SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC 20549


                                 FORM 10-K/A

AMENDMENT NO. 2 TO ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED                 DECEMBER 31, 1997

Commission File Number:                   0-18267

Noise Cancellation Technologies, Inc.
(Exact name of registrant as specified in its charter)

Delaware                                  59-2501025
(State or other jurisdiction of           (IRS Employer
incorporation organization)               Identification No.)

1025 West Nursery Road, Linthicum, MD           21090
(Address of principal executive office)         (Zip Code)

(410) 636-8700
(Registrant's telephone number, including area code)

<PAGE>



                                      PART II

ITEM 6.  SELECTED FINANCIAL DATA

   The selected consolidated financial data set forth below are derived from the
historical  financial  statements  of the  Company.  The data set forth below is
qualified  in its  entirety  by and  should  be read  in  conjunction  with  the
Company's "Consolidated  Financial Statements" and "Management's  Discussion and
Analysis of Financial  Condition  and Results of  Operations"  that are included
elsewhere herein.
<TABLE>
<CAPTION>

                                  (In Thousands of Dollars and Shares)
                                        Years Ended December 31,
                          ------------------------------------------------------
                             1993           1994       1995      1996       1997
                          ------------------------------------------------------
STATEMENTS OF OPERATIONS
DATA:
REVENUES
<S>                           <C>           <C>        <C>       <C>        <C>
 Product Sales                $1,728        $2,337     $1,589    $1,379     $1,720
 Engineering and               3,598         4,335      2,297       547        368
development services
 Technology licensing         
fees and other                    60           452      6,580     1,238      3,630
                              ------        ------     ------    ------     ------
      Total revenues          $5,386        $7,124    $10,466    $3,164     $5,718
                              ------        ------    -------    ------     ------
COSTS AND EXPENSES:
 Cost of sales                $1,309        $4,073     $1,579    $1,586     $2,271
 Cost of engineering and       2,803         4,193      2,340       250        316
development services
 Selling, general and          7,231         9,281      5,416     4,890      5,217
administrative
 Research and development      7,963         9,522      4,776     6,974      6,235
 Interest (income)
expense, net                    (311)         (580)       (49)       17      1,397 (4)
 Equity in net (income) 
loss of unconsolidated
affiliates                     3,582(1)      1,824        (80)       80          -
 Other expense, net                -           718        552       192        130
                             -------       -------    -------   -------    -------
      Total costs and 
      expenses               $22,577       $29,031    $14,534   $13,989    $15,566
                             -------       -------    -------   -------    -------
 Net loss                   $(17,191)(1)  $(21,907)   $(4,068) $(10,825)   $(9,848)

 Preferred stock                   -             -          -         -      1,623
dividend requirement
 Accretion of difference
between carrying
amount and redemption
amount of
redeemable preferred
stock                              -             -          -         -        285
                           --------       --------    -------  --------   --------
 Net (loss) attributable
to common stockholders     $(17,191)(1)  $(21,907)    $(4,068) $(10,825)  $(11,756)
                           ========      ========     =======  ========   ========
 Weighted average number
of common shares
outstanding(2)--basic
and diluted                  70,416        82,906      87,921   101,191    124,101
                           ========       ========    =======  ========   ========

 Basic and Diluted Net
loss per share             $  (0.24)(1)  $  (0.26)    $ (0.05) $  (0.11)  $  (0.09)
                           ========       ========    =======  ========   ========



                                              December 31,
                          ------------------------------------------------------
                             1993       1994       1995      1996       1997
                          ------------------------------------------------------
BALANCE SHEET DATA:
 Total assets                $29,541    $12,371     $9,583    $5,881    $17,361

 Total liabilities             6,301      6,903      2,699     3,271      2,984
 Long-term debt                  ---        ---        105        --         --
 Accumulated deficit         (46,873)   (68,780)   (72,848)  (83,673)   (93,520)
 Stockholders' equity(3)      23,239      5,468      6,884     2,610     14,377
 Working capital              19,990        923      1,734    (1,312)    11,696
(deficiency)
</TABLE>
<PAGE>

(1)In  connection  with  the  sale of  Common  Stock to  Tenneco  Automotive  in
   December  1993,  the Company  recognized  its share of cumulative  losses not
   previously  recorded with respect to its joint venture with Walker  amounting
   to approximately $3.6 million.

(2)Does not include  shares  issuable  upon the  exercise of  outstanding  stock
   options,  warrants and convertible  Preferred Stock, since their effect would
   be antidilutive.

(3) The Company has never declared nor paid cash dividends on its Common Stock.

(4)Includes  interest  expenses of  approximately  $1.4 million  relating to the
   beneficial conversion feature on convertible debt issued in 1997.


ITEM 8.     FINANCIAL STATEMENTS                                               
                                                                               
     The Reports of the Independent Auditors Richard A. Eisner & Company, L.L.P.
and the financial statements and accompanying notes are attached.              
                                                                               
                                                              Page             
                                                                               
Independent Auditors Report                                   F-1              
                                                                               
Consolidated Balance Sheets, as of December 31, 1996, and     F-2              
1997                                                                           
                                                                               
Consolidated Statements of Operations, for the years ended    F-3              
December 31, 1995, 1996 and 1997                                               
                                                                               
Consolidated Statements of Stockholders' Equity, for the      F-4              
years ended December 31, 1995, 1996 and 1997                                   
                                                                               
Consolidated Statements of Cash Flows, for the years ended                     
December  31, 1995, 1996 and 1997                             F-5              
                                                                               
Notes to the Consolidated Financial Statements                F-6              
                                                                               

<PAGE>

F-1

            (Richard A. Eisner & Company, L.L.P. Letterhead)
                     REPORT OF INDEPENDENT AUDITORS

Board of Directors and Stockholders of
  Noise Cancellation Technologies, Inc.

      We have  audited the  accompanying  consolidated  balance  sheets of Noise
Cancellation  Technologies,  Inc. and  subsidiaries  as at December 31, 1996 and
December  31,  1997,  and the related  consolidated  statements  of  operations,
stockholders'  equity  and cash  flows for each of the  years in the  three-year
period  ended   December  31,  1997.   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 did not audit the
1995,  1996  and  1997  financial   statements  of  the  Company's  two  foreign
subsidiaries.   These  subsidiaries  accounted  for  revenues  of  approximately
$1,200,000, $407,000 and $67,000 for the years ended December 31, 1995, 1996 and
1997, respectively,  and assets of approximately $586,000, $515,000 and $301,000
at December 31, 1995, 1996 and 1997, respectively. These statements were audited
by  other  auditors  whose  reports  have  been  furnished  to us,  one of which
contained a reference to its  dependence on the parent for  continued  financial
support.  Our opinion,  insofar as it relates to the amounts  included for these
entities, is based solely on the reports of the other auditors.

      We conducted our audits in accordance  with  generally  accepted  auditing
standards.  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  and the  reports  of  other  auditors  provide  a
reasonable basis for our opinion.

      In our opinion, based on our audits and the reports of the other auditors,
the  financial  statements  enumerated  above  present  fairly,  in all material
respects,   the   consolidated   financial   position   of  Noise   Cancellation
Technologies,  Inc.  and  subsidiaries  as at December 31, 1996 and 1997 and the
consolidated  results of their operations and their  consolidated cash flows for
each of the years in the three-year period ended December 31, 1997 in conformity
with generally accepted accounting principles.

      The  accompanying  consolidated  financial  statements  have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the  financial  statements,  the  Company  has not  been  able to  generate
sufficient  cash flow from  operating  activities to sustain its  operations and
since it has incurred net losses since  inception,  it has been and continues to
be dependent on equity  financing,  joint  venture  arrangements  to support its
business  efforts.  These factors raise  substantial  doubt about its ability to
continue as a going concern.  Management's  plans in regard to these matters are
also  described  in  Note  1.  The  financial  statements  do  not  include  any
adjustments that might result from the outcome of this uncertainty.

/s/ RICHARD A. EISNER & COMPANY, L.L.P.
New York, New York
February 27, 1998
<PAGE>


NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
F-2                                                      (in thousands of
                                                             dollars)
                                                           December 31,
                                                        --------------------
                                                          1996       1997
                                                        ---------- ---------
                        ASSETS
Current assets:
     Cash and cash equivalents                          $     368  $ 12,604
     Accounts receivable:
         Trade:
                Technology license fees and royalties         150       200
                Joint Ventures and affiliates                   2         -
                Other                                         392       368
         Unbilled                                              63         -
         Allowance for doubtful accounts                     (123)      (38)
                                                        ---------- ---------
                     Total accounts receivable          $     484  $    530

     Inventories, net of reserves                             900     1,333
     Other current assets                                     207       213
                                                        ---------- ---------
                     Total current assets               $   1,959  $ 14,680

Property and equipment, net                                 2,053     1,144
Patent rights and other intangibles, net                    1,823     1,488
Other assets                                                   46        49
                                                        ---------  ---------
                                                        $   5,881  $ 17,361
                                                        ========== =========
         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
     Accounts payable                                   $   1,465  $  1,324
     Accrued expenses                                       1,187     1,392
     Accrued payroll, taxes and related expenses              618       181
     Customers' advances                                        1        87
                                                        ---------- ---------
                     Total current liabilities          $   3,271  $  2,984
                                                        ---------- ---------

Commitments and contingencies

                 STOCKHOLDERS' EQUITY
Preferred stock, $.10 par value, 10,000,000 shares
authorized,
    13,250 Series C issued (redemption amount
    $13,314,399)                                        $       -  $ 10,458
Common stock, $.01 par value, 140,000,000 and
185,000,000 shares,
   respectively, authorized; issued and outstanding
111,614,405 and
   133,160,212 shares, respectively                         1,116     1,332
Additional paid-in-capital                                 85,025    96,379
Accumulated deficit                                       (83,673)  (93,521)
Cumulative translation adjustment                             142       119
Common stock subscriptions receivable                           -      (390)
                                                        ---------- ---------
                     Total stockholders' equity         $   2,610  $ 14,377
                                                        ---------- ---------
                                                        $   5,881  $ 17,361
                                                        ========== =========

See notes to consolidated financial statements.  


<PAGE>

<TABLE> 
<CAPTION>
NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES                                               
CONSOLIDATED STATEMENTS OF OPERATIONS                                                                
F-3                                                                                           
                                                     (in thousands, except per                       
                                                           share amounts)                            
                                                       Years ended December 31,                      
                                                    --------------------------------                 
                                                      1995       1996       1997                     
                                                    ---------- ---------- ----------                 
<S>                                                 <C>        <C>         <C>                       
REVENUES:                                                                                            
    Technology licensing fees                        $  6,580  $    1,238  $  3,630                  
    Product sales, net                                  1,589       1,379     1,720                  
    Engineering and development services                2,297         547       368                  
                                                    ---------- ---------- ----------                 
           Total revenues                            $ 10,466  $    3,164  $  5,718                  
                                                    ---------- ---------- ----------                 
                                                                                                     
COSTS AND EXPENSES:                                                                                  
    Costs of sales                                   $  1,579  $    1,586  $  2,271                  
    Costs of engineering and development services       2,340         250       316                  
    Selling, general and administrative                 5,416       4,890     5,217                  
    Research and development                            4,776       6,974     6,235                  
                                                                                                     
    Equity in net loss (income) of unconsolidated                                                    
       affiliates                                         (80)        80          -                  
    Provision for doubtful accounts                       552        192        130                  
    Interest expense (includes $1,420 of discounts                                                   
       on beneficial conversion feature on                                                    
       convertible debt in 1997)                            4         45      1,514                  
    Interest income                                       (53)       (28)      (117)                 
                                                    ---------- ---------- ----------                 
         Total costs and expenses                    $ 14,534   $ 13,989   $ 15,566                  
                                                    ---------- ---------- ----------                 
NET (LOSS)                                           $ (4,068)  $(10,825)  $ (9,848)                 
                                                                                                     
    Preferred stock beneficial conversion feature           -          -      1,623                  
    Accretion of difference between carrying                                                         
       amount and redemption amount of redeemable                                                    
       preferred stock                                      -          -        285                  
                                                    ---------- ---------- ----------                 
NET (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS      $  (4,068) $ (10,825) $ (11,756)                 
                                                    ========== ========== ==========                 
                                                                                                     
Weighted average number of common                                                                    
    shares outstanding - basic and diluted                                                           
                                                       87,921    101,191    124,101                  
                                                    ========== ========== ==========                 
                                                                                                     
BASIC AND DILUTED NET LOSS PER COMMON SHARE          $  (0.05) $   (0.11) $   (0.09)                 
                                                    ========== ========== ==========                 
</TABLE>  

See notes to consolidated financial statements.

<PAGE>

<TABLE> 
<CAPTION>
                                                        
NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES                                                                 
Consolidated Statements of Stockholders' Equity
(In thousands of dollars and shares)                                         
F-4                                                             
                                                                                     Cumul-              Expenses       
                                Series C                                             ative    Stock      to be        
                              Convertible                                            Trans-   Subscrip-  Paid                 
                            Preferred Stock      Common Stock   Additional  Accumu-  lation   tion       With          
                           -----------------   ----------------   Paid-In   lated    Adjust-  Receiv-    Common          
                            Shares    Amount   Shares    Amount   Capital   Deficit  ment     able       Stock     Total      
                           -------    ------   ------    ------ ----------  -------  -------  ---------  --------  -----        
                                                                                                                                 
<S>                        <C>      <C>      <C>      <C>      <C>       <C>       <C>      <C>        <C>       <C>          
Balance at December 31, 1994   -    $   -      86,089   $  861   $ 75,177  $(68,780) $   152  $  (1,196) $ (746)   $ 5,468   
                                                                                                                                  
Sale of common stock,                                                                                                            
 less expenses of $271         -        -       6,800       68      3,921         -        -          -       -      3,989       
Consulting expense                                                                                                               
 attributable to warrants      -        -           -        -          8         -        -          -       -          8       
Shares issued upon                                                                                                               
 exercise of warrants &                                                                                                          
 options                       -        -       1,050       10        692         -        -        (13)      -        689       
Receipt of services in                                                                                                           
 payment of stock                                                                                                                
 subscription                  -        -           -        -          -         -        -      1,196       -      1,196       
Settlement of obligations      -        -           -        -       (344)        -        -          -     746        402       
Net loss                       -        -           -        -          -    (4,068)       -          -       -     (4,068)      
Translation adjustment         -        -           -        -          -         -        (2)        -       -         (2)      
Retirement of shares                                                                                                             
 attributable to license                                                                                                         
 revenue (Note 3)              -        -      (1,110)     (11)      (787)        -         -         -       -       (798)      
                           -----  -------     -------  --------  --------- --------- --------  --------- -------  ---------      
Balance at December 31, 1995   -  $     -      92,829  $   928   $ 78,667  $(72,848) $    150  $    (13) $    -   $  6,884       
                                                                                                                                 
Sale of common stock,                                                                                                            
 less expenses of $245         -        -      18,595      186      6,178         -         -        13       -      6,377       
Shares issued upon exercise                                                                                                      
 of warrants & options         -        -         204        2        102         -         -         -       -        104       
Net loss                       -        -           -        -          -   (10,825)        -         -       -    (10,825)      
Translation adjustment         -        -           -        -          -         -        (8)        -       -         (8)      
Restricted shares issued                                                                                                         
 for Directors' compensation   -        -          20        -         13         -         -         -       -         13       
Consulting expense                                                                                                               
 attributable to options       -        -           -        -         96         -         -         -       -         96       
Retirement of shares related                                                                                                     
 to patent acquisition         -        -         (25)       -        (26)        -         -         -       -        (26)      
Retirement of shares in                                                                                                          
 settlement of employee                                                                                                          
 receivable                    -        -          (8)       -         (5)        -         -         -       -         (5)      
                           -----  -------    --------  --------  --------- --------- ---------  -------- -------  ---------      
Balance at December 31, 1996   - $      -     111,615  $ 1,116   $ 85,025  $(83,673) $    142         -       -    $ 2,610       
                                                                                                                                 
Sale of common stock           -        -       2,857       29        471         -         -         -       -        500       
Shares issued upon exercise                                                                                                      
 of warrants and options       -        -       1,996       20      1,115         -         -       (64)      -      1,071       
Sale of Series C preferred                                                                                                       
 stock less expenses                                                                                                             
 of $551                      13   11,863           -        -          -         -         -         -       -     11,863       
Discount on beneficial                                                                                                           
 conversion price to                                                                                                             
 preferred shareholders        -   (3,313)          -        -      3,313         -         -         -       -          -       
Amortization of discount                                                                                                         
 on beneficial conversion                                                                                                        
 price to preferred                                                                                                              
 shareholders                  -    1,908           -        -     (1,908)        -         -         -       -          -       
Sale of subsidiary  common                                                                                                       
 stock,  less  expenses                                                                                                          
 of $65                        -        -           -        -      3,573         -         -      (326)      -      3,247       
Common stock issued upon                                                                                                         
 conversion of convertible                                                                                                       
 debt, less expense of $168    -        -      16,683      167      4,714         -         -         -       -      4,881     
Net loss                       -        -           -        -          -    (9,848)        -         -       -     (9,848)      
Translation adjustment         -        -           -        -          -         -       (23)        -       -        (23)      
Restricted shares issued                                                                                                         
 for Directors' compensation   -        -          10        -          2         -         -         -       -          2       
Warrant issued in                                                                                                                
 conjunction with                                                                                                                
 convertible debt              -        -           -        -         34         -         -         -       -         34       
Compensatory stock                                                                                                               
 options and warrants          -        -           -        -         40         -         -         -       -         40       
                           ----- --------   ---------  --------   ------- ---------    -------  -------  -------- ---------   
Balance at 
December 31, 1997             13 $ 10,458     133,161 $  1,332    $96,379  $(93,521)   $  119     $(390)   $  -   $ 14,377       
                           ===== ========   ========= =========   ======= =========    =======  =======  ======== =========      
                                                                                                                                 
See notes to consolidated financial statements.                                          
</TABLE>                                                       


<TABLE>
<CAPTION>
NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES                                                    
CONSOLIDATED STATEMENTS OF CASH FLOWS                                                                     
F-5                                                                                                 
                                                                   (in thousands of dollars)              
                                                                    Years Ended December 31,              
                                                                1995            1996        1997          
                                                              ---------      ----------   --------        
<S>                                                            <C>            <C>          <C>            
Cash flows from operating activities:                                                                     
    Net loss                                                   $(4,068)       $(10,825)   $(9,848)        
    Adjustments   to  reconcile  net  loss  to                                                            
    net  cash  (used  in)  operating activities:                                                          
      Depreciation and amortization                              1,127           1,000        899         
      Common stock and warrants issued as consideration for:                                              
         Compensation                                                8             109         42         
         Rent and marketing expenses                               355               -          -         
         Interest on debentures                                      -               -         51         
         Convertible debt                                            -               -         34         
      Debt cost incurred related to convertible debt                 -               -        211
      Common stock retired in settlement of employee                                                      
       account receivable                                            -              (5)         -         
      Receipt of license fee in exchange for inventory                                                    
       and release of obligation                                (3,266)              -          -         
      Discount on beneficial conversion price to                                                          
       convertible debt                                              -               -      1,420         
      Provision for tooling costs and write off                     94             371        515         
      Provision for doubtful accounts                              552             192        130         
      Equity in net (income) loss of unconsolidated                                                      
       affiliates                                                  (80)             80          -         
      Unrealized foreign currency (gain) loss                       32             (45)         8         
      (Gain) Loss on disposition of fixed assets                   107              83         (4)         
      Changes in operating assets and liabilities:                                                        
         (Increase) decrease in accounts receivable                302              61       (127)        
         (Increase) in license fees receivable                       -            (150)       (50)        
         (Increase) decrease in inventories                        212             813       (433)        
         (Increase) decrease in other assets                       299              67        (12)        
         Increase (decrease) in accounts payable and                                                      
          accrued expenses                                        (190)             55        135         
         Increase (decrease) in other liabilities                 (482)            436       (414)        
                                                               ---------       --------   --------        
      Net cash (used in) operating activities                  $(4,998)        $(7,758)   $(7,443)        
                                                               ---------       --------   --------        
Cash flows from investing activities:                                                                     
    Capital expenditures                                       $   (80)        $  (186)   $  (244)        
    Acquisition of patent rights                                  (210)              -          -         
    Sales of short term investments                                 18               -          -   
    Sale of capital expenditures                                     -               -         67      
                                                               ---------       --------   --------        
      Net cash (used in) investing activities                  $  (272)        $  (186)   $  (177)        
                                                               ---------       --------   --------        
Cash flows from financing activities:                                                                     
    Proceeds from:                                                                                        
      Convertible debt (net)                                   $     -         $     -    $ 3,199        
      Sale of common stock (net)                                 3,989           6,377        500        
      Sale of preferred stock (net)                                  -               -     11,863        
      Sale of subsidiary stock (net)                                 -               -      3,247        
      Exercise of stock purchase warrants and options              689             104      1,071        
                                                              ---------        --------   --------       
                                                                                                            
      Net cash provided by financing activities                $ 4,678         $ 6,481    $19,880        
                                                              ---------        --------   -------- 
       
Effect of exchange rate changes on cash                        $     -         $     -    $   (24)        
                                                              --------         -------    --------                     
Net increase (decrease) in cash and cash equivalents           $  (592)        $(1,463)   $12,236        
Cash and cash equivalents - beginning of period                  2,423           1,831        368        
                                                              --------         --------   --------       
Cash and cash equivalents - end of period                      $ 1,831         $   368    $12,604        
                                                              ========         ========   ========       
                                                                                                          
Cash paid for interest                                         $     4         $     4    $     8        
                                                              ========         ========   ========       
</TABLE>
                                                                                
See Notes  6 and 11 with  respect  to  settlement  of  certain  obligation  by
issuance of  securities.                                            
                                                                                
See notes to consolidated financial statements.  
                                                                                
<PAGE>

F-6


                                   NOISE CANCELLATION TECHNOLOGIES, INC.
                                     NOTES TO THE FINANCIAL STATEMENTS

1.  Background:

   Noise  Cancellation  Technologies,  Inc.  ("NCT" or the  "Company")  designs,
develops,  licenses, produces and distributes electronic systems for Active Wave
Management including systems that electronically reduce noise and vibration. The
Company's  systems are  designed for  integration  into a wide range of products
serving major markets in the transportation, manufacturing, commercial, consumer
products  and  communications  industries.  The  Company  has  begun  commercial
application  of its  technology  through  a number  of  product  lines,  with 70
products currently being sold, including NoiseBuster(R)  communications headsets
and NoiseBuster  Extreme!(TM) consumer headsets,  Gekko(TM) flat speakers,  flat
panel transducers ("FPT(TM)"), ClearSpeech(TM),  microphones, speakers and other
products,   adaptive  speech  filters  ("ASF"),   the   ProActive(TM)   line  of
industrial/commercial  active  noise  reduction  ("ANR")  headsets,  an aviation
headset for  pilots,  an  industrial  muffler or  "silencer"  for use with large
vacuums and blowers,  quieting  headsets  for patient use in magnetic  resonance
imaging ("MRI") machines, and an aircraft cabin quieting system.

   The  technology  supporting  the Company's  electronic  systems was developed
using technology  maintained under various patents (the "Chaplin  Patents") held
by  Chaplin-Patents  Holding Co.,  Inc.  ("CPH") as well as patented  technology
acquired or developed by the Company.  CPH, formerly a joint venture with Active
Noise Vibration  Technologies,  Inc.  ("ANVT"),  was established to maintain and
defend these patent rights.  The former joint venture agreement  relating to the
Chaplin  Patents  required  that the Company  only  license or share the related
technology  with entities who are  affiliates of the Company.  As a result,  the
Company  established various joint ventures and formed other strategic alliances
(see Note 3) to further  develop  the  technology  and  electronic  systems  and
components  based on the  Chaplin  Patents,  to  develop  such  technology  into
commercial  applications,  to integrate  the  electronic  systems into  existing
products and to distribute  such systems and products  into various  industrial,
commercial and consumer markets.

   The  Company  has  incurred  substantial  losses  from  operations  since its
inception,  which  have  been  recurring  and  amounted  to $93.5  million  on a
cumulative  basis  through  December  31, 1997 and has working  capital of $11.7
million  at  December  31,  1997.  These  losses,  which  include  the costs for
development of products for commercial use, have been funded  primarily from the
sale of common stock and preferred stock,  including the exercise of warrants or
options  to  purchase  common  stock,  and  by  technology  licensing  fees  and
engineering  and  development  funds  received  from  joint  venture  and  other
strategic  partners.  As discussed in Note 3,  agreements with joint venture and
other strategic  partners  generally  require that a portion of the initial cash
flows,  if  any,  generated  by the  ventures  or the  alliances  be  paid  on a
preferential basis to the Company's  co-venturers until the technology licensing
fees and  engineering  and  development  funds  provided  to the  venture or the
Company are recovered.

   Cash and cash  equivalents  amounted to $12.6  million at December  31, 1997.
Management  believes  that  currently  available  funds may not be sufficient to
sustain the Company for the next 12 months. Such funds consist of available cash
and cash from the  exercise of warrants and  options,  the funding  derived from
technology   licensing  fees,   royalties  and  product  sales  and  engineering
development  revenue.  Reducing operating expenses and capital expenditure alone
may not be sufficient and  continuation as a going concern is dependent upon the
level of realization of funding from technology licensing fees and royalties and
product  sales  and  engineering  and  development  revenue,  all of  which  are
presently uncertain.  In the event that technology licensing fees, royalties and
product  sales,  and  engineering  and  development  revenue are not realized as
planned,  then management  believes additional working capital financing must be
obtained.
There is no assurance any such financing is or would become available.

   There  can be no  assurance  that  additional  funding  will be  provided  by
technology  license  fees,  royalties  and  product  sales and  engineering  and
development  revenue. In that event, the Company would have to substantially cut
back its level of operations.  These  reductions could have an adverse effect on
the Company's  relations with its strategic partners and customers.  Uncertainty
exists with  respect to the adequacy of current  funds to support the  Company's
activities  until positive cash flow from  operations can be achieved,  and with
respect to the  availability  of financing  from other  sources to fund any cash
deficiencies (see Note 6 with respect to recent financing).

   The accompanying  financial  statements have been prepared  assuming that the
Company will  continue as a going  concern,  which  contemplates  continuity  of
operations,  realization  of  assets  and  satisfaction  of  liabilities  in the
ordinary  course of business.  The propriety of using the going concern basis is
dependent  upon,  among  other  things,  the  achievement  of future  profitable
operations and the ability to generate  sufficient cash from operations,  public
and private  financings and other funding sources to meet its  obligations.  The
uncertainties  described in the preceding  paragraphs raise substantial doubt at
December 31, 1997 about the  Company's  ability to continue as a going  concern.
The accompanying financial statements do not include any adjustments relating to
the  recoverability  of the carrying  amount of recorded assets or the amount of
liabilities that might result from the outcome of these uncertainties.


2.  Summary of Significant Accounting Policies:

Consolidation:

   The financial statements include the accounts of the Company and its majority
owned subsidiaries. All material inter-company transactions and account balances
have been eliminated in consolidation.

   Unconsolidated  affiliates  include  joint  ventures  and other  entities not
controlled  by the  Company,  but over which the Company  maintains  significant
influence  and in which the  Company's  ownership  interest is 50% or less.  The
Company's  investments in these entities are accounted for on the equity method.
When the Company's  equity in cumulative  losses  exceeds its investment and the
Company has no  obligation  or intention  to fund such  additional  losses,  the
Company  suspends  applying the equity method (see Note 3). The Company will not
be able to record any equity in income with respect to an entity until its share
of future profits is sufficient to recover any  cumulative  losses that have not
previously been recorded.

Revenue Recognition:

Product Sales:

   Revenue is recognized as the product is shipped.

Engineering and development services:

   Revenue from  engineering and development  contracts is recognized and billed
as the services are performed.  However,  revenue from certain  engineering  and
development  contracts  are  recognized  as  services  are  performed  under the
percentage of completion method after 10% of the total estimated costs have been
incurred.  Under the percentage of completion method,  revenues and gross profit
are  recognized as work is performed  based on the  relationship  between actual
costs incurred and total estimated costs at completion.
Estimated losses are recorded when identified.

   Revenues  recorded  under the  percentage  of completion  method  amounted to
$249,000,  $9,000 and zero for the years ended December 31, 1995, 1996 and 1997,
respectively.

Technology Licensing Fees:

   Technology licensing fees paid by joint venturers, co-venturers,  strategic
partners or other  licensees which are  nonrefundable,  are recognized in income
upon  execution  of the  license  agreement.  If any  license  fee is subject to
completion of any performance criteria specified within the agreement, then such
license fee is deferred until such performance criteria is met. See Note 3, with
respect to the license  fees  recorded by the Company in  connection  with Ultra
Electronics, Ltd. in 1995 and New Transducers, Ltd. in 1997.


Advertising:

  Advertising  costs are  expensed  as  incurred.  Expense  for  years  ended
December  31,  1995,  1996  and 1997 was $0.6  million,  $0.5  million  and $0.5
million, respectively.

Cash and cash equivalents:

   The Company considers all money market accounts and highly liquid investments
with  original  maturities  of  three  months  or less at the  time of  purchase
(principally  comprise high quality  investments in commercial paper) to be cash
equivalents.

Inventories:

   Inventories are stated at the lower of cost (first in, first out) or market.

   With regard to the Company's  assessment of the  realizability  of inventory,
the Company periodically conducts a complete physical inventory, and reviews the
movement of inventory  on an item by item basis to determine  the value of items
which  are slow  moving.  After  considering  potential  for near  term  product
engineering changes and/or technological obsolescence and current realizability,
the Company determines the current need for inventory  reserves.  After applying
the above noted  measurement  criteria at December  31,  1996,  and December 31,
1997,  the Company  determined  that a reserve of $0.3 million and $0.5 million,
respectively, was adequate.

Property and Equipment:

   Property and equipment are stated at cost and depreciation is recorded on the
straight-line  method over the estimated useful lives of the respective  assets.
Leasehold  improvements  are amortized over the shorter of their useful lives or
the related lease term.

Patent Rights:

   Patent  rights are stated at cost and are  amortized on a straight line basis
over  the  remaining  life  of  each  patent  (ranging  from  1  to  15  years).
Amortization  expense was $0.4 million,  $0.4 million and $0.3 million for 1995,
1996 and 1997, respectively.  Accumulated amortization was $1.5 million and $1.8
million at December 31, 1996 and 1997, respectively.

   It is the Company's policy to review its individual  patents when events have
occurred which could impair the valuation on any such patent.

Foreign currency translation:

   The financial  statements  for the United  Kingdom  operations are translated
into U.S.  dollars at year-end  exchange  rates for assets and  liabilities  and
weighted  average  exchange  rates for  revenues  and  expenses.  The effects of
foreign  currency  translation  adjustments  are  included  as  a  component  of
stockholders'  equity  and gains and  losses  resulting  from  foreign  currency
transactions are included in income and have not been material.

Loss per common share:

   The Company adopted Statement of Financial  Accounting Standards ("SFAS") No.
128,  "Earnings  Per  Share,"  in the  year  ended  December  31,  1997  and has
retroactively   applied   the  effects   thereof  for  all  periods   presented.
Accordingly,  the presentation of per share information includes calculations of
basic  and  dilutive  loss  per  share.  The  impact  on the per  share  amounts
previously reported (primary and fully diluted) was not significant. The effects
of potential common shares such as warrants,  options, and convertible preferred
stock has not been included, as the effect would be antidilutive (see Notes 3, 6
and 7).

Concentrations of Credit Risk:

   Financial  instruments which potentially subject the Company to concentration
of credit risk consist of cash and cash  equivalents.  The Company considers all
money market accounts and investments  with original  maturities of three months
or less at the time of purchase to be cash  equivalents.  The Company  primarily
holds its cash and cash equivalents in two banks and commercial paper.  Deposits
in excess of federally  insured  limits were $12.4 million at December 31, 1997.
The Company sells its products and services to original equipment manufacturers,
distributors and end users in various industries worldwide.  As shown below, the
Company's five largest  customers  accounted for  approximately  71% of revenues
during 1997 and 59% of accounts  receivable  at December 31,  1997.  The Company
does not require collateral or other security to support customer receivables.


                                        (in thousands of dollars)
                                         As of December 31, 1997,
                                       and for the year then ended
                                     ---------------------------------
                                      Accounts             
             CUSTOMER                Receivable            Revenue
  --------------------------------   ------------       --------------
  Verity Group.plc                          $---               $3,000
  Telex Communications, Inc.                 ---                  391
  The Sharper Image                           53                  236
  Brookstone                                  60                  228
  Siemens AG                                 200                  200
  All Other                                  217                1,663
                                     ------------       --------------
                            Total           $530               $5,718
                                     ============       ==============

   The Company regularly  assesses the realizability of its accounts  receivable
and  performs  a  detailed  analysis  of  its  aged  accounts  receivable.  When
quantifying the  realizability  of accounts  receivable,  the Company takes into
consideration  the value of past due receivables and the  collectibility of such
receivables, based on credit worthiness.

Use of Estimates:

   The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  of
contingent  assets and  liabilities at the date of the financial  statements and
the  reported  amounts of revenues  and expenses  during the  reporting  period.
Actual results could differ from those estimates.

Stock-Based Compensation:

   During 1996, the Company adopted Statement of Financial  Accounting Standards
No.  123,  "Accounting  for  Stock-Based   Compensation"  (SFAS  No.  123).  The
provisions  of SFAS No. 123 allow the Company to either  expense  the  estimated
fair value of stock  options and warrants or to continue to follow the intrinsic
value  method  set forth in APB  Opinion  25,  "Accounting  for Stock  Issued to
Employees"  (APB 25) but disclose the pro forma effects on net income (loss) had
the fair value of the options or warrants been expensed. The Company has elected
to continue to apply APB 25 in  accounting  for its  employee  stock  option and
warrant incentive plans. Please refer to Note 7 for further information.

Recently issued accounting pronouncements:

   In June 1997, the Financial  Accounting  Standards Board issued Statements of
Financial Accounting Standards No. 129, "Disclosure of Information about Capital
Structure",  No. 130, "Reporting Comprehensive Income" and No. 131, "Disclosures
about  Segments of an Enterprise and Related  Information".  The Company has not
yet determined whether the above  pronouncements  will have a significant effect
on the information presented in the financial statements.


3.  Joint Ventures and Other Strategic Alliances:

   The  following is a summary of certain of the  Company's  joint  ventures and
other strategic alliances as of December 31, 1997.

   The Company and certain of its majority-owned  subsidiaries have entered into
agreements to establish joint ventures and other strategic  alliances related to
the  design,  development,   manufacture,  marketing  and  distribution  of  its
electronic  systems and  products  containing  such  systems.  These  agreements
generally  provide that the Company license  technology and contribute a nominal
amount of initial capital and that the other parties provide  substantially  all
of the  funding to  support  the  venture  or  alliance.  This  support  funding
generally  includes  amounts  paid or  services  rendered  for  engineering  and
development.  In exchange for this funding, the other party generally receives a
preference in the distribution of cash and/or profits from the joint ventures or
royalties from these alliances until such time that the support funding (plus an
"interest"  factor in some instances) is recovered.  At December 31, 1997, there
were no  preferred  distributions  due to joint  venture  partners  from  future
profits of the joint ventures.

   Technology  licensing fees and engineering and development fees paid by joint
ventures to the Company are recorded as income since there is no recourse to the
Company  for  these  amounts  or any  commitment  by the  Company  to  fund  the
obligations of the venture.

   When the Company's  share of cumulative  losses equals its investment and the
Company has no  obligation  or intention  to fund such  additional  losses,  the
Company  suspends  applying  the  equity  method.  The  aggregate  amount of the
Company's  share of losses in these joint  ventures  in excess of the  Company's
investments  which has not been  recorded  was zero at December  31,  1997.  The
Company  will not be able to record  any  equity in income  with  respect  to an
entity until its share of future profits is sufficient to recover any cumulative
losses that have not previously been recorded.

   Certain of the joint  ventures  will be suppliers to the Company and to other
of the joint ventures and will transfer  products to the related  entities based
upon pricing  formulas  established in the agreements.  The formula is generally
based upon fully  burdened  cost, as defined in the  agreements,  plus a nominal
profit.

   Total  revenues  recorded by the Company  relating to the joint  ventures and
alliances,  or their principals,  for technology licensing fees, engineering and
development services and product sales were as follows:



                                             (in thousands of dollars)
                                              Years ended December 31,
                                        -------------------------------------
       Joint Venture/Alliance              1995         1996         1997
--------------------------------------  -----------  -----------  -----------
Walker Noise Cancellation  
Technologies                                $3,994          $90          $61
Ultra Electronics, Ltd.                      3,153           62          ---
ELESA                                          424           28          ---
Siemens Medical Systems, Inc.                  260          319          172
Foster/NCT Supply, Ltd.                        133           10           28
AB Electrolux                                  129           12           34
Hoover Universal, Inc.                         ---          713          ---
Verity Group plc                               ---          ---        3,000
                                        -----------  -----------  -----------

                Total                       $8,093       $1,234       $3,295
                                        ===========  ===========  ===========


   Outlined  below is a summary of the nature and terms of selected  ventures or
alliances:



<PAGE>


Joint Ventures

   OnActive  Technologies,   L.L.C.  ("OAT")  is  a  limited  liability  company
currently owned 42.5% by Applied Acoustic Research, L.L.C. ("AAR"), 42.5% by the
Company  and 15.0% by Hoover  Universal,  Inc.,  a wholly  owned  subsidiary  of
Johnson Controls,  Inc.("JCI") (collectively,  the "Members") under an Operating
Agreement concluded in December, 1995 and amended in May, 1996. OAT will design,
develop,  manufacture,  market,  distribute  and  sell  flat  panel  transducers
("FPT(TM))  and  related  components  for use in audio  applications  and  audio
systems installed in ground based vehicles. Initial capital contributions by the
Company and AAR were  nominal  and no Member is required to make any  additional
contribution  to OAT. In May,  1996,  JCI  acquired a $1.5  million,  15% equity
interest in OAT and acquired  exclusive  rights in the  automotive OEM market to
certain of the Company's and AAR's related  patents for a total of $1.5 million,
which was paid  50/50 to the  Company  and AAR.  In  connection  therewith,  the
Company  recorded a license fee of $750,000  during the year ended  December 31,
1996. The Operating  Agreement provides that services and subcontracts  provided
to OAT by the Members are to be  compensated by OAT at 115% of the Members fully
burdened cost.  However,  during 1996,  administrative  services required by OAT
were  provided by the Company and not charged to OAT.  During 1996 such services
were nominal.  As of December 31, 1995 the Company  recognized $80,000 of income
relating to its share of 1995 profit in OAT. As of December 31, 1996 the Company
reversed  the $80,000 of income  which  related to its share of the 1996 loss in
OAT.  In  consideration  for  certain  marketing  services to be provided by the
Company and Oxford  International,  Ltd. (Oxford), an affiliate of AAR, OnActive
will pay the Company and Oxford two percent  (2%) each of the revenues or thirty
percent (30%) each of the gross margin  (whichever is less) received by OnActive
from the sale of Top Down Surround  Sound(TM) ("TDSS") systems and the licensing
of TDSS technology to certain original equipment manufacturers.

Other Strategic Alliances:

   Ultra Electronics Ltd.  (formerly Dowty Maritime  Limited)  ("Ultra") and the
Company  entered  into a teaming  agreement  in May 1993 to  collaborate  on the
design,  manufacture and  installation of products to reduce noise in the cabins
of various types of aircraft.  In  accordance  with the  agreement,  the Company
provided  informational  and  technical  assistance  relating  to  the  aircraft
quieting  system and Ultra  reimbursed  the  Company  for  expenses  incurred in
connection  with such  assistance.  Ultra was  responsible for the marketing and
sales  of  the  products.  The  Company  was to  supply  Ultra  with  electronic
components  required for the aircraft  quieting system, at a defined cost, to be
paid by Ultra.

   In March  1995,  the Company and Ultra  amended  the  teaming  agreement  and
concluded  a  licensing  and  royalty  agreement  for $2.6  million and a future
royalty of 1-1/2 % of sales commencing in 1998.  Under the agreement,  Ultra has
also  acquired  the  Company's  active  aircraft   quieting  business  based  in
Cambridge,  England, leased a portion of the Cambridge facility and has employed
certain of the Company's employees.

   Accordingly,  the Company recorded $2.6 million as a technology licensing fee
relating to the net amount received from above noted amended  teaming  agreement
and the licensing and royalty agreement in the first quarter of 1995.

   New  Transducers  Ltd.(NXT),  a wholly owned  subsidiary  of Verity Group PLC
("Verity")  and the Company  executed a cross  licensing  agreement  (the "Cross
License")  on March 28,  1997.  Under  terms of the Cross  License,  the Company
licensed patents and patents pending which relate to FPT(TM)  technology to NXT,
and NXT licensed patents and patents pending which relate to parallel technology
to the Company. In consideration of the license,  during the first quarter 1997,
NCT recorded a $3.0 million license fee receivable from NXT as well as royalties
on future  licensing and product  revenue.  The Company also executed a security
deed (the "Security Deed") in favor of NXT granting NXT a conditional assignment
in the patents and patents  pending  licensed to NXT under the Cross  License in
the event a default  in a certain  payment to be made by the  Company  under the
Cross License continued beyond fifteen days.  Concurrent with the Cross License,
the Company and Verity  executed  agreements  granting each an option for a four
year period  commencing on March 28, 1998, to acquire a specified  amount of the
common stock of the other subject to certain  conditions and restrictions.  With
respect to the  Company's  option to Verity (the "Verity  Option"),  3.8 million
shares of common stock  (approximately  3.4% of the then issued and  outstanding
common stock) of the Company are covered by such option and the Company executed
a registration rights agreement (the "Registration  Rights Agreement")  covering
such shares. Five million ordinary shares (approximately 2.0% of the then issued
and outstanding  ordinary shares) of Verity are covered by the option granted by
Verity to the Company. The exercise price under each option is the fair value of
a share of the applicable  stock on March 28, 1997, the date of grant.  On April
15, 1997,  Verity,  NXT and the Company  executed  several  agreements and other
documents (the "New  Agreements")  terminating  the Cross License,  the Security
Deed, the Verity Option and the Registration Rights Agreement and replacing them
with new agreements  (respectively  the "New Cross  License",  the "New Security
Deed", the "New Verity Option" and the "New Registration Rights Agreement"). The
material  changes effected by the New Agreements were the inclusion of Verity as
a party along with its wholly owned  subsidiary NXT;  providing that the license
fee  payable  to NCT  could be paid in  ordinary  shares of  Verity  stock;  and
reducing  the  exercise  price  under the option  granted to Verity to  purchase
shares of the Company's common stock to $0.30 per share. The subject license fee
was  paid  to the  Company  in  ordinary  shares  of  Verity  stock  which  were
subsequently sold by the Company.  On September 27, 1997, Verity, NXT, NCT Audio
Products,  Inc. ("NCT Audio") and the Company  executed  several  agreements and
other documents, terminating the New Cross License and the New Security Deed and
replacing them with new agreements  (respectively,  the "Cross License Agreement
dated  September  27, 1997" and the "Master  License  Agreement").  The material
changes  effected by the most recent  agreements were an expansion of the fields
of use  applicable  to the  exclusive  licenses  granted to Verity  and NXT,  an
increase in the  royalties  payable on future  licensing  and product  revenues,
cancellation  of the New  Security  Deed  covering  the patents  licensed by the
Company,  and the  acceleration  of the date on which the parties  can  exercise
their respective stock purchase option to September 27, 1997.


4.  Inventories:

   Inventories comprise the following:

                                              (in thousands of dollars)
                                                    December 31,
                                             ----------------------------
                                                 1996           1997
                                             -------------   ------------

Components                                   $    543        $   514
Finished goods                                    619          1,291
                                             -------------   ------------
Gross inventory                              $  1,162        $ 1,805
Reserve for obsolete & slow moving inventory     (262)          (472)
                                             -------------   ------------
Inventory, net of reserves                   $    900        $ 1,333
                                             =============   ============


5.  Property and Equipment:

   Property and equipment comprise the following:

                                              (in thousands of dollars)
                                Estimated          December 31,
                               Useful Life    -------------------------
                                 (Years)         1996         1997
                               -------------  ------------ ------------

  Machinery and equipment          3-5        $ 1,763      $ 1,801
  Furniture and fixtures           3-5            749          869
  Leasehold improvements           7-10         1,185        1,177
  Tooling                          1-3          1,062          670
  Other                            5-10           167           74
                                              ------------ ------------
       Gross                                  $ 4,926      $ 4,591
  Less accumulated depreciation                (2,873)      (3,447)
                                              ------------ ------------
       Net                                    $ 2,053      $ 1,144
                                              ============ ============

     Depreciation  expense for the years ended December 31, 1995,  1996 and 1997
was $0.6 million, $ 0.5 million and $0.6 million, respectively.


6.  Common Stock:

   Private Placements:

   On November 8, 1995 the Company  entered into a stock purchase  agreement for
the sale of 4.8 million  shares of its common stock in a private  placement to a
foreign  investor  in  consideration  for $3.3  million in net  proceeds  to the
Company.  The closing of the  transaction  occurred on November  14,  1995.  The
purchaser  of the  common  stock was  subject to  certain  resale  and  transfer
restrictions  including those under Regulation S of the United States Securities
Act of 1933, as amended.

   The Company completed a private placement of 2.0 million shares of its common
stock on August 4, 1995  receiving  approximately  $0.7 million in net proceeds.
The  purchaser  of the common  stock was subject to certain  resale and transfer
restrictions  including those under  Regulation D of the Securities Act of 1933,
as amended. As provided for in the Stock Purchase Agreement,  within nine months
of the closing date, the Company was obligated to file a registration  statement
with the Securities and Exchange  Commission  covering the  registration  of the
shares for resale by the purchaser.

   On March 28, 1996, the Company sold 2.0 million shares of its common stock in
a second private placement with the investor in the private placement  described
in the  preceding  paragraph  that  provided net proceeds to the Company of $0.7
million  under  terms  and  conditions  substantially  the  same as those of the
earlier private  placement.  A registration  statement  covering the 4.0 million
shares of the  Company's  common  stock issued in  connection  with this private
placement  and  the  one  described  in the  preceding  paragraph  was  declared
effective by the Commission on September 3, 1996.

   On April 10, 1996, the Company sold an additional  1,000,000  shares,  in the
aggregate,  of its common stock in a private placement with three  institutional
investors   that   provided  net  proceeds  to  the  Company  of  $0.3  million.
Contemporaneously,  the  Company  sold  secured  convertible  term  notes in the
aggregate principal amount of $1.2 million to those institutional  investors and
granted  them  each an option to  purchase  an  aggregate  of $3.45  million  of
additional  shares of the Company's common stock. The per share conversion price
under the notes and the exercise  price under the options are equal to the price
received by the Company for the sale of such 1,000,000 shares subject to certain
adjustments.

   On  August  13,  1996,  the three  institutional  investors  converted  their
secured,  convertible  term notes and  exercised  their  options  in full.  As a
result,  the Company issued 13,403,130  shares, in the aggregate,  of its common
stock to such  investors,  received  $3.45  million  in cash,  and  effected  by
conversion  to its  common  stock the  payment  of the notes  together  with the
accrued interest thereon.

   On August 29, 1996,  the Company sold 1.8 million  shares of its common stock
to the same foreign investor which purchased 4.8 million shares of the Company's
common  stock in  November,  1995.  The  Company  received  $0.9  million of net
proceeds.  The purchaser is subject to certain resale and transfer  restrictions
with respect to these shares.

   Between  January 15, 1997 and March 25, 1997,  the Company issued and sold an
aggregate  amount  of  $3.4  million  of  non-voting  subordinated   convertible
debentures (the "Debentures") in a private placement pursuant to Regulation S of
the Securities Act of 1933, as amended, (the "Securities Act") to five unrelated
investors (the  "Investors")  through  multiple dealers (the "First Quarter 1997
Financing")  from which the Company  realized $3.2 million of net proceeds.  The
Debentures  were to mature between  January 15, 2000 and March 25, 2000 and earn
8% interest per annum,  payable quarterly in either cash or the Company's common
stock at the  Company's  sole  option.  Subject to certain  common  stock resale
restrictions,  the Investors, at their discretion,  had the right to convert the
principal  due on the  Debentures  into the  Company's  common stock at any time
after  the 45th day  following  the  date of the sale of the  Debentures  to the
Investors.  In the  event of such a  conversion,  the  conversion  price was the
lesser of 85% of the  closing  bid price of the  Company's  common  stock on the
closing date of the  Debentures'  sale or between 75% to 60%  (depending  on the
Investor  and other  conditions)  of the average  closing bid price for the five
trading days  immediately  preceding  the  conversion.  To provide for the above
noted conversion and interest  payment options,  the Company reserved 15 million
shares of the Company's common stock for issuance upon such conversion.  Subject
to certain  conditions,  the Company also had the right to require the Investors
to convert all or part of the Debentures  under the above noted conversion price
conditions  after  February  15, 1998.  As of June 6, 1997,  the  Investors  had
converted  all $3.4 million of the  Debentures  into 16.5 million  shares of the
Company's  common  stock.  At the Company's  election,  interest due through the
conversion  dates  of  the  Debentures  was  paid  through  the  issuance  of an
additional 0.2 million shares of the Company's common stock. In conjunction with
the  Debentures,  the  Company  granted a warrant to purchase  75,000  shares of
common stock to one  investor.  During the year ended  December  31,  1997,  the
Company valued this warrant,  using the  Black-Scholes  pricing model at $34,000
which was  expensed as debt  discount.  The Company has  recorded a $1.4 million
non-cash  interest expense  attributable to the conversions of the Debentures in
the first and second quarters of 1997 as an adjustment during the fourth quarter
of 1997.  If the shares were issued in lieu of debt at the  respective  issuance
dates of the debt,  supplementary  basic and  diluted net loss per share for the
year ended December 31, 1997 would have been a loss of $0.08 per share.

   On June 19, 1997 the  stockholders  approved an  amendment  to the  Company's
Restated  Certificate  of  Incorporation  to increase the  authorized  number of
shares of common  stock  from 140  million  shares to 185  million  shares.  The
Company has reserved 3.9 million shares of such  additional  shares for issuance
upon the  exercise  of the New  Verity  Option  and 2.6  million  shares of such
additional  shares for issuance  upon the  exercise of options  granted or to be
granted  and  future  grants  of   restricted   stock  awards  under  the  Noise
Cancellation Technologies, Inc. Stock Incentive Plan (the "1992 Plan").

   On July 30, 1997 the Company sold 2.9 million  shares,  in the aggregate,  of
its  common  stock at a price of $0.175 per share in the July 30,  1997  Private
Placement that provided net proceeds to the Company of $0.5 million.

   On  September  4, 1997,  the Company  transferred  $5,000 cash and all of the
business  and assets of its Audio  Products  Division as then  conducted  by the
Company and as reflected  on the business  books and records of the Company to a
newly incorporated  company, NCT Audio, in consideration for 5,867 shares of NCT
Audio common stock  whereupon NCT Audio became a wholly owned  subsidiary of the
Company.  The Company also granted NCT Audio an exclusive worldwide license with
respect to all of the  Company's  relevant  patented and  unpatented  technology
relating to FPT(TM) and FPT(TM) based audio speaker products for all markets for
such products  excluding  (a) markets  licensed to or reserved by Verity and NXT
under the  Company's  cross  licensing  agreements  with Verity and NXT, (b) the
ground based  vehicle  market  licensed to OAT, (c) all markets for hearing aids
and other  hearing  enhancing  or  assisting  devices,  and (d) all  markets for
headsets,  headphones and other products performing functions  substantially the
same as those performed by such products in  consideration  for a license fee of
$3.0  million  (eliminated  in  consolidation)  to be  paid  when  proceeds  are
available from the sale of NCT Audio common stock and on-going future  royalties
payable by NCT Audio to the Company as provided in such  license  agreement.  In
addition, the Company agreed to transfer all of its rights and obligations under
its cross licensing  agreements with Verity and NXT to NCT Audio and to transfer
the  Company's  interest  in OAT to NCT  Audio.  Between  October  10,  1997 and
December 4, 1997 NCT Audio issued  2,145  shares of its common stock  (including
533 shares issued to Verity) for an aggregate  purchase price of $4.0 million in
a private placement  pursuant to Regulation D under the Securities Act (the "NCT
Audio Financing"). NCT Audio has not met certain conditions regarding the filing
of a registration  statement for NCT Audio common stock. As such, holders of NCT
Audio common  stock have a right to convert  their NCT Audio common stock into a
sufficient  number of  restricted  shares  of NCT  common  stock to equal  their
original  cash  investment  in NCT Audio,  plus a 20% discount to market.  As of
February 27, 1998, no NCT Audio shareholder has exercised their right to convert
NCT Audio common stock into NCT common stock under the terms noted above.

   Between  October 28, 1997 and December 11, 1997,  the Company  entered into a
series of  subscription  agreements (the  "Subscription  Agreements") to sell an
aggregate  amount of $13.3 million of Series C Convertible  Preferred Stock (the
"Preferred  Stock") in a private  placement,  pursuant  to  Regulation  D of the
Securities Act, to 32 unrelated  accredited  investors  through two dealers (the
"1997  Preferred Stock Private  Placement").  The total Preferred Stock Offering
was completed on December 11, 1997. The aggregate net proceeds to the Company of
the 1997 Preferred Stock Private Placement were $11.9 million. Each share of the
Preferred  Stock has a par  value of $.10 per  share  and a stated  value of one
thousand  dollars ($1,000) with an accretion rate of four percent (4%) per annum
on the stated value.  Each share of Preferred  Stock is  convertible  into fully
paid and  nonassessable  shares of the Company's Common Stock subject to certain
limitations.  Under the terms of the  Subscription  Agreements  the  Company  is
required  to  exercise  its  best  efforts  to  file  a  registration  statement
("Registration  Statement")  on Form S-3  covering  the  resale of all shares of
Common Stock of the Company issuable upon conversion of the Preferred Stock then
outstanding within sixty (60) days after the first Closing of the 1997 Preferred
Stock Private  Placement.  The shares of Preferred Stock become convertible into
shares of Common  Stock at any time  commencing  after  the  earlier  of (i) the
effective date of the Registration Statement; or (ii) ninety (90) days after the
date of filing of the Registration  Statement.  Each share of Preferred Stock is
convertible into a number of shares of Common Stock of the Company as determined
in accordance with the Conversion  Formula as set forth in the agreement using a
conversion  price  equal to the  lesser of (x) 120% of the five (5) day  average
closing bid price of Common Stock  immediately  prior to the closing date of the
Preferred  Stock  being  converted  or (y) 20%  below  the five (5) day  average
closing  bid price of Common  Stock  immediately  prior to the  conversion  date
thereof.  See  Item 7 -  "Management's  Discussion  and  Analysis  of  Financial
Condition  and  Results of  Operations  -  Overview"  for a  description  of the
Conversion Formula.

   The  conversion  terms of the  Preferred  Stock also provide that in no event
shall the average  closing bid price  referred to in the  Conversion  Formula be
less than  $0.625 per share and in no event shall the  Company be  obligated  to
issue more than 26.0  million  shares of its Common  Stock in the  aggregate  in
connection with the conversion of the Preferred Stock. Accordingly, 26.0 million
shares of Common Stock which could be issuable upon  conversion of the Preferred
Stock are included in the offering to which the  prospectus  relates.  Under the
terms of the Subscription  Agreements the Company may be subject to a penalty if
the Registration  Statement is not declared  effective within one hundred twenty
(120) days after the first closing of any incremental portion of the offering of
Preferred  Stock,  such  penalty  to be in an  amount  equal to one and one half
percent (1.5%) per month of the aggregate  amount of Preferred Stock sold in the
offering  up to a maximum of ten percent  (10%) of such  aggregate  amount.  The
Subscription Agreements also provide that for a period commencing on the date of
the signing of the Subscription Agreements and ending ninety (90) days after the
closing of the offering the Company will be prohibited  from issuing any debt or
equity  securities  other than Preferred Stock, and that the Corporation will be
required  to make  certain  payments  in the  event  of its  failure  to  effect
conversion  in a timely  manner or in the event it fails to  reserve  sufficient
authorized  but  unissued  Common  Stock for  issuance  upon  conversion  of the
Preferred Stock.

   The  Securities  and Exchange  Commission  (the "SEC") has taken the position
that when preferred  stock is  convertible to common stock at a conversion  rate
that is the  lower of a rate  fixed at  issuance  or a fixed  discount  from the
common stock market price at the time of conversion, the discounted amount is an
assured incremental yield, the "beneficial conversion feature", to the preferred
shareholders  and should be accounted  for as an embedded  dividend to preferred
shareholders.  As such,  this dividend was  recognized in the earnings per share
calculation.

   Stock subscription receivable:

   The  $0.4  million  stock  subscription   receivable  at  December  31,  1997
represents  a receivable  of $0.1 million due from a director  which was paid in
1998,  and a $0.3  million  receivable  from the escrow  agent for the NCT Audio
financing which has not yet been paid.

   Shares reserved for common stock options and warrants:

   At December 31, 1997  aggregate  shares  reserved  for issuance  under common
stock option plans and warrants  amounted to 17.7 million shares of which common
stock options and warrants for 18.6 million shares are outstanding  (see Note 7)
and 16.2 million shares are exercisable.


7.  Common Stock Options and Warrants:

   The Company  applies APB 25 in  accounting  for its  various  employee  stock
option incentive plans and warrants and,  accordingly,  recognizes  compensation
expense as the  difference,  if any,  between the market price of the underlying
common  stock and the  exercise  price of the  option on the date of grant.  The
effect of  applying  SFAS No.  123 on 1995,  1996 and 1997 pro forma net loss as
stated above is not  necessarily  representative  of the effects on reported net
loss for future periods due to, among other  factors,  (i) the vesting period of
the stock options and (ii) the fair value of  additional  stock option grants in
future periods. If compensation expense for the Company's stock option plans and
warrants had been determined  based on the fair value of the options or warrants
at the grant date for awards under the plans in accordance  with the methodology
prescribed  under  SFAS No.  123,  the  Company's  net loss would have been $5.8
million,  $12.8 million and $15.8 million,  or $(0.07),  $(0.13) and $(0.14) per
share in 1995,  1996 and 1997,  respectively.  The fair value of the options and
warrants  granted in 1995,  1996 and 1997 are estimated in the range of $0.44 to
$1.25, $0.48 to $0.58 and $0.16 to $4.07 per share, respectively, on the date of
grant using the  Black-Scholes  option-pricing  model  utilizing  the  following
assumptions:  dividend yield 0%,  volatility of 1.040,  1.225 and 1.289 in 1995,
1996 and 1997,  respectively,  risk free interest rates in the range of 5.63% to
7.84%, 5.05% to 6.50% and 5.79% to 6.63% for 1995, 1996 and 1997,  respectively,
and expected life of 3 years. The weighted average fair value of options granted
during 1995, 1996 and 1997 are estimated in the range of $0.37 to $0.66,  $0.49,
and  $0.13 to  $0.58  per  share,  respectively  also  using  the  Black-Scholes
option-pricing model.

   Stock Options:

   The  Company's  1987 Stock  Option Plan (the "1987  Plan")  provides  for the
granting of up to  4,000,000  shares of common stock as either  incentive  stock
options or nonstatutory stock options. Options to purchase shares may be granted
under the 1987 Plan to persons who, in the case of incentive stock options,  are
full-time employees  (including  officers and directors) of the Company;  or, in
the case of nonstatutory stock options, are employees or non-employee  directors
of the Company.  The exercise  price of all  incentive  stock options must be at
least equal to the fair market value of such shares on the date of the grant and
may be exercisable  over a ten-year  period.  The exercise price and duration of
the  nonstatutory  stock options are to be determined by the Board of Directors.
Options  granted under the 1987 Plan  generally  vest 20% upon grant and 20% per
annum thereafter as determined by the Board of Directors.



<PAGE>

<TABLE>
<CAPTION>

   Information with respect to 1987 Plan activity is summarized as follows:

                                              Years Ended December 31,
                       -------------------------------------------------------------------------
                              1995                     1996                      1997
                       ---------------------     --------------------       -----------------
                                    Weighted                  Weighted                  Weighted
                                    Average                   Average                   Average
                                    Exercise                  Exercise                  Exercise
                       Shares       Price        Shares       Price         Shares      Price
                       ------       --------     ------       --------      ------      --------
<S>                    <C>          <C>          <C>          <C>           <C>         <C>

Outstanding at           1,790,472    $0.58        1,540,000    $0.56         1,500,000  $ 0.54 
 beginning of year                                 
Options granted                  -        -                -        -         1,350,000    0.51
Options exercised         (232,651)    0.66                -        -                 -       -
Options canceled,           
 expired or forfeited      (17,821)    1.39          (40,000)    1.31        (1,500,000)  (0.54)
                         ---------                 ---------                  ---------
Outstanding at end of 
 year                    1,540,000    $0.56        1,500,000    $0.54         1,350,000  $ 0.51
                         =========                 =========                  =========

Options exercisable      1,540,000    $0.56        1,500,000    $0.54         1,350,000  $ 0.51
 at year-end             =========                 =========                  =========
</TABLE>

   As of December  31,  1997,  options for the  purchase of 217,821  shares were
available for future grant under the 1987 Plan.

   The  Company's  non-plan  options  are  granted  from  time  to  time  at the
discretion of the Board of Directors. The exercise price of all non-plan options
generally  must be at least equal to the fair market value of such shares on the
date of grant and generally are  exercisable  over a five to ten year period
as determined by the Board of Directors. Vesting of non-plan options varies from
(i) fully vested at the date of grant to (ii)  multiple  year  apportionment  of
vesting as determined by the Board of Directors.

   Information  with respect to non-plan stock option  activity is summarized as
follows:

<TABLE>
<CAPTION>
                                                                                
                                      Years Ended December 31,                  
                       ---------------------------------------------------------
                             1995              1996              1997           
                       ----------------  ----------------- ---------------------
                               Weighted           Weighted            Weighted  
                               Average            Average             Average   
                               Exercise           Exercise            Exercise  
                       Shares  Price     Shares   Price    Shares     Price     
                       ------  --------  -------  -------- ------     --------  
<S>                    <C>     <C>       <C>      <C>      <C>        <C>
Outstanding at                                                                  
 beginning of year    1,641,995   $1.98  403,116    $1.04    372,449     $1.08  
Options granted               -       -        -        -  7,844,449      0.41  
Options exercised      (328,667)   0.51  (26,667)    0.50          -         -   
Options canceled,                                                               
 expired or forfeited  (910,212)   2.92   (4,000)    1.33 (3,897,449)     0.53  
                       ========          =======           =========            
Outstanding at end                                                              
 of year                403,116   $1.04  372,449    $1.08  4,319,449     $0.36  
                       ========          =======           =========            
Options exercisable                                                             
 at year-end            399,116   $1.02  370,449    $1.07  4,319,449     $0.36  
                       ========          =======           =========            
</TABLE>

   On October 6, 1992,  the Company  adopted a stock option plan as amended (the
"1992 Plan") for the granting of options to purchase up to 10,000,000  shares of
common stock to officers,  employees, certain consultants and certain directors.
The  exercise  price of all 1992 Plan options must be at least equal to the fair
market  value of such shares on the date of the grant and 1992 Plan  options are
generally  exercisable over a five to ten year period as determined by the Board
of Directors.  Vesting of 1992 Plan options  varies from (i) fully vested at the
date of grant to (ii)  multiple year  apportionment  of vesting as determined by
the Board of Directors.

<TABLE>
<CAPTION>
<PAGE>
                                                                                  
   Information with respect to 1992 Plan activity is summarized as follows:       
                                                                                  
                                     Years Ended December 31,                     
                       ---------------------------------------------------------  
                              1995                1996               1997         
                       -------------------  ----------------   -----------------  
                                  Weighted           Weighted           Weighted  
                                  Average            Average            Average   
                                  Exercise           Exercise           Exercise  
                       Shares     Price     Shares   Price     Shares   Price     
                       --------   --------  -------- --------  ------   --------  
<S>                    <C>        <C>       <C>      <C>       <C>      <C>
Outstanding at                                                                    
 beginning of year     4,058,542   $2.75   4,004,248  $1.00   6,022,765   $0.86   
Options granted        5,386,422    1.04   2,156,500   0.67   4,652,222    0.55   
Options exercised       (161,423)   0.85     (33,533)  0.75  (1,141,795   (0.64)  
Options canceled,                                                                 
 expired or forfeited (5,279,293)   2.29    (104,450)  1.37    (503,256)  (0.99)  
                       =========           =========          =========           
Outstanding at end                                                                
 of year               4,004,248    1.00   6,022,765  $0.86   9,029,936   $0.72   
                       =========           =========          =========           
Options exercisable                                                               
 at year-end           1,534,335   $1.31   5,835,265  $0.86   6,592,436   $0.73   
                       =========           =========          =========           
</TABLE>

   As of December  31,  1997,  no shares  were  available  for future  grants of
restricted  stock awards and for options to purchase common stock under the 1992
Plan.

   As of December  31, 1997,  1.9 million  options have been granted but are not
exercisable until such time as the Company's stockholders approve an increase in
the number of shares of the Company's Common Stock included in the 1992 Plan. At
the time of such  stockholder  approval,  if the market  value of the  Company's
stock exceeds the exercise price of the subject options,  the Company will incur
a non-cash  charge to earnings equal to the spread between the exercise price of
the option and market price, times the number of options involved.

   On November 15, 1994, the Board of Directors  adopted the Noise  Cancellation
Technologies,  Inc. Option Plan for Certain Directors (the "Directors Plan"), as
amended. Under the Directors Plan 821,000 shares have been approved by the Board
of Directors for  issuance.  The options  granted under the Directors  Plan have
exercise  prices equal to the fair market value of the Common Stock on the grant
dates,  and  expire  five years from date of grant.  Options  granted  under the
Directors Plan generally vest at the date of grant.

<TABLE>
<CAPTION>

  Information with respect to Directors Plan activity is summarized as follows:      
                                                                                     
                                   Years Ended December 31,                          
                      ----------------------------------------------------------     
                           1995             1996              1997                   
                      -------------------  ----------------   ------------------     
                                 Weighted            Weighted          Weighted      
                                 Average             Average           Average       
                                 Exercise            Exercise          Exercise      
                      Shares     Price     Shares    Price    Shares   Price         
                      ------     --------  ------    -------- ------   --------      
<S>                   <C>        <C>       <C>       <C>      <C>      <C>
Outstanding at                                                                       
 beginning of year      240,000    $0.97   821,000     $0.73  746,000     $0.73      
Options granted       1,076,000     0.77         -         -        -         -      
Options exercised             -        -         -         -        -         -      
Options canceled,                                                                    
 expired or                                                                          
 forfeited             (495,000)    0.92   (75,000)     0.75        -         -      
                        =======            =======           ========                
Outstanding at end                                                                   
 of year                821,000    $0.73   746,000     $0.73  746,000     $0.73      
                        =======            =======           ========                
Options exercisable                                                                  
 at year-end            305,000    $0.70   746,000     $0.73  746,000     $0.73      
                        =======            =======           ========                
</TABLE>
                                                                              
   As of December 31, 1997, there were 75,000 options for the purchase of shares
available for future grants under the Directors Plan.                           
<TABLE>
<CAPTION>
<PAGE>

   The following  information  summarizes  information about the Company's stock
options outstanding at December 31, 1997:

                                                                                 
                                                                                 
                               Options Outstanding      Options Exercisable      
                               ----------------------  -------------------------         
                                            Weighted                             
                                            Average                              
                                            Remaining                            
                                            Contrac-   Weighted         Weighted 
                                 Number     tual Life  Average  Number  Average  
                Range of         Out-       (In        Exercise Exer-   Exercise 
  Plan          Exercise Price   standing   Years)     Price    cisable   Price  
--------------  --------------   ---------  ---------  -------  -------  ------- 
<S>             <C>              <C>        <C>        <C>     <C>      <C>

1987 Plan       $0.50 to $0.63   1,350,000   1.18      $0.51   1,350,000   $0.51 
                                                                                 
Non-Plan        $0.27 to $4.75   4,319,449   4.14      $0.36   4,319,449   $0.36 
                                                                                 
1992 Plan       $0.27 to $4.00   9,029,936   4.89      $0.72   6,592,436   $0.73 
                                                                                 
Director's Plan $0.66 to $0.75     746,000   1.88      $0.73     746,000   $0.73 
</TABLE>
                                                                            

   Warrants:

   The Company's warrants are granted from time to time at the discretion of the
Board of  Directors.  The exercise  price of all warrants  generally  must be at
least  equal  to the fair  market  value of such  shares  on the date of  grant.
Warrants are generally  exercisable over a five to ten year period as determined
by the Board of Directors. Warrants generally vest on the grant date.

   The Company had shares of its common  stock  reserved at December  31,  1995,
December 31, 1996, and December 31, 1997, for warrants outstanding, all of which
are exercisable.
<TABLE>
<CAPTION>

   Information with respect to warrant activity is summarized as follows:

                                    Years Ended December 31,                  
                      --------------------------------------------------------
                           1995              1996               1997          
                      ---------------- -----------------  --------------------
                              Weighted          Weighted              Weighted
                              Average           Average               Average 
                              Exercise          Exercise              Exercise
                      Shares   Price   Shares    Price    Shares      Price   
                      ------- -------- -------  --------  -------     --------
<S>                   <C>     <C>      <C>      <C>       <C>         <C>
Outstanding at                                                                 
beginning of year   4,829,896  $1.20  4,032,541   $0.71   3,888,539     $0.72 
Warrants granted    2,418,750   0.76         -       -    2,846,923      0.76 
Warrants exercised   (327,105)  0.76   (144,002)   0.45    (854,119)    (0.41)
Warrants canceled,                                                             
expired or                                                                    
forfeited          (2,889,000)  1.57         -           (2,734,423)    (0.75)
                    =========         =========           =========           
Outstanding at                                                                 
end of year         4,032,541  $0.71  3,888,539   $0.72   3,146,920     $0.81 
                    =========         =========           =========           
Warrants                                                                       
exercisable                                                                   
at year end         4,032,541  $0.71  3,888,539   $0.72   3,146,920     $0.81 
                    =========         =========           =========           
</TABLE>
   The following  table  summarizes  information  about warrants  outstanding at
December 31, 1997:
                                                                                
                            Warrants Outstanding           Warrants Exercisable 
                    -----------------------------------   --------------------- 
                                  Weighted                                      
                                  Average                                       
                                  Remaining                                     
                                  Contractual  Weighted                Weighted 
                                  Life         Average                 Average  
                    Number        (In          Exercise   Number       Exercise 
Range of Exercise   Outstanding   Years)       Price      Exercisable  Price    
-----------------   -----------   ------------ --------   -----------  -------- 
$0.69 to $4.00       3,146,920       2.06       $0.81      3,146,920     $0.81  
                                                                                
<PAGE>

8.  Related Parties:

   Environmental Research Information, Inc.

   In 1989, the Company established a joint venture with Environmental  Research
Information, Inc., ("ERI") to jointly develop, manufacture and sell (i) products
intended  for  use  solely  in  the  process  of  electric   power   generation,
transmission and distribution and which reduce noise and/or vibration  resulting
from such process, (ii) personal quieting products sold directly to the electric
utility industry and (iii) products that reduce noise and/or vibration emanating
from fans and fan systems (collectively,  "Power and Fan Products"). In 1991, in
connection with the termination of this joint venture, the Company agreed, among
other things,  during the period ending  February  1996, to make payments to ERI
equal to (i) 4.5% of the  Company's  sales of Power  and Fan  Products  and (ii)
23.75% of fees derived by the Company from its license of Power and Fan Products
technology,  subject to an overall  maximum of $4,500,000.  Michael J. Parrella,
President  of  the  Company,  was  Chairman  of  ERI at the  time  of  both  the
establishment and termination of the joint venture and owns approximately 12% of
the outstanding capital of ERI. In addition,  Jay M. Haft, Chairman of the Board
of Directors of the Company, shares investment control over an additional 24% of
the outstanding  capital of ERI. During the fiscal year ended December 31, 1996,
the  Company  was not  required  to make any such  payments  to ERI under  these
agreements.

   Quiet Power Systems, Inc.

   In 1993, the Company entered into three Marketing  Agreements with QuietPower
Systems,  Inc.  ("QSI")  (until  March 2, 1994,  "Active  Acoustical  Solutions,
Inc."),  a company which is 33% owned by ERI and 2% owned by Mr. Haft. Under the
terms of one of these Marketing  Agreements,  QSI has undertaken to use its best
efforts to seek research and  development  funding for the Company from electric
and natural gas utilities for applications of the Company's  technology to their
industries.  In exchange for this undertaking,  the Company has issued a warrant
to QSI to purchase  750,000 shares of Common Stock at $3.00 per share.  The last
sale price for the Common Stock reported on the NASDAQ National Market System on
May 15, 1993,  the date of the  Marketing  Agreement,  was $2.9375.  The warrant
becomes  exercisable  as to  specific  portions of the total  750,000  shares of
Common Stock upon the occurrence of defined events  relating to QSI's efforts to
obtain such funding for the Company. When such defined events occur, the Company
will  record a charge  for the  amount by which the  market  price of the Common
Stock on such  date  exceeds  $3.00  per  share,  if any.  The  warrant  remains
exercisable  as to each such portion from the  occurrence  of the defined  event
through  October 13,  1998.  As of December  31,  1993,  contingencies  had been
removed  against  525,000  warrants  resulting  in a  1993  non-cash  charge  of
$120,250.  This Marketing  Agreement also grants to QSI a non-exclusive right to
market the  Company's  products that are or will be designed and sold for use in
or with equipment used by electric and/or natural gas utilities for non-retrofit
applications in North America.  QSI is entitled to receive a sales commission on
any sales to a customer of such  products for which QSI is a procuring  cause in
obtaining  the first order from such  customer.  In the case of sales to utility
company customers, the commission is 6% of the revenues received by the Company.
On sales to original equipment manufacturers for utilities, the commission is 6%
on the gross  revenue NCT  receives on such sales from the customer in the first
year, 4% in the second year, 2% in the third year and 1% in the fourth year, and
 .5% in any future years after the fourth year. QSI is also entitled to receive a
5% commission on any research and development funding it obtains for NCT, and on
any license  fees it obtains for the Company  from the license of the  Company's
technology.  The  initial  term of  this  Agreement  is  three  years  renewable
automatically  thereafter on a  year-to-year  basis unless a party elects not to
renew.

   Under the  terms of the  second of the  three  Marketing  Agreements,  QSI is
granted a non-exclusive  right to market the Company's products that are or will
be  designed  and sold for use in or with  feeder  bowls  throughout  the world,
excluding Scandinavia and Italy. Under this Marketing Agreement, QSI is entitled
to  receive  commissions  similar  to those  payable  to end  user and  original
equipment  manufacturer  customers  described  above.  QSI is also  entitled  to
receive  the same 5%  commission  described  above on research  and  development
funding and  technology  licenses which it obtains for the Company in the feeder
bowl area.  The initial  term of this  Marketing  Agreement  is three years with
subsequent automatic one-year renewals unless a party elects not to renew.

   Under the terms of the third Marketing Agreement, QSI is granted an exclusive
right to market the Company's products that are or will be designed and sold for
use in or with  equipment  used by electric  and/or  natural gas  utilities  for
retrofit  applications  in North  America.  QSI is  entitled  to receive a sales
commission  on any sales to a customer of such  products  equal to 129% of QSI's
marketing  expenses  attributable  to the marketing of the products in question,
which expenses are to be deemed to be the lesser of QSI's actual expenses or 35%
of the revenues  received by the Company from the sale of such products.  QSI is
also  entitled to receive a 5% commission  on research and  development  funding
similar  to  that  described  above.  QSI's  exclusive  rights  continue  for an
indefinite  term  provided it meets  certain  performance  criteria  relating to
marketing efforts during the first two years following  product  availability in
commercial  quantity and minimum levels of product sales in subsequent years. In
the event QSI's rights  become  non-exclusive,  depending  on the  circumstances
causing  such change,  the initial term then becomes  either three or five years
from the date of this Marketing  Agreement,  with subsequent  one-year automatic
renewals in each instance unless either party elects not to renew.

   For the years  ended  December  31,  1995,  1996 and 1997 the Company was not
required to pay any commissions to QSI under any of these Marketing Agreements.

   The Company has also  entered into a Teaming  Agreement  with QSI under which
each  party  agrees  to  be  responsible  for  certain  activities  relating  to
transformer  quieting system development  projects to be undertaken with utility
companies.  Under this Teaming Agreement,  QSI is entitled to receive 19% of the
amounts to be received from participating  utilities and the Company is entitled
to receive 81%. During the fiscal year ended December 31, 1995, 1996 and 1997 no
payments were required to be made to QSI.

   In March 1995,  the Company  entered into a Master  Agreement  with QSI under
which QSI was granted an exclusive  worldwide  license under certain NCT patents
and technical  information to market, sell and distribute  transformer  quieting
products,  turbine  quieting  products and certain other products in the utility
industry. Under the Master Agreement, QSI is to fund development of the products
by the Company and the Company is to manufacture the products.  However, QSI may
obtain  the  right to  manufacture  the  products  under  certain  circumstances
including NCT's failure to develop the products or the failure of the parties to
agree on certain  development  matters.  In  consideration of the rights granted
under the  Master  Agreement,  QSI is to pay the  Company a royalty of 6% of the
gross  revenues  received  from the sale of the  products  and 50% of the  gross
revenues  received from  sublicensing the rights granted to QSI under the Master
Agreement  after  QSI has  recouped  150% of the  costs  incurred  by QSI in the
development of the products in question. The Company is obligated to pay similar
royalties to QSI on its sale of the products and the licensing of rights covered
under the Master  Agreement  outside  the  utility  industry  and from sales and
licensing  within the  utility  industry  in the Far East.  In  addition  to the
foregoing  royalties,  QSI is to  pay an  exclusivity  fee  to  the  Company  of
$750,000; $250,000 of which QSI paid to the Company in June 1994. The balance is
payable in equal monthly  installments of $16,667 beginning in April 1995. QSI's
exclusive rights become  non-exclusive  with respect to all products if it fails
to pay any installment of the exclusivity fee when due and QSI loses such rights
with respect to any given product in the event it fails to make any  development
funding payment applicable to that product.  The Master Agreement supersedes all
other agreements  relating to the products  covered under the Master  Agreement,
including those agreements between the Company and QSI described above.

   Immediately following the execution to the Master Agreement,  the Company and
QSI entered into a letter agreement  providing for the termination of the Master
Agreement at the Company's election if QSI did not pay approximately $500,000 in
payables then owed to the Company by May 15, 1995.

   In April 1995,  the Company and QSI entered  into  another  letter  agreement
under  which QSI  agreed to  forfeit  and  surrender  the five year  warrant  to
purchase  750,000  shares of the Company's  common stock issued to QSI under the
first Marketing Agreement described above. In addition,  the $500,000 balance of
the  exclusivity  fee  provided  for under the Master  Agreement  was reduced to
$250,000 to be paid in 30 monthly installments of $8,333 each and the payment of
the  indebtedness  to be  paid  under  the  letter  agreement  described  in the
preceding  paragraph  was revised to be the earlier of May 15, 1996, or the date
of closing of a financing of QSI in an amount exceeding $1.5 million,  whichever
first occurs.  Such  indebtedness  is to be evidenced by a promissory  note, non
payment  of which is to  constitute  an event of  termination  under the  Master
Agreement.

   On May 21, 1996,  the Company and QSI entered into another  letter  agreement
extending the time by which the payments from QSI to the Company under the April
1995  letter  agreement  described  above were to be made.  Under the letter the
payment of certain  arrearages in the payment of the  exclusivity  fee was to be
made not later than June 15, 1996, with the balance  continuing to be payable by
monthly payments of $8,333 and as provided in the May 1995 letter agreement.  In
addition the payment of the other indebtedness owed by QSI to the Company was to
be paid by a payment  of $25,000 at the time QSI  obtained  certain  anticipated
financing with the balance paid by monthly payments of $15,000 each.  Default in
QSI's timely payment of any of the amounts  specified in the May 21, 1996 letter
agreement was to cause the immediate termination of the Master Agreement and all
rights granted to QSI thereunder.

   On April 9, 1997, the Company and QSI entered into another  letter  agreement
revising  the payment  schedule  set forth in the May 21, 1996 letter  agreement
applicable to the payment of the  indebtedness  owed to the Company by QSI other
than the unpaid portion of the exclusivity fee. Under the revised schedule,  the
full amount of such indebtedness is to be paid by an initial payment of $125,000
on or before April 21, 1997,  and a second  payment of $200,000 upon the closing
of a proposed  financing  in June 1997 or on January  1, 1998,  whichever  first
occurs.  The  Company is also  entitled  to receive  15% of any other  financing
obtained  by QSI in the interim as well as interest at the rate of 10% per annum
on the  unpaid  amount  of such  indebtedness  from  July 1,  1997.  The  letter
agreement also provides for the continuation of QSI's payment of the exclusivity
fee in accordance  with the earlier letter  agreements as well as the payment of
$11,108 by April 21, 1997,  for headset  products  sold by the Company to QSI in
1996.  In the event of a default in QSI's  timely  payment of any of the amounts
specified  in the April 9, 1997 letter  agreement,  the Company has the right to
cause the  termination  of the Master  Agreement  and all rights  granted by QSI
thereunder upon 10 days notice of termination to QSI.

   As of February 27, 1998,  QSI has paid all  installments  due and payable for
the  exclusivity  fee and owes the Company  $150,000 which was due on January 1,
1998 and is fully  reserved,  and other than as described  above,  owes no other
amounts to the Company.
<PAGE>

   Other Parties

   The President and Chief Executive Officer, who is also a stockholder of the
Company,  receives an  incentive  bonus equal to 1% of the cash  received by the
Company  upon the  execution of  agreements  or other  documentation  evidencing
transactions  with  unaffiliated  parties.  For the year ended December 31, 1997
approximately $243,000 was incurred in connection with this arrangement.


   During 1995, 1996 and 1997 the Company  purchased $0.5 million,  $0.6 million
and $0.7 million respectively,  of products from its various manufacturing joint
venture entities.


9. Income Taxes:

   The  Company  provides  for income  taxes in  accordance  with  Statement  of
Financial   Accounting   Standards  No.  109,  "Accounting  for  Income  Taxes".
Accordingly,  deferred tax assets and  liabilities are established for temporary
differences between tax and financial reporting bases of assets and liabilities.
A valuation allowance is established when the Company determines that it is more
likely than not that a deferred  tax asset will not be realized.  The  Company's
temporary  differences  primarily result from depreciation  related to machinery
and equipment,  compensation expense related to warrants,  options and reserves.
The  adoption  of  the  aforementioned  accounting  standard  had no  effect  on
previously reported results of operations.

   At  December  31,  1997,   the  Company  had  available  net  operating  loss
carryforwards of approximately $76.9 million and research and development credit
carryforwards  of $1.3 million for federal  income tax purposes  which expire as
follows:

                              (in thousands of dollars)
                                             Research and
                           Net Operating      Development
                Year          Losses            Credits
                          ----------------  ----------------
                1999                 $151               $ --
                2000                  129                 --
                2001                  787                 --
                2002                2,119                 --
                2003                1,974                 --
                2004                1,620                 --
                2005                3,870                141
                2006                1,823                192
                2007                6,866                118
                2008               13,456                321
                2009               16,293                413
                2010                9,386                 61
                2011                8,980                 67
                2012                9,457 (1)
                          ----------------   ----------------
                Total             $76,911             $1,313
                          ================   ================

   (1) Includes  approximately  $4.1 million net operating  loss relating to NCT
Audio Products, Inc.

   The Company's ability to utilize its net operating loss  carryforwards may be
subject to an annual  limitation.  The difference between the statutory tax rate
of 34% and the Company's  effective tax rate of 0% is due to the increase in the
valuation allowance of $1.4 million, $3.3 million and $3.0 million in 1995, 1996
and 1997, respectively.
<PAGE>

   The types of temporary  differences that give rise to significant portions of
the  deferred  tax  assets  and the  federal  and  state  tax  effect  of  those
differences as well as federal net operating  loss and research and  development
credit at December 31, 1996 and 1997 were as follows:

                                           (in thousands of
                                               dollars)
                                        ------------------------
                                          1996          1997
                                        ---------     ----------
    Accounts receivable                 $    281      $     207
    Inventory                                108            191
    Property and equipment                   187             68
    Accrued expenses                         243             69
    Stock compensation                     2,684          2,698
    Other                                    324            299
                                        ---------     ----------
       Total temporary differences      $  3,827          3,532
    Federal net operating losses          22,903         26,149
    Federal research and development       1,246          1,313
    credits
                                        ---------     ----------
                                        $ 27,976       $ 30,994
    Less: Valuation allowance            (27,976)       (30,994)
                                        ---------     ----------
       Deferred taxes                   $      -       $      -
                                        =========     ==========


   10.  Litigation:

   On or about June 15, 1995,  Guido  Valerio  filed suit against the Company in
the  Tribunal  of Milan,  Milan,  Italy.  The suit  requests  the Court to award
judgment in favor of Mr.  Valerio as follows:  (i)  establish and declare that a
proposed independent sales representation  agreement submitted to Mr. Valerio by
the Company and signed by Mr.  Valerio but not  executed by the Company was made
and entered  into  between Mr.  Valerio and the Company on June 30,  1992;  (ii)
declare that the Company is guilty of breach of contract and that the  purported
agreement  was  terminated  by  unilateral  and  illegitimate  withdrawal by the
company;  (iii) order the Company to pay Mr. Valerio $30,000 for certain amounts
alleged to be owing to Mr. Valerio by the Company; (iv) order the Company to pay
commissions  to which Mr.  Valerio  would have been  entitled if the Company had
followed up on certain alleged  contacts made by Mr. Valerio for an amount to be
assessed by technicians and  accountants  from the Court Advisory  Service;  (v)
order the  Company  to pay  damages  for the harm and  losses  sustained  by Mr.
Valerio in terms of loss of  earnings  and  failure to receive due payment in an
amount such as shall be determined following preliminary  investigations and the
assessment to be made by experts and accountants from the Court Advisory Service
and in any event no less than 3 billion Lire ($18.9 million); and (vi) order the
Company to pay  damages for the harm done to Mr.  Valerio's  image for an amount
such as the judge shall deem  equitable and in case for no less than 500 million
Lire  ($3.1  million).  The  Company  retained  an  Italian  law firm as special
litigation counsel to the Company in its defense of this suit. On March 6, 1996,
the  Company,  through  its  Italian  counsel,  filed a brief of reply  with the
Tribunal of Milan  setting  forth the  Company's  position  that:  (i) the Civil
Tribunal of Milan is not the proper venue for the suit, (ii) Mr. Valerio's claim
is  groundless  since the parties  never  entered into an  agreement,  and (iii)
because Mr.  Valerio is not enrolled in the official  Register of Agents,  under
applicable  Italian law Mr. Valerio is not entitled to any  compensation for his
alleged  activities.  A preliminary  hearing before the Tribunal was held on May
30, 1996,  certain pretrial  discovery has been completed and a hearing before a
Discovery  Judge was held on October 17, 1996.  Submissions of the parties final
pleadings  were to be  made in  connection  with  the  next  hearing  which  was
scheduled for April 3, 1997. On April 3, 1997,  the  Discovery  Judge  postponed
this hearing to May 19, 1998, due to reorganization  of all proceedings  pending
before the Tribunal of Milan.  Management  is of the opinion that the lawsuit is
without  merit and will  contest it  vigorously.  In the opinion of  management,
after consultation with outside counsel, resolution of this suit should not have
a material  adverse  effect on the Company's  financial  position or operations.
However,  in the event  that the  lawsuit  does  result in a  substantial  final
judgment against the Company,  said judgment could have a severe material effect
on quarterly or annual operating results.

   On September 16, 1997, Ally Capital  Corporation  ("Ally") filed suit against
the Company, John J. McCloy II, Michael J. Parrella, Jay M. Haft and Alistair J.
Keith in the United States  District Court for the District of Connecticut  (the
"District Court"). The complaint was not served on the Company until January 16,
1998,  and has yet to be served on the  individual  defendants.  The  individual
defendants  are current and former  officers and  directors of the Company.  The
complaint  alleges three (3) causes of action  arising out of an agreement  (the
"Asset Purchase  Agreement")  which the Company entered into with another entity
known as Active Noise and  Vibration  Technologies,  Inc.  ("ANVT")  whereby the
Company agreed to acquire ANVT's patented and unpatented  intellectual property,
the rights and obligations  under a defined list of agreements  between ANVT and
twenty-one  (21) other  parties (the "Listed  Parties")  relating to existing or
potential  joint  ventures,  licensing  and other  business  relationships,  and
certain items of office and laboratory equipment.  For these assets, the Company
paid ANVT two hundred thousand ($200,000.00) dollars and issued ANVT two million
(2,000,000)  shares of the Company's common stock. The Asset Purchase  Agreement
also provided ANVT with the right to certain contingent payments,  to the extent
the Company generated certain levels of revenue from joint venture, licensing or
other contractual  relationships with any of the Listed Parties.  Plaintiff Ally
is an  unsecured  creditor  of ANVT  and is not a party  to the  Asset  Purchase
Agreement;  however,  Ally asserts an interest to part of the consideration paid
ANVT by virtue of an escrow agreement  between ANVT and the escrow agent for the
benefit of ANVT's  secured  and  unsecured  creditors.  Ally  purports to allege
claims of fraud,  negligent  misrepresentation and a claim under the Connecticut
Unfair Trade Practice Act based upon purported representations made to ANVT, not
Ally. Thus, it is alleged that the Company  misrepresented to ANVT the Company's
financial  condition,  the number of shares it could  issue and the value of the
contingent payment rights under the Asset Purchase Agreement. In connection with
the claims, Ally seeks compensatory damages in excess of one million two hundred
thousand ($1,200,000.00)  dollars,  punitive damages and attorney fees. On March
4, 1998,  the  Company  served its motion to dismiss the  complaint  pursuant to
Federal Rule of Civil Procedure 12. The basis for the motion  include:  that the
summons and  complaint  were not served for more than one hundred  twenty  (120)
days  after the  complaint  was filed,  in  violation  of Federal  Rule of Civil
Procedure  4; that Ally lacks  standing to bring its claims as they are based on
purported representations made by the Company to ANVT, not Ally; that the claims
are legally insufficient under Connecticut law; and that plaintiff has failed to
join  necessary  parties,  ANVT and the escrow agent.  As no discovery has taken
place,  the  Company is unable to assess the  likelihood  of an adverse  result.
Management, however, believes it has meritorious defenses and intends a vigorous
defense of this  lawsuit.  However,  in the event this  lawsuit does result in a
substantial  final  judgment  against the Company,  said  judgment  could have a
severe material effect on quarterly or annual operating results.


   11.  Commitments and Contingencies:

   The Company is obligated for minimum annual rentals (net of sublease  income)
under  operating  leases for  offices,  warehouse  space and  laboratory  space,
expiring through April 2007 with various renewal options, as follows:

                                          (in thousands
                                           of dollars)
                 ----------------------  ----------------
                      Year Ending
                      December 31,           Amount
                 ----------------------  ----------------
                         1998                    $   436
                         1999                        437
                         2000                        296
                         2001                         77
                         2002                         63
                      Thereafter                     266
                                         ================
                         Total                    $1,575
                                         ================

   Rent expense (net of sublease income) was $0.8 million, $0.6 million and $0.4
million for each of the three  years ended  December  31,  1995,  1996 and 1997,
respectively.  During 1995, rent expense was paid, in part, through the issuance
of common stock (see Note 6).

   In April,  1996,  the Company  established  the Noise  Cancellation  Employee
Benefit Plan (the "Benefit Plan") which provides, among other coverage,  certain
health care benefits to employees  and directors of the Company's  United States
operations.  The Company  administers  this modified  self insured  Benefit Plan
through a  commercial  third  party  administrative  health care  provider.  The
Company's maximum aggregate benefit exposure in each Benefit Plan fiscal year is
limited to $1.0 million while combined individual and family benefit exposure in
each Benefit Plan fiscal year is limited to $35,000. Benefit claims in excess of
the above mentioned individual or the maximum aggregate stop loss are covered by
a commercial third party insurance  provider to which the Company pays a nominal
premium for the subject stop loss coverage.  The Company  records  benefit claim
expense in the period in which the benefit claim is incurred. As of February 27,
1998, the Company was not aware of any material benefit claim liability.

   On September 16, 1994, the Company  acquired the patents,  technology,  other
intellectual  property and certain related tangible assets of ANVT. In addition,
ANVT is entitled to a future contingent  earn-out based on revenues generated by
the  ANVT  contracts  assigned  to the  Company  as well  as  certain  types  of
agreements  to be entered into by the Company with parties  previously  having a
business  relationship with ANVT. Future  contingent  payments,  if any, will be
charged  against the  associated  revenues.  As of the period ended December 31,
1997, no such contingent earn-out or payments were due ANVT.
<PAGE>


   12.  Information on Business Segments:

   The Company operates in only one business  segment,  specifically  engaged in
the design, development,  production and distribution of electronic systems that
actively reduce noise and vibration.  The Company's worldwide activities consist
of operations in the United States, Europe and Japan. Revenue, (income) loss and
identifiable assets by geographic area are as follows:

                                  (in thousands of dollars)
                                         December 31,
                           -----------------------------------------
                              1995           1996          1997
                           ------------   ------------  ------------
    Revenues
       United States            $6,095         $2,674        $2,089
       Europe                    4,065            480         3,270
       Far East                    306             10           359
                           ------------   ------------  ------------
            Total              $10,466         $3,164        $5,718
                           ============   ============  ============
    Net (Income) Loss
       United States            $3,761         $9,752        $9,211
       Europe                      (36)           912           411
       Far East                    343            161           226
                           ------------   ------------  ------------
          Total                 $4,068        $10,825        $9,848
                           ============   ============  ============
    Identifiable Assets
        United States           $8,997         $5,366       $17,060
        Europe                     586            515           301
                           ------------   ------------  ------------
           Total                $9,583         $5,881       $17,361
                           ============   ============  ============




<PAGE>
                                                        


                                        SIGNATURES

      Pursuant  to the  requirements  of Section  13 or 15(d) of the  Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to report to
be signed on its behalf by the undersigned, thereunto duly authorized.

                        NOISE CANCELLATION TECHNOLOGIES, INC.


                        By:   /s/ CY E. HAMMOND
                              -------------------------------
                              Cy E. Hammond
                              Senior Vice President and
                              Chief Financial Officer

May 1, 1998