
upon the fair value of the equity or liability instruments issued. This
statement is effective for us beginning July 1, 2005. We have not yet determined
the impact of applying the various provisions of SFAS No. 123R.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets--an amendment of APB Opinion No. 29" that amends Opinion No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The provisions of this statement are
effective for non-monetary asset exchanges for us beginning July 1, 2005. We
believe the adoption of SFAS 153 will not have an impact on our results of
operations or financial position.
10
Results of Operations
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Net loss. Net loss for the year ended December 31, 2004 increased
approximately $416,000, or 43%, compared to the year ended December 31, 2003.
This increase was due to an increase of approximately $154,000 in cost of goods
sold and an increase of approximately $245,000 in NCT Hearing and affiliates
charges.
Net sales. Net sales for the year ended December 31, 2004 increased
approximately $16,000, or 1%, compared to the year ended December 31, 2003. This
increase was primarily due to an increase related to our entrance into the
consumer audio market, partially offset by reductions in sales to our fast-food
and telephone markets.
Sales from our fast-food market decreased approximately $57,000 for the
year ended December 31, 2004 compared to 2003 due mainly to reduced purchases by
one of our major distributors of fast-food parts. The number of units sold in
the fast-food market, including both headsets and parts, decreased to
approximately 29,000 units for the year ended December 31, 2004 from
approximately 36,000 units during 2003. This decrease was primarily the result
of continued market competition from Far-East headset manufacturers and
increased industry use of equipment maintenance support contractors who provide
a wide range of restaurant equipment, thereby eliminating the need for owners
and franchisees to purchase headset products from individual manufacturers. We
expect that sales from our fast-food markets will continue to decline in future
periods as a result of these factors.
Sales from our telephone market decreased approximately $21,000 for the
year ended December 31, 2004 compared to 2003 due mainly to reduced purchases by
one of our major distributors. Telephone headset purchases by this distributor
decreased approximately $27,000 for the year ended December 31, 2004 compared to
2003.
For the year ended December 31, 2004, we generated sales of approximately
$87,000 from our entrance into the consumer audio market. We entered this market
in September 2004 with the introduction of our NoiseBuster Active Noise
Reduction headphones.
Cost of goods sold. For the year ended December 31, 2004, cost of goods
sold increased approximately $154,000, or 42%, compared to 2003. This increase
was due mainly to an increase of $114,000 in the inventory reserve for the year
ended December 31, 2004 as compared to 2003. We increased our inventory reserve
in December 2004 as part of the implementation of our strategy to reduce future
costs by using third parties to assemble our high volume products.
Gross profit. Gross profit margin decreased to 56.6% for the year ended
December 31, 2004 from 69.1% for the year ended December 31, 2003. In December
2004, we increased our inventory reserve by approximately $114,000 as discussed
above. Without this increase, the gross profit margin for the year ended
December 31, 2004 would have been 66.1%. During the year ended December 31,
2003, we received a $15,000 credit from a vendor. Without this credit, the gross
profit margin for the year ended December 31, 2003 would have been 67.8%.
Selling, general and administrative expenses. For the year ended December
31, 2004, selling, general and administrative expenses increased approximately
$4,000, or 1%, compared to 2003. This increase was due to: (1) an increase of
approximately $52,000 in consulting expenses related to investor communications
and public relations; (2) an increase of approximately $47,000 in professional
services and (3) an increase of approximately $60,000 in marketing expenses
related to the introduction of our NoiseBuster headphones. Substantially
offsetting these increases were: (1) a decrease of approximately $88,000 in
payroll and related expenses, (2) a decrease of approximately $37,000 in
insurance expenses and miscellaneous fees and (3) a decrease of approximately
$32,000 in health insurance and claims expenses. These decreases resulted from
our continued costs savings through work force reductions and tighter controls
over expenditures.
NCT Hearing and affiliates charges. For the year ended December 31, 2004,
NCT Hearing and affiliates charges increased approximately $245,000, or 78%,
compared to 2003. This increase was due mainly to the additional work performed
by their engineering staff in connection with our next generation NoiseBuster
headphones released in September 2004 and the anticipated release of our
ProActive safety earmuff in the second quarter of 2005.
11
Interest expense. Interest expense for the year ended December 31, 2004
increased approximately $22,000 compared to 2003. Interest expense - NCT Hearing
comprised $20,000 of the increase. These charges were incurred on the
outstanding notes payable to NCT Hearing, which represent amounts owed to NCT
Hearing for services provided to us by NCT Hearing and its affiliated companies,
as well as cash advances. As of December 31, 2004, the balance of these
outstanding noncurrent notes payable, including interest, was $2,207,255
compared to $1,824,520 as of December 31, 2003.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Net loss. Net loss for the year ended December 31, 2003 decreased
approximately $12,430,000, or 93%, compared to the year ended December 31, 2002.
This decrease was due mainly to the recognition of an $11,500,000 intangible
assets impairment charge in 2002 as well as a reduction of approximately
$254,000 in selling, general and administrative expenses and a reduction of
approximately $756,000 in depreciation and amortization expense during 2003.
Net sales. Net sales for the year ended December 31, 2003 decreased
approximately $470,000, or 29%, compared to the year ended December 31, 2002.
Pro Tech continued the sale of products through distributors, augmenting these
sales with direct sales from our own outbound telemarketing operation. During
the year ended December 31, 2003, we sold approximately 35,800 headsets and
headset related products, as compared to approximately 60,500 during the same
period 2002, a 41% decrease.
Sales from our fast-food market decreased approximately $313,000, or 28%,
in 2003 as compared to 2002. Net unit sales of fast-food headsets decreased 51%
due mainly to reduced purchases by three of our major distributors. This
decrease was primarily the result of slowed demand from their customer base.
Sales from our radio market decreased approximately $100,000, or 97%, in
2003 compared to 2002. After evaluating the revenue and costs of this market, we
determined that it was not profitable for us and decided to exit this market
during 2002.
Sales from our telephone market remained approximately the same in 2003
compared to 2002. We faced delays in introduction of new products for this
market due to a lack of working capital.
Cost of goods sold. Cost of goods sold for the year ended December 31, 2003
decreased approximately $410,000, or 53%, compared to 2002. This decrease was
due mainly to the decrease in sales volume for 2003. In addition, replacement of
headsets in connection with a component failure that we experienced during the
second quarter of 2001 was completed as of September 30, 2002. The number of
units replaced through warranty during the year ended December 31, 2003
decreased by approximately 7,300 compared to 2002, representing approximately
$54,000 in costs. Although these component failures had been corrected, we
continued to honor the warranty associated with these headsets and repaired or
replaced the headsets for customers as needed. Also contributing to the decrease
in cost of goods sold was a $15,000 credit from a vendor in settlement of
disputed charges from prior years.
Gross profit. Gross profit margin percent increased to 69.1% for the year
ended December 31, 2003 from 53.0% for the year ended December 31, 2002. This
increase was a result of: (1) a favorable change in the mix of customers; (2) a
decrease in the expenses incurred to honor warranty replacements; and (3) a
$15,000 credit from a vendor, mentioned above. The change in the mix of
customers resulted from the decrease in sales to our three major distributors.
These distributors purchased in large quantities and, therefore, were given
discounted prices resulting in lower profit margins. The decrease in expenses
related to warranty is a result of fewer headsets being replaced in connection
with the component failure mentioned above.
Selling, general and administrative expenses. Selling, general and
administrative expenses for the year ended December 31, 2003 decreased
approximately $254,000, or 20%, compared to the year ended December 31, 2002.
Starting in 2002 and continuing throughout 2003, we implemented cost savings to
reduce selling, general and administrative expenses. These cost savings included
a reduction of work force in all areas of the products operations and tighter
controls over expenditures. The decrease in expenses was due mainly to a
decrease of approximately $292,000 in payroll and related expenses comprised
mainly of a $133,000 decrease in health benefit expenses and a $121,000 decrease
in payroll and payroll taxes reflecting workforce reductions.
12
We did not have an impairment charge on intangible assets for the year
ended December 31, 2003 as compared to a charge of $11,500,000 for the year
ended December 31, 2002. We are required to test the recoverability of our
long-lived assets (which include our intangible assets) whenever events or
changes in circumstances indicate that their carrying amount may not be
recoverable. We tested the recoverability of the intangible assets as of
December 31, 2003 and determined that the carrying amount of such assets were
less than their fair value. No impairment charge was necessary for the year
ended December 31, 2003.
Interest expense. Interest expense - NCT Hearing for the year ended
December 31, 2003 increased approximately $35,000, or 168%, compared to 2002.
These charges were incurred on the outstanding notes payable to NCT Hearing,
which represent amounts owed to NCT Hearing for services provided to us by NCT
Hearing and its affiliated companies, as well as cash advances. As of December
31, 2003, the balance of the outstanding notes payable, including interest, was
$1,824,540, as compared to $1,064,703 as of December 31, 2002.
Liquidity and Capital Resources
We have experienced net losses since our inception. These losses have been
funded primarily from product sales, the sale of convertible preferred stock and
advances from NCT Hearing and its affiliates. During the year ended December 31,
2004, we funded working capital requirements with continued use of our
short-term factoring arrangement and advances from NCT Hearing and its
affiliates. In addition, NCT Hearing and its affiliates paid expenses on our
behalf, which were allocated to us. We continue to closely monitor all our
expenditures. We received approximately $115,000 in advances during the first
quarter 2005 from NCT Hearing to assist us in funding our working capital needs
during 2005. Management believes we will have sufficient funds to meet our
estimated anticipated working capital requirements through December 31, 2005.
However, our liquidity is affected by many factors, including, among others, the
level of product sales, capital expenditures, the level of new product
development efforts and other factors related to the uncertainties of our
industry and the economy in general. Accordingly, we may be required to seek
additional financing during the next 12 months. Management can give no assurance
that any additional financing, including from NCT Hearing, will be available to
us on commercially reasonable terms, or at all. The failure to obtain any needed
financing could have a material adverse effect on us.
On April 5, 2004, NCT Hearing converted an aggregate of $640,466 of our
outstanding noncurrent secured promissory notes payable into 27,846,351 shares
of our common stock.
On June 27, 2004, we negotiated the rollover of our $62,009 outstanding
note payable to Westek Electronics, a stockholder, into a note payable bearing
interest at 8.5% and payable in monthly installments of $3,500 with the
remaining balance maturing on June 27, 2005.
At December 31, 2004, cash and cash equivalents were $59,097.
The current ratio (current assets to current liabilities) was 0.48 to 1.00
at December 31, 2004, as compared to 0.51 to 1.00 at December 31, 2003. We had a
working capital deficit of $636,388 at December 31, 2004 compared to a deficit
of $647,747 at December 31, 2003. This $11,000 decrease in working capital
deficit was due mainly to a decrease in our notes payable to stockholder of
approximately $102,000 and a decrease in accounts payable of approximately
$73,000. Offsetting these decreases in current liabilities was a decrease in net
inventories of approximately $150,000.
Cash flows used in operating activities were approximately $177,000 during
the year ended December 31, 2004. This use of funds was driven primarily by the
2004 generated net loss of approximately $1,390,000 and the decrease of
approximately $73,000 in accounts payable. These uses of funds were offset by
depreciation and amortization expense of approximately $342,000 and an
approximate $814,000 increase in notes payable for services received and an
increase in provision for obsolete inventories of approximately $114,000.
The net cash provided by financing activities was approximately $219,000
during the year ended December 31, 2004, due mainly to approximately $267,000 in
net cash received from NCT Hearing and its affiliates, offset by payments made
on notes payable and capital lease obligations.
We have no lines of credit with banks or other lending institutions.
13
Capital Expenditures
There were no material commitments for capital expenditures as of December
31, 2004, and no material commitments are anticipated in the near future. In
connection with the proposed release of a new product, the ProActive safety
earmuff, we have been in detailed discussions with the manufacturer and
anticipate incurring approximately $110,000 in tooling costs (for the mold
needed for the product) payable as follows: 25% at the beginning of production,
25% with the first shipment of product and the remainder based upon unit
production, not to exceed 12 months. We expect to finance these costs from
working capital. In the event that our working capital is not sufficient, we
will seek additional funding from NCT Hearing.
Contractual Obligations
The impact that our contractual obligations as of December 31, 2004 are
expected to have on our liquidity and cash flow in future periods is as follows:
Payments due by period
-----------------------------------------------------------------
More
Less than than 5
Contractual Obligations Total 1 year 1-3 years 3-5 years years
------------ ------------ ------------ ----------- ----------
Long-Term Debt $ 4,076 $ 2,646 $ 1,430 $ - $ -
Related Party Long-Term Debt 2,207,255 - 2,207,255 - -
Capital Leases 23,474 13,109 10,365 - -
Operating Leases 112,747 96,563 16,184 - -
Purchase Obligations 110,000 110,000 - - -
------------ ------------ ------------ ----------- ----------
Total $2,457,552 $ 222,318 $2,235,234 $ - $ -
============ ============ ============ =========== ==========
Off-Balance Sheet Arrangements
As of December 31, 2004, we did not have any off-balance sheet
arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Factors Affecting Our Business and Prospects
There are many factors that affect our business and our operating results,
some of which are beyond our control. The following discussion describes some of
the important factors that may cause our actual results in future periods to
differ materially from those currently expected or desired.
We have incurred substantial losses since our inception and we expect to
have a continuing need for additional financing.
We have incurred substantial losses from operations since our inception,
including operating losses of $13,404,878, $974,446 and $1,390,155 for the years
ended December 31, 2002, 2003 and 2004, respectively, and we had an accumulated
deficit of $19,362,815 at December 31, 2004. We expect that we will continue at
a loss until, at the earliest, we generate sufficient revenue to offset the cost
of our operations. Our future revenue levels and potential profitability depend
on many factors, including the demand for our existing products and services,
our ability to develop and sell new products and services and our ability to
control costs. We can give no assurance that we will experience any significant
revenue growth or that we will ever achieve profitability. Even if we do achieve
profitability for a fiscal year, we may be unable to sustain profitability on a
quarterly or annual basis in the future. It is possible that our revenues will
grow more slowly than we anticipate or that operating expenses will exceed our
expectations.
We believe that we will have sufficient funds to meet anticipated working
capital requirements for the next twelve months. However, our liquidity is
affected by many factors, including, among others, the level of product sales,
capital expenditures, the level of new product development efforts and other
factors related to the uncertainties of our industry and the economy in general.
In the event that our operations do not generate sufficient cash, we could be
required to reduce our level of operations while attempting to raise additional
working capital. We can give no assurance that additional financing, including
funding from NCT Hearing, will be available to us on
14
acceptable terms or at all. The failure to obtain any necessary additional
financing would have a material adverse effect on us. If adequate funds are not
available or are not available on acceptable terms, our ability to fund our
expansion, take advantage of business opportunities, develop or enhance products
or services or otherwise respond to competitive pressures would be significantly
limited, and we might need to significantly restrict our operations.
We depend on the development of our businesses in the consumer audio and
industrial safety markets and we could be materially adversely affected if these
businesses do not develop as we expect.
While the contact center and quick service restaurant markets are still a
substantial portion of our business, we believe that our future prospects will
depend in large part on the growth in demand for our NoiseBuster consumer audio
headphones and our pending ProActive industrial hearing protection products. We
do not have extensive experience in selling products to customers in the
consumer audio and industrial safety markets. If we are unable to effectively
market our products to customers in these markets, it would have a material
adverse effect on the potential demand for these products and on our business,
financial condition, operating results and cash flows.
If we are unable to match production to demand, we will be at risk of
losing business or our gross margins could be materially adversely affected.
The demand for our products is dependent on many factors and this demand is
inherently difficult to forecast. We have experienced sharp fluctuations in
demand for many of our products. Significant unanticipated fluctuations in
demand could cause the following operating problems, among others:
o If forecasted demand does not develop, we could have excess inventory
and excess capacity. Over forecast of demand could result in higher
inventories of finished products, components and subassemblies. If we
were unable to sell these inventories, we would have to write off some
or all of our inventories of excess products and unusable components
and subassemblies. Excess manufacturing capacity could lead to higher
production costs and lower margins.
o If demand increases beyond that forecasted, we would have to rapidly
increase production. We depend on suppliers to provide additional
volumes of components and subassemblies, and are experiencing greater
dependencies on single source suppliers. Therefore, we might not be
able to increase production rapidly enough to meet unexpected demand.
This could cause us to fail to meet customer expectations. There could
be short-term losses of sales while we are trying to increase
production. If customers turn to competitive sources of supply to meet
their needs, there could be a long-term impact on our revenues.
o Rapid increases in production levels to meet unanticipated demand
could result in higher costs for components and subassemblies,
increased expenditures for freight to expedite delivery of required
materials and higher overtime costs and other expenses. These higher
expenditures could lower our profit margins. Further, if production is
increased rapidly, there may be decreased manufacturing yields, which
may also lower our margins.
Any of the foregoing problems could materially adversely affect our
business, financial condition and operating results.
The failure of our suppliers to provide quality components or products in a
timely manner could adversely affect our results.
Our growth and ability to meet customer demands depend in part on our
capability to obtain timely deliveries of components, subassemblies and products
from our suppliers. We buy components and subassemblies from a variety of
suppliers and assemble them into finished products. We also have certain of our
products manufactured for us by third party suppliers. The cost, quality and
availability of these goods are essential to the successful production and sale
of our products. Obtaining components, subassemblies and finished products
entails various risks, including the following:
o We obtain certain subassemblies, components and products from single
suppliers and alternate sources for these items are not readily
available. An interruption in supply from any of our single source
suppliers in the future would materially adversely affect our
business, financial condition and operating results.
15
o Prices of components, subassemblies and finished products may rise. If
this occurs and we are not able to pass these increases on to our
customers or to achieve operating efficiencies that would offset the
increases, it would have a material adverse effect on our business,
financial condition and operating results.
o Due to the lead times required to obtain certain subassemblies,
components and products from certain foreign suppliers, we may not be
able to react quickly to changes in demand, potentially resulting in
either excess inventories of such goods or shortages of the
subassemblies, components and products. Failure in the future to match
the timing of purchases of subassemblies, components and products to
demand could increase our inventories and/or decrease our revenues,
consequently materially adversely affecting our business, financial
condition and operating results.
o Most of our suppliers are not obligated to continue to provide us with
components and subassemblies. Rather, we buy most components and
subassemblies on a purchase order basis. If our suppliers experience
increased demand or shortages, it could affect deliveries to us. In
turn, this would affect our ability to manufacture and sell products
that are dependent on those components and subassemblies. This would
materially adversely affect our business, financial condition and
operating results.
We face significant competition from well-established companies.
We face formidable competition in each of the markets in which we operate.
Many of these companies have substantially greater management, technical,
financial, marketing and product development resources than we do. In addition,
many of our competitors have substantially greater name recognition and shorter
production and distribution lead times than we do. For example, our lightweight
telephone headsets face substantial competition from Plantronics and GN Netcom,
our NoiseBuster headphones compete with products offered by Bose and Sony and
our pending ProActive earmuffs are expected to compete with earmuffs offered by
Aearo and Bacou. While we believe that the quality of our products and services
equals or exceeds those of our competitors, we can give no assurance that we
will be able to compete effectively against these companies.
Our success depends upon our ability to develop new products and to enhance
our existing products.
The markets in which we participate are characterized by rapid
technological advances, evolving standards, changing customer needs and frequent
new product introductions and enhancements. To keep pace with technological
developments, satisfy increasingly sophisticated customer requirements and
achieve market acceptance, we must enhance and improve our existing products,
and we must also continue to introduce new products and services. If we are
unable to develop new products or adapt our current products to meet changes in
the marketplace, if we are unable to enhance and improve our products
successfully in a timely manner, or if we fail to position and/or price our
products to meet market demand, customers may not buy our products and our
business and operating results will be adversely affected. If our enhancements
to existing products do not deliver the functionality that our customers demand,
our business and operating results will be adversely affected. Accelerated
product introductions and short product life cycles require high levels of
expenditures for research and development that could adversely affect our
operating results. Further, any new products we develop may not be introduced in
a timely manner and may not achieve the broad market acceptance necessary to
generate significant revenues.
We may not be able to protect our intellectual property.
We rely on a combination of patent, trademark, trade secrets,
confidentiality procedures and contractual commitments to protect our
proprietary information. Despite our efforts, these measures can only provide
limited protection. Unauthorized third parties may try to copy or reverse
engineer portions of our products or otherwise obtain and use our intellectual
property. Any patents owned by or licensed to us may be invalidated,
circumvented or challenged. Any of our pending or future patent applications,
whether or not being currently challenged, may not be issued with the scope of
the claims we seek, if at all. If we cannot protect our proprietary technology
against unauthorized copying or use, we may not remain competitive.
Our business may be harmed if we are found to have infringed intellectual
property rights of third parties.
Third parties may assert claims against us alleging that we have infringed
their intellectual property rights. If we do not succeed in any such litigation,
we could be required to expend significant resources to pay damages,
16
develop non-infringing intellectual property or to obtain licenses to the
intellectual property that is the subject of the litigation. However, we cannot
be certain that any such licenses, if available at all, will be available to us
on commercially reasonable terms. Also, defending these claims may be expensive
and divert the time and efforts of our management.
Changes in regulatory requirements may adversely impact our operating
results or reduce our ability to generate revenues if we are unable to comply.
Many of our products must meet the requirements set by regulatory
authorities in the numerous jurisdictions in which we sell them. As regulations
and local laws change, we must modify our products to address those changes.
Regulatory restrictions may increase the costs to design and manufacture our
products, resulting in a decrease in our margins or a decrease in demand for our
products if the costs are passed along. Compliance with regulatory restrictions
may impact the technical quality and capabilities of our products, reducing
their marketability.
While we believe that we currently have adequate control structures in
place, we are still exposed to potential risks from recent legislation requiring
companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of
2002.
We are working toward evaluating our internal control systems in order to
allow management to report on, and our independent registered public accountants
to attest to, our internal controls, as required by the Sarbanes-Oxley Act. We
are performing the system and process evaluation and testing (and any necessary
remediation) required in an effort to comply with the management certification
and public accountant attestation requirements of Section 404 of the
Sarbanes-Oxley Act. As a result, we expect to incur additional expenses and
diversion of management's time. While we anticipate being able to fully
implement the requirements relating to internal controls and all other aspects
of Section 404 in a timely fashion, we cannot be certain as to the timing of
completion of our evaluation, testing and remediation actions or the impact of
the same on our operations since there is no precedent available by which to
measure compliance adequacy. If we are not able to implement the requirements of
Section 404 in a timely manner or with adequate compliance, we might be subject
to sanctions or investigation by the SEC. Any such action could adversely affect
our financial results.
Our stock price may be volatile and your investment could lose value.
Historically, the market price of our common stock has been volatile. The
trading price of our common stock could be subject to wide fluctuations in
response to various factors, some of which are beyond our control. These factors
include:
o quarterly variations in our operating results;
o announcements by us or our competitors of new products, significant
contracts, commercial relationships or capital commitments;
o our ability to develop and market new and enhanced products on a
timely basis;
o concerns about our liquidity; and
o general trends involving the economy or OTC Bulletin Board traded
companies.
In addition, the stock market in general, and the market for technology
companies in particular, have experienced price and volume fluctuations that
have often been unrelated or disproportionate to the operating performance of
those companies. These market and industry factors may seriously affect the
market price of our common stock regardless of our actual operating performance.
Trading in our common stock is subject to the SEC's penny stock rules.
Trading in our common stock is currently subject to the requirements of the
"penny stock" rules of the SEC. The penny stock rules impose additional sales
practice requirements on broker-dealers who sell penny stock securities to
persons other than established customers or accredited investors. For example,
the broker must make a special suitability determination for the purchaser and
must have received the purchaser's written consent to the transaction prior to
the sale. The rules also require that the broker:
17
o deliver to purchasers, prior to any penny stock transaction, a
disclosure schedule explaining the penny stock market and the risks
involved in investing in penny stocks;
o disclose the broker's commissions and current quotations for the penny
stock;
o disclose whether the broker is the sole market maker for the penny
stock and, if so, the broker's presumed control over the market; and
o send monthly statements disclosing recent price information for the
penny stocks held in the customer's account and information on the
limited market in penny stocks.
These additional burdens may discourage brokers from effecting transactions
in our common stock, which could severely limit the market liquidity of our
common stock and the ability of stockholders to sell our common stock in the
market.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposures include fluctuations in interest rates.
We are exposed to short-term interest rate risk on certain debt obligations and
trade accounts receivable sales. We do not use derivative financial instruments
to hedge cash flows for these obligations. In the normal course of business, we
employ established policies and procedures to manage these risks.
Based upon a hypothetical 10% proportionate increase in interest rates from
the average level of interest rates during the last twelve months, and taking
into consideration commissions paid to selling agents, growth of new business
and the expected borrowing level of variable-rate debt, the expected effect on
net income related to our financial instruments would be immaterial.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this Annual
Report on Form 10-K. See Item 15.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our President and Chief Financial
Officer, evaluated the effectiveness of our disclosure controls and procedures
(as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as
amended) as of December 31, 2004. Based on that evaluation, our President and
Chief Financial Officer concluded that our disclosure controls and procedures as
of December 31, 2004 were effective in ensuring that information required to be
disclosed by us in reports that we file or submit under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms. We believe that a
control system, no matter how well designed and operated, cannot provide
absolute assurance that the objectives of the control system are met, and no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, could be detected within a company.
Changes in Internal Controls
There were no changes in our internal control over financial reporting that
occurred during the quarter ended December 31, 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
18
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information about our executive
officers and directors as of February 28, 2005.
Name Age Position
---- --- --------
Richard Hennessey 45 President, Chief Operating Officer and
Director
Mary Christian-Hein 43 Senior Vice President, Chief Financial
Officer and Treasurer
Irene Lebovics 52 Chairman of the Board
Keith Larkin 81 Director
Michael J. Parrella 57 Director
Cy E. Hammond 50 Director
Mark Melnick 46 Secretary
No family relationships exist among any of our executive officers or
directors.
Richard Hennessey has served as our President and Chief Operating Officer
since February 1999 and as a director since August 1998. He also served as our
Secretary from August 1998 to January 2002. Mr. Hennessey previously served as
our Vice President of Marketing from June 1996 to February 1999 and as our
Director of Marketing from August 1995 to June 1996.
Mary Christian-Hein has served as our Senior Vice President, Chief
Financial Officer and Treasurer since September 2004. She previously served as
Assistant Controller of NCT Group, our ultimate parent company, from May 2001 to
September 2004. From 1991 to 2001, Ms. Christian-Hein held various accounting
and finance positions with Warrantech Corporation, an independent provider of
service contracts and after-market warranties, including Director of Reporting
and Compliance, from 1996 to 2001.
Irene Lebovics has served as our Chairman of the Board since November 2003
and as a director since September 2000. She has also served as NCT Group's
President since April 2000 and as a member of its board of directors since April
2001. Ms. Lebovics previously served as NCT Group's Executive Vice President
from February 1999 to April 2000, its Secretary from February 1999 until
September 2001, a Senior Vice President from January 1993 to February 1999 and
as a Vice President from July 1989 to January 1993.
Keith Larkin is our founder and has served as a director since our
incorporation in 1994. He previously served as our Chairman of the Board from
1994 to November 2003, our Chief Executive Officer and Treasurer from 1994 to
February 2002 and as our President from 1994 to February 1999. Mr. Larkin is
also the founder of Plantronics, the current industry leader in lightweight
telephone headsets.
Michael J. Parrella has served as a director since September 2000. He has
also served as NCT Group's Chief Executive Officer since August 1995, as its
Chairman of the Board since April 2000 and as a member of its board of directors
since 1986. Mr. Parrella previously served as NCT Group's President from August
1995 to April 2000, its Executive Vice President from November 1994 to July 1995
and as its President and Chief Operating Officer from February 1988 to November
1994.
Cy E. Hammond has served as a director since September 2000. He has also
served as NCT Group's Senior Vice President, Chief Financial Officer and
Treasurer since January 1996 and as a member of its board of directors since
March 2004. Mr. Hammond previously served as a Vice President of NCT Group from
February 1994 to January 1996 and as Controller from January 1990 to January
1994.
Mark Melnick has served as our Secretary since January 2002. He has also
served as a Senior Vice President of NCT Group since October 2004 and as its
General Counsel and Secretary since September 2001. He also served as a Vice
President of NCT Group from September 2001 to September 2004. Prior to joining
NCT Group, Mr. Melnick served as Counsel, Senior Counsel and then Assistant
General Counsel of CBS Cable and its predecessor-in-interest, Group W Satellite
Communications (a division of Westinghouse Broadcasting Co.), in the cable
television field, from 1989 to 2000.
19
Audit Committee Functions
Our board of directors does not have a standing audit committee and our
board as a whole performs all audit committee functions, including oversight of
our independent registered public accountants and oversight of our management on
matters relating to accounting, financial reporting and disclosure, internal
controls and compliance with laws, regulations and corporate policies. None of
the members of the board of directors is "independent" as defined under the
rules of the Nasdaq Stock Market. The board of directors has determined that Mr.
Hammond qualifies as an "audit committee financial expert" as defined by the
SEC.
Code of Ethics
We have adopted a Code of Ethics that applies to our Chief Executive
Officer (or persons performing similar functions) and all senior financial and
accounting officers, including our Chief Financial Officer (or persons
performing similar functions). The Code of Ethics is filed as Exhibit 14 to this
Annual Report.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our directors and executive officers and persons who own more than 10% of a
registered class of our equity securities to file reports of initial ownership
of, and transactions in, our securities with the SEC. These directors, executive
officers and stockholders are also required to furnish us with copies of all
Section 16(a) forms they file. Based solely on a review of the copies of forms
furnished to us, and written representations from certain reporting persons, we
believe that our directors, executive officers and 10% stockholders met all
applicable filing requirements during the year ended December 31, 2004, except
that Mr. Hennessey and Ms. Debra Kirven, our former Chief Financial Officer,
each filed one late Form 4 covering one transaction; Ms. Christian-Hein filed a
late Form 3; and NCT Hearing, a beneficial owner of approximately 86% of our
common stock, filed three late Form 4's covering a total of three transactions.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
Set forth below is information for the three years ended December 31, 2004,
2003 and 2002 relating to compensation received by our President. None of our
other executive officers' total annual salary and bonus for the fiscal year
ended December 31, 2004 exceeded $100,000.
Long-Term Compensation
----------------------------------
Annual Compensation Awards
--------------------------------------------- ----------------------------------
Restricted Securities
Name and Principal Other Annual Stock Underlying
Position Year Salary ($) Bonus ($) Compensation ($) Awards (#) Options/SARs (#)
- ---------------------------- ------ ------------- ------------- ---------------- -------------- ----------------
Richard Hennessey 2004 $ 127,083(a) - - - 200,000
President and Chief 2003 149,000(b) - - - -
Operating Officer 2002 151,667 - - - -
__________
(a) Mr. Hennessey voluntarily accepted a reduction in salary of approximately
$23,000 to lessen our cash flow requirements during the first half of 2004.
(b) Includes $87,500 accrued but not yet paid to Mr. Hennessey.
20
Option Grants in 2004
The following table summarizes options granted to our President during
2004.
Individual Grants
----------------------------------------------------------
Potential Realized Value
at Assumed Annual
Number of Percent of Rates of Stock Price
Securities Total Options Appreciation for Option
Underlying Granted to Exercise and Warrant Term (a)
Options Employees Price Expiration --------------------------------
Name Granted in 2004 Per Share Date 5% 10%
- ------------------- ----------- --------------- ----------- ------------ ----------------- --------------
Richard Hennessey 200,000 31.5% $ 0.03 03/09/2011 $ 2,443 $ 5,692
__________
(a) The dollar amounts in these columns are the result of calculations of the
respective exercise prices at the assumed 5% and 10% rates of appreciation
compounded annually through the applicable expiration dates. Actual gains
realized, if any, on stock option exercises and common stock holdings are
dependent on the future performance of our common stock and overall market
conditions.
2004 Option Exercises and Year-End Option Values
The following table sets forth information with respect to the exercise of
options during 2004 and the unexercised options held by our President as of
December 31, 2004.
Number of Shares
Number of Underlying Value of Unexercised
Shares Unexercised Options at In-the-Money Options at
Acquired December 31, 2004 December 31, 2004
On Value ------------------------------------ ----------------------------
Name Exercise (#) Realized Exercisable(#) Unexercisable(#) Exercisable Unexercisable
- -------------------- ------------- ----------- --------------- ---------------- ------------- -------------
Richard Hennessey - - 450,000 - $ 12,000 -
Compensation of Directors
Pursuant to the terms of a written agreement entered into in 2002 and
amended in 2003, we pay Mr. Larkin an annual retainer of $4,200 and provide him
with coverage under our health benefit plans then in effect for our employees
for his service on our board of directors. No other member of our board of
directors receives additional compensation for serving as a director.
Compensation Committee Interlocks and Insider Participation
Our board of directors does not have a standing compensation committee and
our board as a whole performs all compensation committee functions. During 2004,
no executive officer served on the compensation committee or the board of
directors of another entity whose executive officer served on our board of
directors.
21
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information regarding beneficial ownership
of our common stock as of February 28, 2005 by:
o each person known by us to beneficially own more than 5% of our
outstanding common stock;
o each of our directors, including our President; and
o all of our executive officers and directors as a group.
Beneficial ownership is determined in accordance with the rules of the SEC.
These rules generally attribute beneficial ownership of securities to persons
who possess sole or shared voting power or investment power with respect to
those securities and include shares of common stock issuable upon the exercise
or conversion of options, warrants, convertible preferred stock and convertible
notes that are immediately exercisable or convertible or are exercisable or
convertible within 60 days. Except as otherwise indicated, all of the shares
reflected in the table are shares of common stock and all persons listed below
have sole voting and investment power with respect to the shares beneficially
owned by them, subject to applicable community property laws. The information is
not necessarily indicative of beneficial ownership for any other purpose.
Shares of Common
Stock
Beneficially Percent of
Beneficial Owner Owned Class
------------------------------------------ ------------------ ------------
Executive Officers and Directors:
Keith Larkin 1,550,000 (a) 2.1%
Richard Hennessey 450,000 (b) *
Irene Lebovics - (c) -
Michael J. Parrella - (c) -
Cy E. Hammond - (c) -
All Current Executive Officers and
Directors as a Group (Seven persons) 2,000,000 (d) 2.7%
5% or Greater Stockholders:
NCT Hearing Products, Inc. 62,769,954 (e) 85.5%
Alpha Capital Aktiengesellschaft 16,437,156 (f) 18.3%
* Less than one percent.
__________
(a) Includes 790,000 shares issuable pursuant to options that may be exercised
within 60 days of February 28, 2005. Also includes 240,000 shares of common
stock owned by The Seek Foundation, a corporation organized under Section
501(c)(3) of the Internal Revenue Code, whose directors are Mr. Larkin and
his spouse. Excludes 40,000 shares held by Westek Electronics, a company
controlled by Mr. Larkin's son and 400 shares held by Mr. Larkin's
grandchildren, shares as to which Mr. Larkin disclaims beneficial
ownership.
(b) Consists of 450,000 shares issuable pursuant to options that may be
exercised within 60 days of February 28, 2005.
(c) Ms. Lebovics and Messrs. Parrella and Hammond are executive officers and
directors of NCT Group. NCT Hearing is a wholly owned subsidiary of NCT
Group. Ms. Lebovics and Mr. Parrella are also directors of NCT Hearing. Ms.
Lebovics and Messrs. Parrella and Hammond disclaim beneficial ownership of
the shares of our common stock held by NCT Hearing.
(d) Includes 1,240,000 shares issuable pursuant to options that may be
exercised within 60 days of February 28, 2005 and 240,000 shares held by
The Seek Foundation, as described in footnote (a).
(e) The address of NCT Hearing Products, Inc. is 20 Ketchum Street, Westport,
Connecticut 06880.
(f) Alpha Capital Aktiengesellschaft's business address is Pradafant 7, 9490
Furstentums, Vaduz, Lichtenstein. Konrad Ackermann, Director, has voting
and dispositive control of these shares on behalf of Alpha Capital.
Consists of shares issuable upon conversion of 460 shares of our series B
convertible preferred stock, along
22
with accretion. Pursuant to a contractual restriction between Alpha Capital
and us, Alpha Capital is prohibited from beneficially owning more than
4.99% of our common stock at any given time, subject to certain exceptions.
Equity Compensation Plan Information
The following table summarizes certain information with respect to our
equity compensation plans as of December 31, 2004.
Number of securities
to be issued upon Weighted-average
exercise of exercise price of Number of securities
Plan outstanding options outstanding options remaining available for
Category and rights and rights future issuance
--------------------- ------------------------ ----------------------- --------------------------
Equity compensation
plans approved by
stockholders 1,495,000 $0.158 28,493,000
Equity compensation
plans not approved
by stockholders - - -
------------------------ ----------------------- --------------------------
Total 1,495,000 $0.158 28,493,000
======================== ======================= ==========================
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
NCT Hearing and Affiliates
On March 29, 2004, we issued a $200,000 secured promissory note to NCT
Hearing, bearing interest at the prime rate and due on April 1, 2005, in
exchange for cash advanced to us by NCT Hearing. This note was consolidated into
a new note dated June 30, 2004 (see below).
On March 31, 2004, we issued a $121,387 secured promissory note to NCT
Hearing, bearing interest at the prime rate and due on April 1, 2005, in
exchange for services provided to us by NCT Hearing and its affiliates. This
note was discharged on April 5, 2004 (see below).
On April 5, 2004, NCT Hearing converted an aggregate of $640,466 of our
secured promissory notes into 27,846,351 shares of our common stock. NCT Hearing
converted the full amount outstanding (including accrued interest) of $284,069
under a December 31, 2003 note and of $121,387 under a March 31, 2004 note. In
addition, NCT Hearing converted a partial amount of $234,943 under a June 30,
2003 note.
On April 21, 2004, we obtained an expansion of our existing, exclusive
worldwide technology license from NCT Hearing in exchange for 9,821,429 shares
of our common stock. The expanded license covers over 50 patents, patents
pending and innovations relating to active noise reduction and noise and echo
cancellation, and encompasses all styles of headsets, including headphones,
earmuffs, earbuds and earplugs, as well as all markets, including consumer
audio, industrial safety, spectator racing, two-way radio communications and
aviation. In addition, the expanded license permits us to use NCT Hearing's
existing brand names, including NoiseBuster active noise reduction lightweight
consumer audio and communications headsets, ProActive active noise reduction
industrial safety earmuffs and two-way radio headsets and ClearSpeech noise and
echo cancellation algorithm-based products.
On June 30, 2004, we issued a $1,672,666 secured promissory note to NCT
Hearing, bearing interest at the prime rate and due on April 1, 2006, in
exchange for services of $183,423 provided to us by NCT Hearing and its
affiliates and the consolidation of $1,489,243 outstanding (including accrued
interest) on our notes dated June 30, 2003 and March 29, 2004.
On September 17, 2004, we issued a $35,000 secured promissory note to NCT
Hearing, bearing interest at the prime rate and due on April 1, 2006, in
exchange for cash advanced to us by NCT Hearing.
On September 30, 2004, we issued a $218,617 secured promissory note to NCT
Hearing, bearing interest at the prime rate and due on October 1, 2006, in
exchange for services provided to us by NCT Hearing and its affiliates during
the three months ended September 30, 2004.
23
On December 31, 2004, we issued a $238,758 secured promissory note to NCT
Hearing, bearing interest at the prime rate and due on October 1, 2006, in
exchange for services provided to us by NCT Hearing and its affiliates during
the three months ended December 31, 2004.
During the year ended December 31, 2004, NCT Hearing advanced cash to us in
anticipation of the receipt of funds from outstanding accounts receivable. These
advances are non-interest bearing and are payable within 35 days. As of December
31, 2004, outstanding cash advances to us from NCT Hearing under this
arrangement were $57,847. NCT Hearing is not obligated to provide any additional
cash advances to us.
As of December 31, 2004, we owed an aggregate of $2,265,102, to NCT Hearing
for cash advances, research, administrative and accounting services provided to
us. As of December 31, 2004, $2,207,255 is included in noncurrent notes payable
bearing interest at the prime rate (5.25% at December 31, 2004) and the
remaining $57,847 is included in due to factor and other liabilities on our
balance sheet.
Other Related Party Transactions
On April 1, 2004, we assigned the rights to all outstanding amounts
receivable, or $66,775, due under a promissory note from Keith Larkin, a member
of our board of directors, to Westek Electronics, Inc. who holds a promissory
note issued by us. In consideration for this assignment, the stockholder applied
$66,775 against our June 27, 2003 note payable to the stockholder. We
subsequently renegotiated the terms of this note, which was due on June 27,
2004. The new $62,009 note, dated June 27, 2004, represents principal of $61,621
plus accrued interest of $388 from the matured note. The new note bears interest
at 8.5% and is payable in installments of $3,500 due on the last day of each
month starting on June 30, 2004 through May 31, 2005, with the remaining balance
due on June 27, 2005.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit and Non-Audit Fees
The following table sets forth the aggregate fees billed or accrued by us
for the audit and other services provided by Eisner LLP for the years ended
December 31, 2003 and 2004.
Year Ended December 31,
------------------------------
2003 2004
-------------- -------------
Audit Fees (a) $ 52,500 $ 65,000
Audit-Related Fees - -
Tax Fees (b) 3,250 3,250
All Other Fees - -
-------------- -------------
Total $ 55,750 $ 68,250
============== =============
__________
(a) Represents fees billed and accrued for professional services rendered in
connection with the annual audit and quarterly review of our financial
statements included in our annual reports on Form 10-K and quarterly
reports on Form 10-Q.
(b) Represents fees billed for professional services rendered in conjunction
with federal and state tax return preparation and other tax matters.
24
Board Policy on Pre-Approval of Audit and Permissible Non-Audit Services of
Independent Registered Public Accountants
Our board of directors has pre-approved all audit services and permitted
non-audit services provided by the independent registered public accountants and
the compensation, fees and terms for these services. The board has also
determined not to adopt any blanket pre-approval policy but instead to require
that the board pre-approve the compensation and terms of service for audit
services provided by the independent registered public accountants and any
changes in terms and compensation resulting from changes in audit scope, company
structure or other matters. The board has also determined to require
pre-approval by the board of the compensation and terms of service for any
permitted non-audit services provided by the independent registered public
accountants. Any proposed non-audit services in excess of pre-approved levels
require further pre-approval by the board. Our Chief Financial Officer reports
regularly to the board on the services performed and fees incurred by the
independent registered public accountants for audit and permitted non-audit
services during the prior quarter.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following financial statements are filed as part of this Annual Report:
Page
-----
Report of Independent Registered Public Accounting Firm F-1
Balance Sheets as of December 31, 2003 and December 31, 2004 F-2
Statements of Operations for the years ended December 31, 2002, 2003 and 2004 F-3
Statements of Stockholders' Equity for the years ended December 31, 2002, 2003 and 2004 F-4
Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004 F-5
Notes to the Financial Statements F-6
(a)(2) Financial Statement Schedules
The following financial statement schedule is filed as part of this Annual
Report:
Page
-----
Report of Independent Registered Public Accounting Firm on Schedule II F-22
Schedule II. Valuation and Qualifying Accounts F-23
All other financial statement schedules are omitted because they are not
required or the required information is shown in the financial statements or
notes thereto.
(a)(3) Exhibits
The following exhibits are filed herewith or are incorporated by reference to
exhibits previously filed with the SEC.
Exhibit
Number Description of Exhibit
3.1(a) Amended and Restated Articles of Incorporation of Pro Tech
Communications, Inc., dated as of August 14, 2000 (incorporated
by reference to Exhibit 3(a) of the registrant's Quarterly Report
on Form 10-QSB for the quarter ended July 31, 2000 (File No.
0-28602)).
3.1(b) Articles of Amendment to Articles of Incorporation of Pro Tech
Communications, Inc., dated as of September 29, 2000
(incorporated by reference to Exhibit 3(b) of the registrant's
Registration Statement on Form S-1 (Registration No. 333-49318)
filed on November 3, 2000).
25
3.1(c) Articles of Amendment to Articles of Incorporation of Pro Tech
Communications, Inc., dated as of July 30, 2001 (incorporated by
reference to Exhibit 3(a) of the registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2001 (File No. 0-28602)).
3.1(d) Articles of Amendment to Articles of Incorporation of Pro Tech
Communications, Inc., dated as of August 2, 2002 (incorporated by
reference to Exhibit 3(a) of the registrant's Annual Report on
Form 10-K for the year ended December 31,2003 (File No. 0-28602)).
3.2 Bylaws of Pro Tech Communications, Inc. (incorporated by reference
to Exhibit 3(c) of the registrant's Registration Statement on Form
S-1 (Registration No. 333-49318) filed on November 3, 2000).
*10.1 Pro Tech Communications, Inc. Amended and Restated Stock Option
Plan (incorporated by reference to Exhibit 4(c) of the
registrant's Registration Statement on Form S-8 (Registration No.
333-49488) filed on November 7, 2000).
10.2(a) License Agreement, dated as of September 12, 2000, by and between
Pro Tech Communications, Inc. and NCT Hearing Products, Inc.
10.2(b) Amendment to License Agreement, dated as of April 21, 2004, by and
between Pro Tech Communications, Inc. and NCT Hearing Products,
Inc.
14 Pro Tech Communications, Inc. Code of Ethics for the CEO and
Senior Financial Officers (incorporated herein by reference to
Exhibit 14 to the registrant's Annual Report on Form 10-K for
the year ended December 31, 2003 (File No. 0-28602)).
23.1 Consent of Eisner LLP.
31.1 Certification of President pursuant to Rule 13a-14(a) under the
Securities Act of 1934.
31.2 Certification of Chief Financial Officer pursuant Rule 13a-14(a)
under the Securities Act of 1934.
32.1 Certification of President and Chief Financial Officer pursuant to
Rule 13a-14(b) under the Securities Act of 1934 and 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
_______________________
* Pertains to a management contract or compensation plan or arrangement.
26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pro Tech Communications, Inc.
We have audited the accompanying balance sheets of Pro Tech Communications, Inc.
as of December 31, 2003 and 2004 and the related statements of operations,
stockholders' equity and cash flows for each of the years ended December 31,
2002, 2003 and 2004. 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 standards of the Public Company
Accounting Oversight Board (United States). 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 enumerated above present fairly, in all
material respects, the financial position of Pro Tech Communications, Inc. as of
December 31, 2003 and 2004 and the results of its operations and its cash flows
for each of the years ended December 31, 2002, 2003 and 2004 in conformity with
accounting principles generally accepted in the United States of America.
/s/ Eisner LLP
- ---------------
Eisner LLP
New York, New York
January 28, 2005
With respect to Note 1(a)
March 22, 2005
F-1
PRO TECH COMMUNICATIONS, INC.
BALANCE SHEETS
December 31,
----------------------------------
2003 2004
---------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 21,193 $ 59,097
Accounts receivable, less allowance for doubtful accounts
of $31,437 and $28,277, respectively 88,769 137,396
Inventories, net of reserves (Note 2) 493,555 343,847
Due from officer/stockholder (Note 16) 66,044 -
Other current assets (Note 3) 17,571 35,886
---------------- --------------
Total current assets 687,132 576,226
Property and equipment, net (Note 4) 449,672 306,398
Intangible assets, net of accumulated amortization of $180,721
and $375,331, respectively (Note 5) 2,530,094 2,610,484
Other assets 6,138 5,939
---------------- --------------
$ 3,673,036 $ 3,499,047
================ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 231,282 $ 158,698
Accrued expenses (Note 6) 195,201 229,145
Current portion of capital lease obligations (Note 13) 10,434 11,492
Due to factor and other liabilities (Notes 7 and 16) 11,117 61,864
Note payable (Note 8) 2,385 2,646
Note payable to stockholder (Notes 8 and 16) 142,001 39,728
Preferred stock, series A and B, subject to mandatory conversion into
a variable number of shares of common stock (Note 9) 742,459 709,041
---------------- --------------
Total current liabilities 1,334,879 1,212,614
Noncurrent note payable (Note 8) 4,076 1,430
Noncurrent notes payable due to affiliates (Notes 10 and 16) 1,824,540 2,207,255
Capital lease obligations (Note 13) 21,333 9,841
---------------- --------------
Total liabilities 3,184,828 3,431,140
---------------- --------------
Commitments (Note 13)
Stockholders' equity (Notes 11 and 12):
Preferred stock, $.01 par value, 1,000,000 shares authorized
Series A convertible preferred, 4% cumulative dividend,
stated value $1,000 per share, issued and outstanding, 50 shares (Note 9)
Series B convertible preferred, 4% cumulative dividend,
stated value $1,000 per share, issued and outstanding,
500 and 460 shares, respectively (Note 9) - -
Common stock, $.001 par value, authorized 300,000,000 shares,
issued and outstanding 33,200,311 and 73,390,133 shares, respectively 33,200 73,390
Additional paid-in capital 18,427,668 19,357,332
Accumulated deficit (17,972,660) (19,362,815)
---------------- --------------
Total stockholders' equity 488,208 67,907
---------------- --------------
$ 3,673,036 $ 3,499,047
================ ==============
The accompanying notes are an integral part of the financial statements.
F-2
PRO TECH COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
For the Year Ended December 31,
----------------------------------------------
2002 2003 2004
-------------- ------------- -------------
Net sales $ 1,648,949 $ 1,178,535 $ 1,194,756
Cost of goods sold 774,316 364,413 518,340
-------------- ------------- -------------
Gross profit 874,633 814,122 676,416
Selling, general and administrative expenses 1,296,088 1,042,085 1,045,870
Depreciation and amortization 1,093,778 338,071 341,650
NCT Hearing and affiliates charges (Note 16) 313,559 314,207 559,470
Impairment charge on intangible assets 11,500,000 - -
Provision for doubtful accounts 29,800 6,591 14,621
-------------- ------------- -------------
Loss before other income (expense) (13,358,592) (886,832) (1,285,195)
Other income (expense):
Interest income 3,109 2,931 734
Interest expense (33,297) (26,353) (18,586)
Interest expense - NCT Hearing (Note 14) (21,102) (56,455) (76,535)
Interest expense - convertible preferred stock (Note 9) - (11,089) (20,969)
Miscellaneous income, net 5,004 3,352 10,396
-------------- ------------- -------------
Net loss (13,404,878) (974,446) (1,390,155)
Adjustments attributable to preferred stock (Note 9):
Preferred stock beneficial conversion feature 45,810 - -
Preferred stock dividend 22,000 10,911 -
-------------- ------------- -------------
Net loss attributable to common stockholders $(13,472,688) $ (985,357) $ (1,390,155)
============== ============= =============
Basic and diluted loss per share $ (0.41) $ (0.03) $ (0.02)