THIS DOCUMENT IS A COPY OF THE FORM 10-K FILED ON APRIL 1, 1998
     PURSUANT TO A RULE 201 TEMPORARY HARDSHIP EXEMPTION.

                             SECURITIES AND EXCHANGE COMMISSION
                                   WASHINGTON, D.C. 20549
                                         FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) 
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED       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                       (I.R.S. Employer or
incorporation organization)                           Identification No.)

1025 West Nursery Road, Suite 120,  Linthicum, MD.                 21090
(Address of principal executive offices)                          (Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:  None.

Securities registered pursuant to Section 12 (g) of the Act:  Common Stock, 
$.01 par value.

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed  by  Section  13 or 15 (d) of the  Securities  Exchange  Act of 1934
during the preceding 12 months (or for such shorter  period that the  Registrant
was  required  to file such  reports),  and (2) has been  subject to such filing
requirements for the past 90 days. X Yes No

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of Registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /

The  aggregate  market  value of the voting stock held by  nonaffiliates  of the
Registrant is $115.5 million as of March 23, 1998.

The number of shares outstanding of the Registrant's common stock is 132,938,948
as of March 23, 1998.

                            DOCUMENTS INCORPORATED BY REFERENCE.

     Portions of the Proxy  Statement for the Annual Meeting of  Stockholders to
      be held on June 29, 1998, are  incorporated  by reference into Part III of
      this Form 10-K.



<PAGE>


                                           PART I


ITEM 1.  BUSINESS

A.    General Development of Business

      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.

   In early 1998,  the Company  introduced  the GekkoTM  flat  speakers  and the
ClearSpeechTM  corporate  intranet  telephone software (the "I-Phone") which the
Company  believes  will have wide  application  in the audio and  communications
industries.  As part of its product line expansion  plans,  the Company plans to
introduce over 25 new products and associated  accessories  during the first six
months of 1998.

   In keeping with the  direction  established  in late 1994,  during 1997 the
Company continued the practice of marketing its technology  through licensing to
third  parties  for fees and  subsequent  royalties.  During  1997,  the Company
entered into ten new technology license agreements. See G. "Strategic Alliances"
and Note 3 - "Notes to Consolidated Financial Statements."

   In late 1995 the Company  redefined its corporate mission to be the worldwide
leader  in the  advancement  and  commercialization  of Active  Wave  Management
technology.   Active  Wave  Management  is  the  electronic   and/or  mechanical
manipulation of sound or signal waves to reduce noise,  improve  signal-to-noise
ratio and/or enhance sound quality.

   As  distribution  channels are  established  and as product  sales and market
acceptance  and  awareness  of the  commercial  applications  of  the  Company's
technologies  build,  revenues from  technology  licensing  fees,  royalties and
product  sales  are  forecasted  to fund an  increasing  share of the  Company's
requirements.  The revenues  from these  sources,  if realized,  will reduce the
Company's dependence on engineering and development  revenues.  This progression
is reflected in the revenue  percentages  discussed briefly below and more fully
in Item 7.  "Management's  Discussion  and Analysis of Financial  Condition  and
Results of Operations."

   From the Company's inception through December 31, 1997,  approximately 23% of
its  operating  revenues  have  come  from the sale of  products  and 31% of its
operating revenues have come from licensing of the Company's  technology,  while
approximately  46% of its  operating  revenues  have come from  engineering  and
development services.

   Active noise control offers many advantages over traditional  passive methods
of noise control such as  conventional  mufflers,  ear protectors and acoustical
padding.  Active noise control systems: (i) generally reduce only unwanted noise
and permit  desired  sounds such as the human voice,  music or warning  tones to
pass freely,  (ii) are more successful in attenuating low frequency noise, (iii)
contribute  to energy  savings and provide  other  economic  benefits in various
applications, and (iv) generally are smaller and lighter.

   Active Wave Management is the utilization of active noise control  technology
and certain other  technologies  which results in the  electronic and mechanical
manipulation of sound or signal waves to reduce noise,  improve  signal-to-noise
ratio and/or enhance sound quality.

   NCT believes  that it has a  significant  position in Active Wave  Management
technology, holding 256 patents and an extensive portfolio of know-how and other
unpatented technology.

     The Company has entered  into a number of strategic  supply,  manufacturing
and marketing  alliances  with leading  global  companies to  commercialize  its
technology. These strategic alliances historically have funded a majority of the
Company's  research and  development,  and  provided  the Company with  reliable
sources  of  components,  manufacturing  expertise  and  capacity,  as  well  as
extensive   marketing  and   distribution   capabilities.   NCT  has  continuing
relationships  with  Walker  Manufacturing  Company  ("Walker")  (a  division of
Tennessee Gas Pipeline Company, a wholly owned subsidiary of Tenneco,  Inc.), AB
Electrolux ("Electrolux"),  Analog Devices, Inc. ("ADI"), Ultra Electronics Ltd.
("Ultra"),  The  Charles  Stark  Draper  Laboratory,  Inc.  ("Draper"),  Applied
Acoustic Research,  L.L.C.  ("AAR"),  Hoover Universal,  Inc. ("Hoover") and New
Transducers,  Ltd.  ("NXT"),  among others,  in order to penetrate major markets
more  rapidly  and  efficiently,  while  minimizing  the  Company's  own capital
expenditures.

   In March 1995,  the Company and Ultra  amended  their  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.

   On November  15,  1995,  the Company and Walker  executed a series of related
agreements (the "Restructuring  Agreements")  regarding the Company's commitment
to help fund $4.0  million of product and  technology  development  work and the
transfer of the  Company's  50%  interest in WNCT to Walker.  The  Restructuring
Agreements  provided  for the  transfer  of the  Company's  interest in WNCT (an
equally  owned  partnership  between  Walker and the  Company)  to  Walker,  the
elimination  of  the  Company's  previously  expensed  obligation  to  fund  the
remaining $2.4 million of product and technology  development work, the transfer
to Walker of certain  Company owned  tangible  assets related to the business of
WNCT, the expansion of certain  existing  technology  licenses and the Company's
performance  of  certain  research  and  development  activities  for  Walker at
Walker's expense as to future activities.

   An important factor for the Company's  continuing  development is its ability
to recruit and retain key personnel.  As of February 28, 1998 the Company had 85
employees,  including 47 engineers and technical  staff.  Among its  engineering
staff and  consultants  are several  scientists  and inventors  that the Company
believes  are  preeminent  in the  active  noise  and  vibration  control  field
worldwide.

   The Company was  incorporated  in Nevada on May 24, 1983. In April 1985,  the
Company  moved its  corporate  domicile to Florida and assumed its present name,
and in January 1987,  following the  assumption of control of the Company by the
present  management,  it changed its state of incorporation  to Delaware.  NCT's
executive offices, research and product development facility are located at 1025
West Nursery Road, Suite 120, Linthicum,  Maryland 21090; telephone number (410)
636-8700. NCT maintains sales and marketing offices at 1 Dock Street, Suite 300,
Stamford,  Connecticut  06902;  telephone  number (203) 961-0500.  The Company's
European  operations are conducted through its product development and marketing
facility in  Cambridge,  England.  NCT also  maintains  a marketing  facility in
Tokyo, Japan.

B.    Business Strategy

   The Company  revised its strategy and redefined  its mission  during 1994 and
1995,  expanding its  technology  development  into areas outside of traditional
active noise and vibration  control in order to address  markets  having greater
opportunities  such as  communications  and audio.  The  acquisition  of certain
assets  and all of the  intellectual  property  of Active  Noise  and  Vibration
Technologies,  Inc. ("ANVT")  broadened the Company's  portfolio of intellectual
property  and removed  restrictions  on the Company  regarding  licensing of the
Chaplin Patents (see C. "Technology") to unaffiliated third parties. The Company
can now license the Chaplin  Patents  directly to  unaffiliated  third  parties,
which provides the Company with a greater ability to earn  technology  licensing
fees and royalties from such patents. Thus, while the Company continues to focus
on products  which the Company  believes will generate near term revenue,  it is
increasing its emphasis on technology licensing fees and royalties. Further, the
Company is working  continuously  to lower the cost of its  products and improve
their technological performance.

C.    Technology

   Active  noise  attenuation  is not a new idea.  Creating a mirror image of an
unwanted noise or sound wave and using it to cancel or reduce the original sound
wave dates  back to the early part of this  century.  The first  systems  used a
simple "delay and invert" approach and showed some promise,  but the prohibitive
cost of computing power and the inadequacy of acoustics and related technologies
limited their effectiveness.

   In the mid-1970's,  a major  breakthrough  took place with the application of
adaptive  filters  to  generate  anti-noise.   These  filters  allowed  for  the
development of active control systems that could  continuously  adapt to changes
in noise output both in the external world and from control components. A second
breakthrough  in the  mid-1970's  was  made  by  Professor  G.B.B.  Chaplin.  He
recognized that many noise sources,  particularly  machines,  exhibit "tonal" or
repetitive  noise.   Chaplin  further  recognized  that  the  predictability  of
repetitive  noise  allows for  creation  of an accurate  anti-noise  signal and,
therefore, more effective cancellation or attenuation.

   Practical  application  of this  technology  was  still not  possible  as the
electronic  technology available at the time was insufficient for implementation
of active noise reduction systems.  Since that time, digital computer technology
has evolved to the point where cost-effective microprocessors,  known as digital
signal processors ("DSP") can perform the complex calculations involved in noise
cancellation  and  reduction.  This advance has made it feasible to apply active
noise reduction to previously  unsolveable  problems in low frequency noise at a
reasonable cost.

  Active Noise  Reduction.  Active  noise  reduction  systems are  particularly
effective at reducing low frequency noise. As opposed to a passive noise control
system  that is  designed  to mask a  noise,  active  noise  control  removes  a
significant  portion of the noise energy from the  environment by creating sound
waves that are equal in frequency but opposite in phase. The illustration  below
shows the relationship, in time, of a noise signal, an anti-noise signal and the
residual noise that results when they meet.
                          ACTIVE NOISE REDUCTION


                            [Graphic Omitted]


   Active Wave  Management.  Active Wave Management is the combination of active
noise reduction  technology and certain other  technologies which results in the
electronic  and/or  mechanical  manipulation  of sound or signal waves to reduce
noise, improve signal-to-noise ratio and/or enhance sound quality.

   Signal  Enhancement.  Active Wave  Management  technology also can be used to
attenuate  unwanted  signals that enter into a communications  network,  as when
background  noise enters  telecommunications  or radio  systems from a telephone
receiver, or microphone. The Company has developed patented technology that will
attenuate the background  noise  "in-wire",  so that the signals  carried by the
communications  network include less of the unwanted noise, allowing the speaker
to be heard more clearly over the network.  An application of this technology is
in-wire  attenuation  of siren noise over two-way radio  communications  between
emergency vehicles and dispatchers at hospitals and police or fire stations.

   Silicon Micromachined  Microphone (SMM). In 1994, NCT purchased the exclusive
rights to manufacture and commercialize a silicon micromachined  microphone as a
technically  superior and less  expensive  alternative  to  currently  available
electret microphones. The SMM has potential applications not only in the audible
range of frequencies, but in the ultrasonic range as well.

   Adaptive Speech Filter ("ASF").  The adaptive speech filter algorithm removes
noise from voice  transmissions.  ASF  parameters  can be  adjusted  to optimize
performance  for a particular  noise,  or can be set to provide noise  reduction
across  a wide  range  of  noises.  ASF  applications  include  teleconferencing
systems,   cellular  telephones  and  "airphones",   telephone  switches,   echo
cancellers, and communications systems in which background noise is predominant.
ASF is currently  available  for use on three  hardware  platforms.  The Company
added an echo cancellation algorithm to its Windows-based ACM version of ASF and
has begun testing.

   NCT Audio. The Company has expanded its flat panel  transducer  technology to
include audio systems for the  reproduction of speech and music.  The Company is
developing Top Down Surround  SoundTM  ("TDSS") for the automobile audio market,
in both original equipment manufacturer ("OEM") and after-market versions.  TDSS
employs  FPT(TM)  to  produce  sound  much  closer  to the  listener's  ear than
conventional speakers. This placement and revolutionary  technology allows for a
"sweet space" listening experience as opposed to a conventional speaker system's
"sweet spot"  listening  experience.  The Company has also  developed flat audio
speaker products utilizing FPT(TM) technology for commercial and consumer use.

D.    NCT Proprietary Rights and Protection

   NCT holds a large number of patents and patent  applications.  The  Company's
intellectual  property  strategy  has  been  to  build  upon  its  base  of core
technology  patents  with  newer  advanced   technology  patents  developed  by,
purchased by or  exclusively  licensed to the Company.  In many  instances,  the
Company  has  incorporated  the  technology  embodied in its core  patents  into
patents covering specific product  applications,  including the products' design
and  packaging.  The Company  believes  this  building-block  approach  provides
greater  protection  to the Company  than relying  solely on the  original  core
patents. As its patent holdings increase, the Company believes the importance of
its core patents will diminish from a competitive viewpoint.

   During 1994 the Company  purchased certain assets of ANVT, which included all
of ANVT's  intellectual  property rights.  Among the ANVT intellectual  property
rights were ANVT's interest in the 10 basic Chaplin Patents which are now solely
owned by NCT as the sole shareholder of CPH. These patents cover inventions made
by  Professor  G.B.B.  Chaplin in the late 1970s and early  1980s (some of which
have now expired).

   The  Chaplin  Patents  form only one group of core  patents  upon which NCT's
technology is based. In March 1990, the Company acquired exclusive  ownership of
10 patents  developed  under the auspices of the National  Research  Development
Corporation ("NRDC"), an organization sponsored by the British Government. Among
other things, the NRDC Patents,  of which the Swinbanks and Ross patents are the
most  important,  utilize the  adaptive  feed  forward  approach to active noise
control.  The  Swinbanks  patent  covers an  improved  method of  analyzing  the
incoming  noise or vibration  through the use of a "frequency  domain"  adaptive
filter  which  splits the  incoming  noise into  different  frequency  bands for
analysis and  recombines the data to generate the  anti-noise  signal.  The Ross
patent  covers  the use of a "time  domain"  filter  which  uses input and error
signals to enhance a system's  ability to compensate for feedback from actuators
to sensors.  Without this filter, the system will detect and begin canceling its
own self-generated anti-noise.

   The  Company  has built  upon these core  patents  with a number of  advanced
patents and patent  applications.  These include the Digital  Virtual  Earth(TM)
patent,  which covers digital  feedback  control,  and patents on  multi-channel
noise control.  The Company has also applied for patents on combined feedforward
and  feedback  control,  control  using  harmonic  filters,  filters  for signal
enhancement and speech filtering, control systems for noise shaping and others.

   As part of the purchase of certain ANVT assets,  the Company acquired all the
rights to nine inventions  previously  belonging to the Topexpress  Group in the
United Kingdom. The international patent coverage of these inventions varies but
eight have been granted  patent  protection  with numerous  counterpart  foreign
applications still pending.  Among the other intellectual property acquired from
ANVT are  patents  relating  to  active  auto  mufflers  and  noise  suppression
headrests,  several patent applications on advanced algorithms, and active noise
headsets,  many related  disclosures  and various  disclosures in other areas of
active  attenuation of noise and vibration.  Additionally,  the Company acquired
the rights to three basic inventions known as the Warnaka Patents.

   In 1994,  the  Company  obtained a license  for the  exclusive  rights to the
silicon  micromachined  microphone  technology developed by Draper in Cambridge,
Massachusetts.  At this time, two patents  describing the basic  technology have
been issued and one is pending.

   In 1995 the Company  acquired  several U.S. patents dealing with ASF which is
used in the Company's Clear Speech(TM) product line.

     In 1996 and 1997 the  Company  was  granted 90 new  patents in the field of
Active Wave Management.

   The Company  holds or has rights to 256  inventions  as of December 31, 1997,
including 96 United States patents and over 245  corresponding  foreign patents.
The Company has pending 177 US and foreign patent applications.  NCT's engineers
have made 122 invention  disclosures  for which the Company is in the process of
preparing  patent  applications.  The  Company's  presently  owned  patents have
expiration  dates which will occur  during the years 1998  through 2015 with the
majority occurring during or after 2009.

   No assurance can be given as to the range or degree of protection  any patent
issued to, or  licensed  by, the  Company  will  afford or that such  patents or
licenses  will  provide  protection  that has  commercial  significance  or will
provide competitive  advantages for the Company's products.  No assurance can be
given that the  Company's  owned or  licensed  patents  will  afford  protection
against  competitors  with  similar  technology,  or that others will not obtain
patents  claiming  aspects  similar to those covered by the  Company's  owned or
licensed patents or patent applications.  No assurance exists that the Company's
owned or licensed patents will not be challenged by third parties,  invalidated,
rendered  unenforceable  or  designed  around.  Furthermore,  there  can  be  no
assurance  that any pending patent  applications  or  applications  filed in the
future will result in the issuance of a patent. The invalidation, abandonment or
expiration  of patents  owned or licensed  by the  Company  and  believed by the
Company to be commercially significant could permit increased competition,  with
potential adverse effects on the Company and its business prospects.

   Annuities and maintenance  fees for the Company's  extensive patent portfolio
are a significant portion of the Company's annual expenses.  If, for the reasons
described in Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations -- "Liquidity and Capital Resources" below, it becomes
necessary  for the Company to reduce its level of  operations,  the Company will
not be able to continue to meet the extensive  monetary outlay for annuities and
maintenance  fees to  keep  all  the  patents  and  applications  from  becoming
abandoned and will have to prioritize its portfolio accordingly.

   The Company has conducted only limited patent  searches and no assurances can
be given  that  patents  do not exist or will not be issued in the  future  that
would have an adverse effect on the Company's  ability to market its products or
maintain its  competitive  position  with respect to its  products.  Substantial
resources  may be  required  to obtain  and defend  patent  and other  rights to
protect present and future technology and other property of the Company.

   The Company has been granted the following trademarks:

         Mark               Field of Use      
      NCT logo              company logo
      NoiseBuster(R)        headsets
      NoiseEater(R)         HVAC systems

   The Company has also applied for 22 trademarks including:

         Mark                          Field of Use
      NoiseBuster Extreme!(TM)         headsets
      Variactive(TM)                   headsets
      FPT(TM)                          flat panel transducers
      ClearSpeech(TM)                  adaptive speech filter products
      Gekko(TM)                        flat audio speakers
      Sweet Space(TM)                  flat audio speakers
      Sound Gallery(TM)                flat audio speakers
      ProActive(TM)                    headsets
      Top Down Surround Sound(TM)      vehicular audio speakers

  No  assurance  can be  given as to the  range or  degree  of  protection  any
trademark  issued to, or  licensed  by,  the  Company  will  afford or that such
trademarks or licenses will provide protection that has commercial  significance
or will provide competitive  advantages for the Company's products. No assurance
can be given  that  the  Company's  owned or  licensed  trademarks  will  afford
protection against competitors with similar products or trademarks. No assurance
exists that the Company's owned or licensed trademarks will not be challenged by
third parties, invalidated, or rendered unenforceable. Furthermore, there can be
no assurance that any pending  trademark  applications or applications  filed in
the  future  will  result in the  issuance  of a  trademark.  The  invalidation,
abandonment  or expiration  of  trademarks  owned or licensed by the Company and
believed by the Company to be commercially  significant  could permit  increased
competition,  with  potential  adverse  effects on the Company and its  business
prospects.

   The Company has conducted only limited  trademark  searches and no assurances
can be given  that  trademarks  do not exist or will not be issued in the future
that  would  have an  adverse  effect on the  Company's  ability  to market  its
products or maintain its  competitive  position  with  respect to its  products.
Substantial  resources may be required to obtain and defend  trademark rights of
the Company.

   The Company's policy is to enter into confidentiality  agreements with all of
its executive officers,  key technical personnel and advisors, but no assurances
can be made that Company  know-how,  inventions  and other secret or unprotected
intellectual property will not be disclosed to third parties by such persons.


E.    Existing Products

      NCT Hearing Products

   MRI  Headphones.  Since 1991,  the Company has been  producing  active  noise
reduction  headsets for use by patients  undergoing  MRI  procedures.  NCT's MRI
headphone   reduces  the  noise   generated  by  the   gradient   coils  of  the
superconducting MRI magnet. This noise is known to be disturbing to patients and
is a factor in a  patient's  ability to tolerate  the  scanning  procedure.  The
Company's  product is an  implementation  of a patented  technology owned by NCT
which  permits the  delivery  of  anti-noise  signals and music  directly to the
patient  while the patient is in the bore of the MRI scanner.  While  undergoing
the MRI  examination,  a patient can be communicated  with by the doctor or scan
operator through NCT's system.  The Company is a supplier to Siemens,  a leading
manufacturer of MRI machines in the U.S.

   NoiseBuster   Extreme!(TM).   NCT  is  currently  marketing  its  NoiseBuster
Extreme!(TM)  personal  active  noise  reduction  headphone  for  consumers at a
suggested  retail  price  of $69.  This  active  headphone  selectively  reduces
unwanted  noise  generated  by aircraft  engines,  lawnmowers,  street  traffic,
household  appliances and other  annoying noise sources,  permitting the user to
hear desired sounds, such as human  conversation,  warning signals or music. The
NoiseBuster  Extreme!(TM) is a lightweight,  portable headphone wired to a small
controller  that can be clipped to the user's  clothing or belt.  The controller
pack accepts two AAA batteries for a minimum of 100 hours continuous  operation.
The  NoiseBuster  Extreme!(TM)  contains a port where the  consumer  can plug in
personal  audio  devices such as a radio,  tape player or compact disc player so
the user can enjoy music while in a noisy setting.  The product can also be used
with an aircraft's in-flight entertainment system.

   The Company is marketing  the  NoiseBuster  Extreme!TM  through  distribution
channels, including electronics retail stores, specialty catalogues and directly
through a toll-free  "800"  number.  Initial  product  shipments of the original
NoiseBuster(R) were made in September 1993. Product shipments of the NoiseBuster
Extreme!(TM) began during the first quarter of 1997.

   The NoiseBuster Extreme!(TM) line is being expanded to include communications
headsets for cellular,  multimedia and telephony. The products will be the first
ANR offerings for these applications and will improve speech  intelligibility in
the presence of background noise.
Product shipments began during the first quarter of 1998.

   NB-AVC.  In August 1994, the Company began shipping an active noise reduction
communications  headset  specifically  designed for use by  commercial  aviation
pilots. The product is FAA-TSO certified and sold by Telex as the Airman ANR. At
6.9 oz,  one-third  the weight of other active  noise  reduction  headsets,  the
Airman  ANR  is the  first  ultra-lightweight,  open-back  headset  of its  kind
developed for the general aviation market.  A  high-performance  noise canceling
electret microphone is connected to a flexible boom. The controller pack accepts
four AA batteries for a minimum of 40 hours continuous operations and includes a
belt clip.

   ProActive(TM)  1000/1500.  In March 1995,  the  Company  began  shipping  its
ProActive(TM)  1000 headphones and ProActive(TM) 1500  communications  headsets.
These products are lightweight, open-back in style and can provide up to 20dB of
active noise reduction between  30-1200Hz.  When used in work settings dominated
by  low-frequency  noise,  these products  improve  comfort,  reduce fatigue and
improve  concentration  and  productivity  for  the  user.  In the  case  of the
ProActive(TM) 1500 two-way and mobile  communications  version,  the clarity and
intelligibility  of  communications  is  improved  when the  masking  effect  of
background noise is reduced.  These products are powered by a rechargeable NICAD
battery  designed  for use during a 12-hour  work day.  The battery  fits into a
small,  lightweight belt-pack that can be clipped onto the belt. The battery can
be recharged  overnight using NCT's personal  charger which is included with the
product.

   ProActive(TM)  3000/3500. In August 1995, the Company expanded its industrial
headset product line to include the  ProActive(TM)  3000 series.  These products
combine active noise reduction of low-frequency noise with a closed-back passive
ear muff,  appropriate for general  industrial use. This is the first product of
its kind in which the active  electronics  as well as the power source have been
totally  integrated  into the  earmuff,  providing  the user with  mobility  and
safety. The electronics are powered by a NICAD rechargeable battery specifically
designed  for use  during a  12-hour  work day.  The  battery  can be  recharged
overnight using NCT's personal charger.  The  ProActive(TM)  3000 active earmuff
and  ProActive(TM)  3500  active  communications  earmuff  address  the  hearing
protection requirements of a variety of industries.

   ProActive(TM)   3100/3600.   In  December  1995,  the  Company   announced  a
behind-the-head  version of its ProActive(TM)  3000 line for use with hard hats.
This is the first  implementation  of active noise reduction  earmuffs in a hard
hat  style  and will  address  the  needs of  industries  such as  construction,
utilities  and  others  requiring  both  hearing  protection  and hard  hats for
workers. Product shipments commenced in the second quarter of 1996.

   NB-PCU.  The Company is working with a leading  manufacturer  and supplier of
aircraft  cabin  products  on the  integration  of NCT's  active  noise  control
technology into in-flight passenger entertainment systems. As a component of the
system, NCT has also developed a low-cost headset specifically for in-flight use
to be used in conjunction  with the  integrated  electronics.  NCT's  technology
electronically  reduces  aircraft engine noise while enhancing the audibility of
desired sounds like speech, music and warning signals. Lowering the engine drone
can help alleviate the anxiety and fatigue often  associated with flying.  While
the  system  is in use,  passengers  inside  an  aircraft  cabin  can  carry  on
conversations at a comfortable  level or hear in-flight movies and music without
over  amplification  and distortion.  Installation of this product in commercial
airliners commenced during the fourth quarter of 1997.


      NCT Communications

   Adaptive Speech Filter ("ASF").  ASF removes  background noise from voice and
data  transmission  and  recognition.  Available in real-time  double  precision
fixed-point  DSP,  floating-point  DSP,  and  Windows  95/Windows  NT ACM driver
versions,  ASF can be used as a  pre-processor  for voice  and data  compression
algorithms,  and also  contributes  to  improved  voice  and  data  recognition.
Additional  uses  include  teleconferencing  systems,  cellular  and  airphones,
telephone  switches,   echo  cancellers  and  communications  systems  in  which
background noise is predominant.

      ClearSpeech(TM).  NCT has introduced its  ClearSpeech(TM)  line of digital
communications   accessories.   These  products  employ  the  NCT  patented  ASF
technology  to cancel  background  noise from  either  transmitted  or  received
speech.  These  products can be used with  hands-free  cellular  phone  cradles,
two-way  radios,  AM/FM  radios,  SMR  networks and speaker  phones.  Users will
benefit from clearer, more intelligible conversations,  free of background noise
and other transmission interference.

   Gekko(TM)  Flat  Speaker.  In  January,  1998,  the  Company  introduced  the
Gekko(TM) Flat Speaker  product line for home theater and home audio.  Gekko(TM)
Flat Speakers  feature the Company's  FPT(TM)  patented audio  technology  which
evenly disperses  high-quality sound and a unique, slim design for wall mounting
as picture frames with quality artwork.  The Gekko(TM) Flat Speaker received the
Best of Showcase Honoree award in the home theater category from Innovations '98
at the 1998  International  Winter  Consumer  Electronics  Show in Las  Vegas in
January,  1998. Initial product shipments are expected to commence in the second
quarter 1998.

     Revenues

      Product Revenues

   The following  table sets forth the percentage  contribution  of the separate
classes of the Company's products to the Company's product revenues for the year
ended December 31, 1997.

                            (000's)       As a %
             Products        Amount     of Total
             --------       -------     --------
         Hearing Products    $1,652        96.0%
         Communications          27         1.6%
         Other                   41         2.4%
                            --------   ----------
               Total         $1,720       100.0%
                            ========   ==========

      Technology Licensing Fees

   The following  table sets forth the percentage  contribution  of the separate
classes of the Company's  technology to the Company's  technology  licensing and
royalty revenue for the year ended December 31, 1997.

                           (000's)        As a %
          Technology        Amount      of Total
          ----------       -------      --------
        Audio               $3,000         82.6%
        Communications         345          9.5%
        Microphones            200          5.6%
        Other                   85          2.3%
                           -------      --------
             Total          $3,630        100.0%
                           =======      ========


F.  Products Under Development

     NCT Hearing Products

   Advanced  Digital  Electronic  Headsets.  NCT is working to develop  advanced
headset models using its proprietary  digital  technology.  Management  believes
that there is a broad market for specialty  industrial headsets that will permit
factory and assembly  workers to operate close to loud  machinery in the marine,
steel, textile, paper, construction,  road building and metalworking industries,
among others.  Conventional ear muffs and protectors are not as effective as the
Company's  active  headsets,  which can selectively  block machinery noise while
allowing  the  worker to listen to  ordinary  human  communications  and,  where
appropriate,  to hear warning signals, tones or bells. The Company is working to
develop headset models that will operate on a lightweight,  rechargeable battery
pack, thus allowing the worker to move freely about the factory.

     NCT Communications

   ClearSpeech(TM)  Product Line.  There are several  additional  communications
products under  development.  Design  improvements are being made to the current
ClearSpeech(TM)  product line to improve  market  penetration.  NCT is exploring
relationships with chip manufacturers to develop custom integrated  circuits for
the ASF  technology  to reduce the cost of the  ClearSpeech(TM)  product line as
well as for use as a new product.

     NCT Microphones

   Silicon Micromachined  Microphone ("SMM"). In 1994, NCT obtained a license to
the exclusive  rights to manufacture and  commercialize a silicon  micromachined
microphone.  A  small,  compact,  surface-mountable  silicon  actuator,  the SMM
provides customers with improved and adjustable  sensitivity,  a low noise floor
and resistance to environmental  extremes.  The ability to integrate  additional
circuitry on the SMM chip has also proven  attractive  to potential  users.  The
SMM's low noise floor and adjustable  sensitivity  improve voice  recognition in
high  ambient  noise  environments.  NCT is working  with voice  processing  and
computer  hardware  companies to utilize the SMM to enhance the  performance  of
their systems.  In the first quarter of 1996, NCT released initial prototypes of
the  devices.   In  December,   1997,   the  Company   announced   that  Siemens
Semiconductors  of  Siemens  AG  ("Siemens")  had  licensed  the  Company's  SMM
technology  and that  Siemens  would  develop,  manufacture  and market the SMM.
Samples  are  expected  to be  available  in the fourth  quarter  1998.  Initial
production is scheduled to commence in the first quarter 1999.

     NCT Audio

   Top Down Surround Sound(TM).  TDSS is a novel automobile audio speaker system
developed  by the  Company.  Initial  demonstrations  and  listener  tests  have
indicated  a high  degree  of  enthusiasm  for  the  "sweet  space"  which  TDSS
generates.  The Company has established a joint venture,  OnActive, with AAR and
Hoover for the automobile audio speaker market.

     Small Fans

   Household  Appliances.  NCT has developed  fan quieting  systems for multiple
applications,  including a quiet  kitchen hood fan and a quiet  vacuum  cleaner.
NCT's active fan systems are designed with higher  efficiency than  conventional
fans and have  demonstrated  up to a 30%  reduction  in energy  usage.  The cost
sensitivity of the consumer  appliance  marketplace  has been a barrier to prior
introduction of this technology.  As a result of  relationships  NCT enjoys with
its component supply joint venture partners, the Company believes that the price
sensitivity issues of consumer product markets may be addressed in the near-term
as  miniaturization  of the  technology  continues  and the  unit  cost of NCT's
electronic  components  continues  to decline.  Management  believes  that NCT's
proprietary  technology  will be incorporated in a wide range of other products,
including air conditioners, dishwashers, clothes washers and dryers, hair dryers
and other types of fans.

     Panels and Enclosures

   Electric  Utility  Transformers.  Electric  power  distribution  by utilities
requires  the  use of  large  transformers,  often  placed  in  residential  and
commercial neighborhoods, which emit a low frequency "hum" that irritates people
living and working  nearby.  Utilities try to mask this noise by passive  means,
although  usually  not very  successfully.  The  Company  has  developed  active
enclosure and active panel systems which reduce the "hum" of  transformer  noise
by use of flat  actuators  that  cause the  enclosure  or panels to vibrate in a
manner to reduce the noise.  The Company can  install  its active  panel  system
directly to the metal sides or "skin" of an installed  transformer,  thus making
its systems available to retrofit markets as well as to OEMs. As an alternative,
an active enclosure can be built to house the transformer.

   In March 1995, the Company entered into an agreement with QuietPower Systems,
Inc., ("QSI") (see Item 13. "Certain Relationships and Related Transactions" and
Note 8 - "Notes to the Consolidated Financial Statements") by which QSI received
the  exclusive  rights  to  market,  sell and  distribute  transformer  quieting
products and gas turbine quieting  products in the utility  industry.  Under the
agreement QSI funds development of the systems. The agreement generally provides
that the Company manufactures the products and receives a royalty of 6% from QSI
on the sales of the products.

G. Strategic Alliances

   The Company's  transition  from a concern  primarily  engaged in research and
development  to one engaged in the licensing  production,  marketing and sale of
Active Wave Management  systems has been  facilitated by the  establishment  and
maintenance  of  strategic  alliances  with  major  domestic  and  international
business  concerns.  In exchange for the benefits to such concerns' own products
offered by the Company's  technology,  these  alliances under the terms of their
joint  venture  agreements  or  licenses  provide  marketing,  distribution  and
manufacturing  capabilities for the Company's products and enable the Company to
limit the expense of its own research and  development  activities.  In order to
ensure  dependable  sources of supply and to maintain  quality  control and cost
effectiveness  for  components  and  integrated  circuits  incorporated  in  the
Company's  systems,  an important element of the Company's  strategy has been to
identify and enter into alliances with  integrated  circuit  manufacturers  that
will develop and produce  custom-made  chips for NCT product  applications,  and
with  manufacturers of components that will supply and integrate  components for
NCT systems. The following is a summary of the Company's key alliances:



<PAGE>



---------------------------------------------------------------------
                                 Date Initial
                                 Relationship
   Key Strategic Alliances       Established        Applications
------------------------------- --------------- ---------------------

Walker Manufacturing Company      Nov. 1989     Mufflers,
(a division of Tennessee Gas                    Industrial
Pipeline Company)                               Silencers and Other
                                                Vehicular
                                                Applications

AB Electrolux                     Oct. 1990     Consumer Appliances



Ultra Electronics, Ltd.           June 1991     Aircraft Cabin
                                                Quieting Systems

Analog Devices, Inc.              June 1992     Integrated Circuits
                                                and Related Products

The Charles Stark Draper          July 1994     Microphones
Laboratory, Inc.

Applied Acoustic Research,        Aug. 1995     TDSS
L.L.C.

Hoover Universal, Inc.             May 1996     TDSS
(a wholly owned subsidiary of
Johnson Controls, Inc.)

New Transducers Ltd.              Mar. 1997     FPT(TM)

Oki Electronic Industry Co.       Oct. 1997     Communications
Ltd.

Siemens AG                        Dec. 1997     Microphones

VLSI Technology, Inc.             Feb. 1998     Communications
---------------------------------------------------------------------


     Walker Manufacturing Company (a division of Tennessee Gas Pipeline Company)
(U.S.) Walker Electronic Mufflers,  Inc. (A wholly owned subsidiary of Tennessee
Gas Pipeline Company) (U.S.)

   In  November  1989,  NCT  signed  its  strategic   alliance  with  Walker,  a
world-leading  manufacturer  of  automotive  parts and  mufflers.  The  alliance
consisted of a Joint Venture and  Partnership  Agreement  with  ownership in the
resulting joint venture WNCT shared equally between NCT Muffler, Inc. and Walker
Electronic  Mufflers,  Inc. ("WEM"),  a wholly owned subsidiary of Tennessee Gas
Pipeline Company. On November 15, 1995, the Company and Walker executed a series
of related agreements (the "Restructuring  Agreements") that provided for, among
other matters, the transfer of the Company's 50% interest in WNCT to Walker, the
transfer  to Walker of certain  Company  owned  tangible  assets  related to the
business of WNCT and the expansion of certain existing technology licenses. WNCT
is currently  producing  and selling  industrial  silencers on which the Company
receives a royalty.

      AB Electrolux (Sweden)

   The  Company's  relationship  with  Electrolux,  one of the  world's  leading
producers of white goods,  was initiated in October 1990. The Company signed its
current agreement with Electrolux,  a Joint Development and Supply Agreement, in
June 1991. This agreement provides for NCT to design,  develop and supply active
systems for quieting Electrolux products.  Electrolux has agreed to purchase the
electronic  components for its active noise control  products  exclusively  from
NCT,  provided the Company and its supply  joint  ventures are price and quality
competitive.  To date, NCT has completed  development of two household appliance
products for Electrolux. No date has been established for product introduction.

      Ultra Electronics Ltd. (U.K.)

   Since 1991, NCT and Ultra and its predecessor,  part of the Dowty Group, have
been designing and developing  systems to enhance  passenger comfort by quieting
aircraft  passenger  compartments in certain  propeller driven  aircraft,  which
Ultra sells to the worldwide  turbo-prop aircraft market. In May 1993, Ultra and
the  Company  signed a teaming  agreement  to produce  and install the NCT cabin
quieting system on the SAAB 340 aircraft.  Deliveries under this agreement began
in 1994. In March 1995, the Company and Ultra amended the teaming  agreement and
concluded a licensing and royalty agreement for $2.6 million. In addition, Ultra
will pay the Company a royalty of 1 1/2% of sales of products  incorporating NCT
technology beginning in 1998.

     Analog Devices, Inc. (U.S.)

   In June 1992,  NCT and ADI formed an equally  owned joint  venture to design,
develop,  and  manufacture  computer chips to be  incorporated  in the Company's
active noise and vibration  control  systems.  ADI is a leading  manufacturer of
precision,  high-performance  integrated  circuits  used in analog  and  digital
signal  processing  applications.  Under the terms of the  agreement,  ADI, as a
subcontractor to the joint venture,  will complete the design and development of
specialized chips incorporating NCT's technology.

      The Charles Stark Draper Laboratory, Inc. (U.S.)

   In July 1994, NCT and Draper Laboratory of Cambridge,  Massachusetts  entered
into an  agreement  whereby NCT became the  exclusive  licensee to a new silicon
micromachined  microphone  developed by Draper. Under terms of the agreement and
subsequent  agreements,  Draper will  perform  engineering  services  for NCT to
further develop the technology.  The microphone  technology has application in a
wide variety of applications within the acoustic and communications fields.

      Applied Acoustic Research, L.L.C, (U.S.)

   In December, 1995, NCT and AAR of State College,  Pennsylvania formed a joint
venture, OnActive Technologies,  L.L.C. ("OAT"), to commercialize advanced audio
applications, such as FPTTM and TDSS, into total audio systems and solutions for
the ground based vehicle market. Both partners, who initially owned equal shares
of the joint venture,  have licensed their  proprietary  technology to the joint
venture.

   In May, 1996,  Hoover  Universal,  Inc., a wholly owned subsidiary of Johnson
Controls,  Inc.  ("JCI")  acquired a 15% equity interest in OAT for $1.5 million
and acquired  rights to certain of the Company's and AAR's related patents for a
total of $1.5  million,  half of which was paid to the Company and half of which
was paid to AAR.

      New Transducers Ltd (UK).

   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 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 from NXT and the  Company  will  receive
royalties  on future NXT  licensing  and  product  revenue.  On April 15,  1997,
Verity, NXT and the Company executed several agreements and other documents (the
"New Agreements")  terminating the Cross License, and certain related agreements
and replacing them with a new cross license (the "New Cross  License"),  and new
related agreements. The material changes effected by the New Agreements included
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.  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 a related  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  included  an  expansion  of  the  fields  of use  applicable  to the
exclusive  licenses  granted to Verity and NXT and an increase in the  royalties
payable on future licensing and product revenues.

      Oki Electronic Industry Co., Ltd. (`Oki")

   In October, 1997, the Company and Oki executed a license agreement. Under the
terms of the  agreement  which  included an up-front  license fee and future per
unit royalties,  Oki licensed the Company's  ClearSpeech(TM)  noise cancellation
algorithm   for   integration   onto   large-scale   integrated   circuits   for
communications   applications.   The  Company  has  granted  Oki  the  right  to
manufacture, use and sell products incorporating the algorithm. The algorithm is
specifically   designed  to  remove  background  noise  from  speech  and  other
transmitted   signals,   greatly  improving   intelligibility   and  clarity  of
communications.

      Siemens Semiconductors, Siemens AG ("Siemens")

   In  December,  1997,  the Company and Siemens  executed a license  agreement.
Under the terms of the  agreement,  which  included an up-front  license fee and
future per unit royalties,  Siemens licensed the Company's SSM and will develop,
manufacture and market such microphones as surface  mountable  devices.  The SMM
technology delivers  microphone  technology on a silicon chip, a breakthrough in
the microphone marketplace. Siemens and the Company have targeted the SMM to the
multimedia,  cellular phone, wireless phone, voice recognition and other related
markets.  The  SMM's  small  chip  dimensions  of only 3 mm on each side make it
useful for packaging  into products with tight size  constraints,  such as noise
cancelling ear plugs and hearing aids.

      VLSI Technology, Inc. ("VLSI")

   In February,  1998, the Company and VLSI executed a license agreement.  Under
the terms of the agreement,  which included up-front development fees and future
per  unit  royalties,   VLSI  licensed  the  Company's   ClearSpeech(TM)   noise
cancellation  and echo  cancellation  algorithms for use with VLSI's current and
future  integrated  circuits  targeted  to the  digital  cellular  and PCS phone
market, as well as emerging computer telephony  markets.  The noise cancellation
algorithm is specifically  designed to remove  background  noise from speech and
other  transmitted  signals,  greatly improving  intelligibility  and clarity of
communications.  The echo  cancellation  algorithm  cancels  acoustical echo for
hands-free telephony operations including cellular and speaker phones.

H.    Marketing and Sales

   In addition to marketing its Active Wave  Management  technology  and systems
through its strategic  alliances as described above, the Company has an internal
sales and  marketing  force of  seventeen  people,  its  executive  officers and
directors,  and eight independent sales  representatives.  The independent sales
representatives may earn commissions of generally up to 6% of revenues generated
from sales of NCT products to customers  introduced to NCT by them, and up to 5%
of research and development funding revenues provided by such customers.  During
1997 and through  February  1998,  the Company  expanded its internal  sales and
marketing force by nine, from eight to seventeen professionals and will continue
to expand its internal sales force on a limited basis as the need dictates.

   Note  12 - "Notes  to the  Consolidated  Financial  Statements"  sets  forth
financial  information relating to foreign and domestic operations and sales for
the years ended December 31, 1997, 1996 and 1995.

   The Company does not have a significant  foreign  exchange  transaction  risk
because the majority of its non-U.S.  revenue is in U.S. dollars.  The remaining
revenue is in British pounds sterling and the Company's  underlying cost is also
in pounds sterling creating a natural foreign exchange protection.

I.    Concentrations of Credit Risk

   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 gross 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.

   Financial  instruments which potentially subject the Company to concentration
of  credit  risk  consist  principally  of cash and cash  equivalents  and trade
receivables.  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.

J.  Competition

   The Company is aware of a number of direct competitors in the field of Active
Wave Management.  Indirect competition also exists in the field of passive sound
and vibration attenuation. The Company's principal competitors in active control
systems include Andrea Electronics Corporation,  Bose Corporation,  Digisonix (a
division of Nelson  Industries,  Inc.),  Group Lotus PLC and Lotus Cars Limited,
Lord  Corporation,   Matsushita  Electric   Industrial  Co.,  Ltd.,   Sennheiser
Electronic Corp. and Sony  Corporation,  among others.  The Company's  principal
competitors in other fields of Active Wave Management  include IBM  Corporation,
Lucent Technologies, Inc. and Texas Instruments,  Incorporated. To the Company's
knowledge,  each of such  entities  is  pursuing  its own  technology  in active
control  systems,  either on its own or in  collaboration  with others,  and has
recently  commenced attempts to commercially  exploit such technology.  NCT also
believes that a number of other large companies,  such as the major domestic and
foreign communications,  computer,  automobile and appliance manufacturers,  and
aircraft  parts  suppliers  and  manufacturers,  have  research and  development
efforts  underway  in Active  Wave  Management  and active  noise and  vibration
control. Many of these companies, as well as the Company's potential competitors
in the passive sound and vibration  attenuation  field and other  entities which
could enter the active noise and vibration attenuation field and other fields of
Active Wave Management as the industry  develops,  are well established and have
substantially greater management,  technical,  financial,  marketing and product
development resources than the Company.

K.  Government Contracts

   The Company has acted as a government  subcontractor  in connection  with its
performance of certain engineering and development  services.  No such contracts
were in effect during 1997.  Government contracts provide for their cancellation
at  the  government's  sole  discretion,   in  which  event  the  contractor  or
subcontractor may recover its actual costs up to the date of cancellation,  plus
a specified profit percentage. Governmental expenditures for defense are subject
to the political process and to rapidly changing world events, either or both of
which may result in significant reductions in such expenditures in the proximate
future.  Government  contracts  are  not  viewed  as a  significant  part of the
Company's business.

L.  Research and Development

     Company-sponsored   research  and  development   expenses  aggregated  $6.2
million,  $7.0 million and $4.8 million for the fiscal years ended  December 31,
1997, 1996 and 1995, respectively.




M.  Environmental Regulation Compliance

   Compliance with Federal,  state and local provisions regulating the discharge
of materials into the  environment,  or otherwise  relating to the protection of
the   environment,   does  not  have  any  material   effect  upon  the  capital
expenditures, earnings or competitive position of the Company.

   Compliance by existing and  potential  customers of the Company with Federal,
state and local laws and  regulations  pertaining to maximum  permissible  noise
levels  occurring from the operation of machinery or equipment or the conduct of
other activities could be beneficial to sellers of noise reduction  products and
enhance demand for certain  applications of the Company's  technology as well as
products  developed or to be developed by the Company.  However,  at the present
time it is too  early  to  determine  what  quantitative  effect  such  laws and
regulations will have on the sale of the Company's products and technology.

N.  Employees

   The Company had 85 employees on February 28, 1998.  None of such employees is
represented  by a labor union.  The Company  considers  its  relationships  with
employees to be satisfactory.


ITEM 2.  PROPERTIES

   The  Company's  executive  office is located at the site of its  research and
technical   support   laboratory  in  Linthicum,   Maryland,   where  it  leases
approximately  40,000  square feet of space under  leases  which  expire in July
2000. The leases provide for current monthly rentals of  approximately  $35,000,
subject to annual inflationary adjustments

   The Company  maintains a sales and marketing office in Stamford,  Connecticut
where it leases  approximately  5,000  square  feet of space under a lease which
expires  in  December  2001  and  provides  for  a  current  monthly  rental  of
approximately $5,000.

   The Company's United Kingdom  operations are conducted in Cambridge,  England
where it leases 12,500 square feet of space under a lease which expires in March
1999, and provides for a current monthly rental of approximately $14,000.




<PAGE>


ITEM 3.  LEGAL PROCEEDINGS

   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 15, 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
isrepresented 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.  On March 16,  1998,  Ally  filed a notice of  voluntary
dismissal as to the individual defendants,  Messrs. McCloy,  Parrella,  Haft and
Keith.  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.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

     There  were no matters  submitted to a vote of security holders during the
fourth quarter of the year ended December 31, 1997.




<PAGE>


                                          PART II

ITEM 5.MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

(a) The Company's Common Stock is currently traded on the NASDAQ National Market
System under the symbol "NCTI".  High and low last sale information for 1997 and
1996 for the Common Stock for specified quarterly periods is set forth below:

                          1997                   1996
                    ----------------    --------------------
                     HIGH       LOW       HIGH          LOW
      1st Quarter    29/32      3/8        7/8         17/32
      2nd Quarter    15/32     7/32      1 5/32        21/32
      3rd Quarter    1 1/8     7/32       15/16         5/8
      4th Quarter   2 1/32     9/16       11/16        11/32


(b)  At December 31, 1997, there were approximately 4,500 record holders of the
Company's Common Stock.

(c)  The  Company has neither  declared nor paid any dividends on its shares of
common  stock  since  inception.  Any  decisions  as to the  future  payment  of
dividends will depend on the earnings and financial  position of the Company and
such  other  factors  as the Board of  Directors  deems  relevant.  The  Company
anticipates that it will retain earnings,  if any, in order to finance expansion
of its operations.

(d)  See Item 7 - "Management's  Discussion and Analysis of Financial Condition
and Results of Operations - Overview" for a description  of the Company's  sales
of unregistered securities during the year ended December 31, 1997.


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.



<PAGE>




                                  (In Thousands of Dollars and Shares)
                                        Years Ended December 31,
                          ------------------------------------------------------
                             1993       1994       1995      1996       1997
                          ------------------------------------------------------
STATEMENTS OF OPERATIONS
DATA:
REVENUES
 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)    3,582(1)    1,824        (80)       80         --
loss of unconsolidated
affiliates
 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)
Less:
 Preferred stock         
   dividend requirement        -           -         -         -      1,623
 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      87,921   101,191   124,101     82,906
                        ==========    =======  =======   =======     ======
Basic and Diluted Net
   loss per share       $  (0.24)(1)  $(0.26)  $ (0.05)  $ (0.11)    $ (.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  
(deficiency)                  19,990        923      1,734    (1,312)    11,696


(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.




<PAGE>


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS

      Forward Looking Statements

   Statements in this filing which are not historical facts are  forward-looking
statements under provisions of the Private  Securities  Litigation Reform Act of
1995.  All  forward-looking  statements  involve  risks and  uncertainties.  The
Company wishes to caution readers that the following  important  factors,  among
others,  in some  cases  have  affected,  and in the future  could  affect,  the
Company's  actual  results and could cause its actual results in fiscal 1998 and
beyond  to  differ  materially  from  those  expressed  in  any  forward-looking
statements made by, or on behalf of, the Company.

   Important  factors  that could  cause  actual  results  to differ  materially
include but are not limited to the Company's ability to: achieve  profitability;
achieve a competitive position in design, development, licensing, production and
distribution of electronic  systems for Active Wave  Management;  produce a cost
effective  product  that will gain  acceptance  in relevant  consumer  and other
product  markets;   increase  revenues  from  products;   realize  funding  from
technology  licensing  fees,  royalties,  product  sales,  and  engineering  and
development revenues to sustain the Company's current level of operation; timely
introduce new products;  continue its current level of operations to support the
fees  associated  with the Company's  patent  portfolio;  maintain  satisfactory
relations  with its  five  customers  that  accounted  for 71% of the  Company's
revenues  in 1997;  attract  and retain  key  personnel;  prevent  invalidation,
abandonment or expiration of patents owned or licensed by the Company and expand
its patent  holdings to diminish  reliance on core  patents;  have its  products
utilized beyond noise attenuation and control; maintain and expand its strategic
alliances;  and  protect  Company  know-how,  inventions  and  other  secret  or
unprotected intellectual property.

      Overview

   The  Company  is  continuing  the  transition  initiated  in 1995 from a firm
focused  principally  on research and  development  of new  technology to a firm
focused on the  commercialization of its technology through technology licensing
fees,  royalties  and product  sales.  Prior to 1995,  the  Company  derived the
majority of its revenues from  engineering and development  funding  provided by
established  companies  willing to assist the Company in the  development of its
active noise and vibration  control  technology,  and from technology  licensing
fees paid by such companies. The Company's strategy generally has been to obtain
technology  licensing fees when initiating joint ventures and alliances with new
strategic  partners.  Revenues  from  product  sales  were  limited  to sales of
specialty products and prototypes.  In 1997, the Company received  approximately
6% of its operating revenues from engineering and development funding,  compared
with 17% in 1996.  Since 1991,  revenues from product sales have  generally been
increasing,  although in 1996 product sales  declined  slightly due to delays in
production  and reduced  pricing of certain  products.  In 1997,  revenues  from
product  sales  resumed its  year-to  year  increase.  Management  expects  that
technology licensing fees, royalties and product sales will become the principal
source of the  Company's  revenue  as the  commercialization  of its  technology
proceeds.

   As a result of the 1994  acquisition  of certain  ANVT  assets,  the  Company
became the  exclusive  licensee of ten  seminal  patents,  the Chaplin  Patents,
through its wholly owned  subsidiary,  CPH. The Company's ability to license the
Chaplin Patents directly to unaffiliated third parties provides the Company with
a greater  ability to earn  technology  licensing  fees and royalties  from such
patents.  Further, the Company believes that its intellectual property portfolio
prevents other competitors and potential competitors in the field of Active Wave
Management from  participating in certain commercial areas without licenses from
the Company.

     Subsequent  paragraphs  in  this  "Overview"),  Note 1 to the  accompanying
Consolidated  Financial  Statements and the  "Liquidity  and Capital  Resources"
section which  follows  describe the current  status of the Company's  available
cash balances.

     As  previously   disclosed,   the  Company   implemented   changes  in  its
organization  and focus in late  1994.  Additionally,  in late 1995 the  Company
redefined its corporate  mission to be the worldwide  leader in the  advancement
and  commercialization  of  Active  Wave  Management  technology.   Active  Wave
Management is the electronic and/or  mechanical  manipulation of sound or signal
waves to reduce  noise,  improve  signal-to-noise  ratio  and/or  enhance  sound
quality. This redefinition is the result of the development of new technologies,
as previously noted, such as ASF, TDSS, FPT(TM),  and the SMM, which the Company
believes can produce  products for fields beyond noise and  vibration  reduction
and control.  These  technologies  and products are consistent with shifting the
Company's focus to technology licensing and product marketing in more innovative
industries  having  greater  potential  for near term  revenue  generation.  The
redefinition  of corporate  mission is reflected  in the revised  business  plan
which the Company  began to implement  during the first  quarter of 1996 and has
continued through 1997.

  As  distribution  channels are  established  and as product  sales and market
acceptance  and  awareness  of the  commercial  applications  of  the  Company's
technologies  build as  anticipated  by  management,  revenues  from  technology
licensing fees, royalties and product sales are forecasted to fund an increasing
share  of the  Company's  requirements.  The  funding  from  these  sources,  if
realized,  will reduce the Company's  dependence on engineering  and development
funding.  The beginning of this process is shown in the shifting  percentages of
operating revenue, discussed below.

   In January 1996, the Company  adopted a plan that  management  believed would
generate  sufficient funds for the Company to continue its operations into 1997.
The  Company  did not meet the plan's  revenue  targets  for 1996 or 1997 and as
noted  below,  found it  necessary  to raise  additional  capital  to fund  it's
operations for 1997 and beyond (refer to "Liquidity and Capital Resources" below
and to Notes 1 and 6 - "Notes to the Consolidated Financial Statements.").

   Success in generating  technology licensing fees, royalties and product sales
are  significant  and  critical to the  Company's  success.  The Company  cannot
predict whether it will be successful in obtaining market  acceptance of its new
products or in completing its current  negotiations with respect to licenses and
royalty revenues.

   From the  Company's  inception  through  December  31,  1997,  its  operating
revenues,  including technology licensing fees and royalties,  product sales and
engineering  and  development  services,  have  consisted of  approximately  23%
product  sales,  46%  engineering  and  development  services and 31% technology
licensing fees.

   The  Company  has  entered   into  a  number  of  alliances   and   strategic
relationships  with established firms for the integration of its technology into
products.  The speed with which the Company can achieve the commercialization of
its  technology  depends in large  part upon the time  taken by these  firms and
their  customers  for  product  testing,  and  their  assessment  of how best to
integrate  the  Company's   technology   into  their  products  and  into  their
manufacturing  operations.  While the Company  works with these firms on product
testing and  integration,  it is not always able to  influence  how quickly this
process can be completed.

   The Company began  shipping  ProActive(TM)  headsets in 1995 and continues to
sell  NoiseBuster  Extreme!(TM)  consumer  headsets.  The Company is now selling
products  through three of its alliances:  Walker is  manufacturing  and selling
industrial  silencers;  Siemens is buying and  contracting  with the  Company to
install quieting  headsets for patient use in Siemens' MRI machines;  and in the
fourth quarter of 1994 Ultra began  installing  production  model aircraft cabin
quieting systems in the SAAB 340 turboprop  aircraft.  Management believes these
developments  and  those  previously  disclosed  help  demonstrate  the range of
commercial  potential for the Company's  technology  and will  contribute to the
Company's  transition from  engineering and development to technology  licensing
fees, royalties and product sales.

   The  availability  of  high-quality,   low-cost  electronic   components  for
integration   into   the   Company's   products   also   is   critical   to  the
commercialization of the Company's  technology.  The Company is working with its
strategic  partners  and  other  suppliers  to  reduce  the size and cost of the
Company's  systems,  so  that  the  Company  will  be  able  to  offer  low-cost
electronics and other components suitable for high-volume production.

   The Company has continued to make  substantial  investments in its technology
and  intellectual  property and has incurred  development  costs for engineering
prototypes,  pre-production models and field testing of several products. During
1994,  the  Company   acquired  a  license  to  two  patents  in  the  field  of
micro-machined  microphones and concluded the acquisition of all of the patents,
know-how and intellectual property of a former competitor, ANVT. During 1995 the
Company  acquired  several U.S.  patents dealing with adaptive speech  filtering
which is used in the  Company's  ClearSpeech(TM)  product line. In 1996 and 1997
the Company was granted 90 new patents for various  applications in the field of
Active Wave Management. Management believes that the Company's investment in its
technology has resulted in the expansion of its intellectual  property portfolio
and improvement in the functionality, speed and cost of components and products.

   The  Company  has  become   certified  under  the   International   Standards
Organization  product quality program known as "ISO 9000",  and has successfully
undergone two quality  audits.  Since the third quarter of 1994, the Company has
reduced its worldwide  work force by 51% from 173 to 85 current  employees as of
February 28, 1998.

   Because the Company  did not meet its revenue  targets for 1996 and 1997,  it
entered into certain transactions, which provided additional funding as follows:

     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 16.3 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 which
$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  quarter 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 July 30, 1997, in a private placement pursuant to Section 4(2) of the Act,
the Company sold 2.9 million shares, in the aggregate,  of its common stock at a
price of $0.175 per share that  provided  net  proceeds  to the  Company of $0.5
million (the "July 30, 1997 Private Placement").

     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 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 was
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.  Such Registration  Statement was filed with the SEC on
December 29, 1997. 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 following formula (the "Conversion Formula"):

                                     [(.04) x (N/365) x (1,000)] + 1,000
                                               Conversion Price

      where

            N           = the number of days between (i) the Closing Date of the
                        Series C Convertible  Preferred  Stock being  converted,
                        and (ii) the Conversion Date thereof.

            Conversion
            Price       = 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 Series C  Convertible  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.

            Closing
            Date        =  the  date  of  the   Closing  as  set  forth  in  the
                        subscription   agreement  pertaining  to  the  Series  C
                        Convertible Preferred Stock being converted.


   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.  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.

     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  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.

     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.


     Results of Operations

Year ended December 31, 1997 compared with year ended December 31, 1996.

   Total  revenues in 1997 increased by 81% to $5.7 million from $3.2 million in
1996.  Total expenses  during the same period  increased by 11% or $1.6 million,
primarily   reflecting  the  one-time  $1.4  million  non-cash  interest  charge
associated  with the First  Quarter 1997  Financing.  See Note 6 - "Notes to the
Consolidated Financial Statements."

   Technology  licensing fees and royalties increased by 193% or $2.4 million to
$3.6 million from $1.2 million in 1996. The 1996 amount was derived  principally
from  numerous  technology  license fees  reflecting  the  Company's  continuing
emphasis  on  expanding  technology  license  fee  revenue.  The 1997  amount is
primarily due to the $3.0 million  technology  license fee from Verity and other
technology  licensing fees aggregating $0.6 million.  See Note 3 - "Notes to the
Consolidated Financial Statements".

   Product  sales  increased in 1997 by 25% to $1.7 million from $1.4 million in
1996  reflecting  increases in  NoiseBuster  Extreme!(TM)  and aviation  headset
sales.

  Engineering  and development  services  decreased by 33% to $0.4 million from
$0.5  million  in  1996,   primarily  due  to  the  de-emphasis  of  engineering
development funding as a primary source of revenue for the Company.

   Cost of product sales increased 44% to $2.3 million from $1.6 million in 1996
and the  product  margin  decreased  to (32)% from (15)% in 1996.  The  negative
margin of $0.6  million in 1997 was  primarily  due to  reserves  for  inventory
movement and tooling  obsolescence  in the amount of $0.7 million related to the
industrial  headset product lines. The negative margin in 1996 was primarily due
to a  lower  sales  price  of  the  NoiseBuster(R)  and a  reserve  for  tooling
obsolescence in the amount of $0.3 million.

   Cost of engineering  and development  services  increased 26% to $0.3 million
from $0.2  million  in 1996  primarily  due to the  de-emphasis  of  engineering
development  funding  as a primary  source of revenue  for the  Company as noted
above.

   Selling,  general and administrative expenses for the year increased by 7% or
$0.3 million to $5.2 million from $4.9 million for 1996 which was  primarily due
to increased professional fees and related expenses.

   Depreciation and amortization included in selling, general and administrative
expenses  decreased  from  $0.5  million  in 1996 to  $0.4  primarily  due to an
increase in fully depreciated machinery and equipment.

   Research  and  development  expenditures  for 1997  decreased  by 11% to $6.2
million  from $7.0  million in 1996,  primarily  due to limited  cash  resources
during most of 1997 to fund internal development projects.

   In 1997,  interest  income  increased  to $0.1 million from near zero in 1996
reflecting the increase in late 1997 of available funds to invest.

   Under all of the Company's  existing  joint venture  agreements at the end of
1997,  the Company was not  required to fund any capital  requirements  of these
joint ventures beyond its initial capital contribution.  In accordance with U.S.
generally accepted accounting principles, 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 of
accounting for its investment.

   The  Company  has net  operating  loss  carryforwards  of $76.9  million  and
research and development credit carryforwards of $1.3 million for federal income
tax purposes at December 31, 1997. No tax benefit for these operating losses has
been recorded in the Company's  financial  statements.  The Company's ability to
utilize  its net  operating  loss  carryforwards  may be  subject  to an  annual
limitation.

Year ended December 31, 1996 compared with year ended December 31, 1995.

   Total  revenues in 1996  decreased by 70% to $3.2 million from $10.5 in 1995.
Total  expenses  during  the  same  period  decreased  by  4% or  $0.5  million,
reflecting the continuing  results of cost reduction  plans,  and the refocus of
expenditures to more immediate markets.

   Technology  licensing  fees decreased by 81% or $5.3 million to $1.2 million.
The 1995 amount was derived  principally  from a $2.6  million  license fee from
Ultra, a $ 3.3 million  license fee from Walker and other  licenses  aggregating
$0.7  million.  The 1996 amount is derived from smaller,  more numerous  license
fees,  reflecting  the  Company's  continuing  emphasis on expanding  technology
licensing fee revenue and the  shortfall in generation of such revenue  referred
to above. See Note 3 - "Notes to the Consolidated Financial Statements".

   Product sales decreased by 13% to $1.4 million reflecting  decreased aviation
headset sales, decreased  NoiseBuster(R) sales at lower prices and a decrease in
industrial  silencer  sales in connection  with the transfer of that business to
Walker.

   Engineering  and  development  services  decreased  by 76% to  $0.5  million,
primarily due to a de-emphasis of engineering  development  funding as a primary
source of revenue,  the  elimination  of funding from Ultra for  aircraft  cabin
quieting in connection  with the transfer of that business to Ultra in the first
quarter of 1995,  a decrease in the amount of muffler  development  funding from
Walker in connection  with the transfer of that business to Walker in the fourth
quarter of 1995 and staff reductions.

   Cost of product sales  remained  unchanged at $1.6 million and product margin
decreased to (15)% from 1% in 1995.  The negative  margin in 1996 was  primarily
due to the lower  sales  price of the  NoiseBuster(R)  and a reserve for tooling
obsolescence in the amount of $0.3 million.  In 1995, the low product margin was
primarily due to the lower sales price of the NoiseBuster(R).

     Cost of engineering and development  services decreased 89% to $0.3 million
primarily due to the changes noted above.

   Selling, general and administrative expenses for the year decreased by 10% to
$4.9  million  from $5.4 million for 1995.  Of this  decrease,  $0.6 million was
directly   attributable   to  reductions  in  salaries  and  related   expenses.
Advertising   and  marketing   expenses   decreased  by  32%  to  $0.5  million.
Professional  fees  increased by 6% to $1.8  million.  Travel and  entertainment
increased by 18% or $0.1 million.

   Depreciation and amortization included in selling, general and administrative
expenses  increased by $0.3 million or 143%,  from $0.2 million to $0.5 million,
primarily due to increased amortization of patents allocated to selling, general
and administrative expenses from research and development.

   Research  and  development  expenditures  for 1996  increased  by 46% to $7.0
million from $4.8  million for 1995,  primarily  due to increases to  internally
funded development projects.

   In 1996,  interest  income  decreased  to near zero from $0.1 million in 1995
reflecting the decrease in 1996 of available funds to invest.

   Under all of the Company's  existing  joint venture  agreements at the end of
1997,  the Company was not  required to fund any capital  requirements  of these
joint ventures beyond its initial capital contribution.  In accordance with U.S.
generally accepted accounting principles, 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 of
accounting for its investment.  As of December 31, 1995, the Company  recognized
$80,000 of income  relating to its 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.

      Liquidity and Capital Resources

   The  Company  received  $1.1  million  from the  exercise  of stock  purchase
warrants and options during 1997, $1.0 million in 1996 and $0.7 million in 1995.

   In January 1996, the Company  adopted a plan that  management  believed would
generate  sufficient funds for the Company to continue its operations into 1997.
The  Company  did not meet the plan's  revenue  targets  for 1996 or 1997 and as
noted  below,  found it  necessary  to raise  additional  capital  to fund  it's
operations  for  1997 and  beyond  (refer  to  Notes  1 and 6 - "Notes  to the
Consolidated Financial Statements.").

   Because the Company  did not meet its  revenue  targets for 1997,  it entered
into certain transactions, which provided additional funding as follows:

     Between January 15, 1997 and March 25, 1997, the Company issued and sold an
aggregate  amount of $3.4 million of the  Debentures  in 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 16.3 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 which
$34,000  which was  expensed as debt  discount.  The Company has  recorded  $1.4
million of non-cash  interest  expense  attributable  to the  conversions of the
Debentures in the first and second  quarter 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 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 FPTs(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  on  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
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 the
Subscription  Agreements  to sell an  aggregate  amount of $13.3  million of the
Preferred  Stock  in 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 was  required  to  exercise  its best  efforts to file a
Registration  Statement 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  Registration  Statement  was filed with the SEC on December 29,
1997.  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 described above under "Overview".

   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.  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.

     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  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.

     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.

   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.  These  losses,  which include the
costs for development of products for commercial use, have been funded primarily
from the sale of common stock,  including the exercise of warrants or options to
purchase  common  stock,  and  by  technology   licensing  and  engineering  and
development  funds  received  from joint venture and other  strategic  partners.
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
alliances be paid on a preferential  basis to the Company's  co-venturers  until
the license fees and engineering  and development  funds provided to the venture
or the Company are recovered.

     In January 1998, the Company adopted a plan that management believes should
generate sufficient  additional funds for the Company to continue its operations
into 1999.  Under this plan, the Company needs to generate  approximately  $31.5
million to fund its operations in 1998. Included in such amount is approximately
$23.3  million  in sales of new  products  and  approximately  $8.1  million  of
technology  licensing  fees and  royalties.  The  Company  believes  that it can
generate these funds from 1998  operations,  although there is no certainty that
the Company will achieve this goal. Success in generating  technology  licensing
fees,  royalties and product sales are significant and critical to the Company's
ability to succeed.  The Company cannot predict whether it will be successful in
obtaining  market  acceptance of its new products or in  completing  its current
negotiations  with  respect to licenses  and royalty  revenues.  If,  during the
course of 1998,  management of the Company  determines that it will be unable to
meet or  exceed  the plan  discussed  above,  the  Company  will  consider  cost
reductions and/or additional  financing  alternatives.  The Company will monitor
its  performance  against the plan on a monthly basis and, if necessary,  reduce
its  level  of  operations  accordingly.  The  Company  believes  that  the plan
discussed above  constitutes a viable plan for the continuation of the Company's
business into 1999. See "Forward Looking Statements" above.

     There can be no  assurance  that  additional  funding  will be  provided by
technology licensing fees, royalties, product sales, engineering and development
revenue or additional capital. In that event, the Company would have to cut back
its  level  of  operations  substantially  in  order  to  conserve  cash.  These
reductions  could have an adverse  effect on the  Company's  relations  with its
strategic  partners  and  customers.  See  Note 1 - "Notes  to the  Consolidated
Financial Statements".

   At December 31,  1997,  cash and cash  equivalents  were $12.6  million.  The
available  resources were invested in interest bearing money market accounts and
commercial paper. The Company's  investment objective is preservation of capital
while earning a moderate rate of return.

   The Company's  working capital  increased from $(1.3) million at December 31,
1996, to $11.7 million as of December 31, 1997.  This increase was due primarily
to the 1997 financings discussed above.

   During 1997, the net cash used in operating activities was $7.4 million. This
utilization  reflects  the  emphasis  on  the  commercial   development  of  its
technology   into  several  product   applications   which  were  scheduled  for
introduction in 1997 and 1998.

   The  Company's  available  cash balances at December 31, 1997 are higher than
projected at the end of 1996, primarily due to the 1997 financings noted above.

   The net cash used in investing activities amounted to $0.2 million during the
year  primarily  for capital  expenditures.  The net cash  provided by financing
activities  amounted to $19.9 million primarily from the exercise of options and
warrants and the 1997 financings noted above.

   The Company has no lines of credit with banks or other  lending  institutions
and therefore has no unused borrowing capacity.

   The Company believes that the level of financial resources available to it is
an  essential  competitive  factor.  The Company  may elect to raise  additional
capital,  from  time to  time,  through  equity  or debt  financing  in order to
capitalize on business opportunities and market conditions.

     Capital Expenditures

   The Company intends to continue its business strategy of working with supply,
manufacturing,   distribution  and  marketing   partners  to  commercialize  its
technology.  The benefits of this strategy  include:  (i) dependable  sources of
electronic and other  components,  which  leverages on their  purchasing  power,
provides  important  cost savings and accesses the most  advanced  technologies;
(ii) utilization of the manufacturing capacity of the Company's allies, enabling
the Company to  integrate  its active  technology  into  products  with  limited
capital   investment;   and  (iii)  access  to   well-established   channels  of
distribution and marketing capability of leaders in several market segments.

   There were no material  commitments  for capital  expenditures as of December
31, 1997, and no material commitments are anticipated in the near future.

   Year 2000 Compliance

   The Company  believes  the cost of  administrating  its Year 2000  Compliance
program will not have a material adverse impact on future earnings. However, the
potential  costs and  uncertainties  associated  with any Year  2000  Compliance
program will depend on a number of factors, including software, hardware and the
nature of the industry in which the Company,  its  subsidiaries,  suppliers  and
customers  operate.  In addition,  companies must coordinate with other entities
with which they electronically interact, such as customers, suppliers, financial
institutions, etc.

   Although the Company's  evaluation of its systems is still in process,  there
has been no indication  that the Year 2000  Compliance  issue,  as it relates to
internal  systems,  will have a material  impact on future  earnings.  While the
Company  is not  aware  of any  material  Year  2000  Compliance  issues  at its
customers and suppliers,  such potential problems remain a possibility and could
have a material adverse impact on the Company's future results.


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


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
         ACCOUNTING AND FINANCIAL DISCLOSURE.

   There have been no disagreements  with independent  accountants on accounting
and financial disclosure matters.


<PAGE>


                                          PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

   The  following  table sets forth the names,  ages,  positions and the offices
held by each of the executive  officers and directors of the Company as of March
31, 1998:


     Name              Age             Positions and Offices

Jay M. Haft            62   Chairman of the Board of Directors
Michael J. Parrella    50   President and Director
Irene Lebovics         45   Senior Vice President, Marketing
Cy E. Hammond          43   Senior Vice President, Chief Financial Officer
John B. Horton         63   Senior Vice President, General Counsel and Secretary
Michael A. Hayes, PhD  45   Senior Vice President, Chief Technical Officer
John J. McCloy II      60   Director
Samuel A. Oolie        61   Director
Stephan Carlquist      42   Director
Morton Salkind         65   Director


   Jay M. Haft  currently  serves as Chairman of the Board of  Directors  of the
Company.  He served as President of the Company from November 1994 to July 1995.
He is also a Director of the Company's subsidiary,  NCT Audio Products,  Inc., a
position  which he has held since August 25, 1997.  Mr. Haft is a strategic  and
financial  consultant for growth stage companies.  He is active in international
corporate finance, mergers and acquisitions, as well as in the representation of
emerging growth companies.  He has actively  participated in strategic  planning
and fund raising for many high-tech  companies,  leading edge medical technology
companies  and  technical  product,  service and  marketing  companies.  He is a
Managing  General Partner of Gen Am "1" Venture Fund, an  international  venture
capital fund.  Mr. Haft is also a Director of numerous  other public and private
corporations,  including Robotic Vision Systems, Inc. (OTC), Extech, Inc. (OTC),
Encore Medical Corporation (OTC),  Viragen,  Inc. (OTC), PC Service Source, Inc.
(OTC), DUSA  Pharmaceuticals,  Inc. (OTC),  Oryx Technology Corp. (OTC),  Thrift
Management,  Inc. (OTC) and Conserver Corporation of America (OTC). He serves as
Chairman  of the Board of  Extech,  Inc.  He is  currently  of counsel to Parker
Duryee Rosoff & Haft, in New York. He was previously a senior corporate  partner
of such  firm  (1989-1994),  and prior to that a  founding  partner  of  Wofsey,
Certilman, Haft et al (1966-1988).  He is a member of the Florida Commission for
Government  Accountability to the People, a National Vice-President of the Miami
Ballet and a Director of the Concert Association of Florida.

   Michael  J.  Parrella  currently  serves as  President  and  Director  of the
Company.  He was elected President and Chief Operating Officer of the Company in
February 1988 and served in that capacity  until  November  1994.  From November
1994 to July  1995 Mr.  Parrella  served  as  Executive  Vice  President  of the
Company. He initially became a director in 1986 after evaluating the application
potential of the  Company's  noise  cancellation  technology.  At that time,  he
formed an  investment  group to  acquire  control  of the Board and to raise new
capital to restructure the Company and its research and development efforts. Mr.
Parrella serves as President of NCT Audio Products, Inc., a position to which he
was elected on  September  4, 1997,  and was  appointed a Director on August 25,
1998. He was also Chairman of the Board of Environmental  Research  Information,
Inc., an environmental consulting firm, from December 1987 to March 1991.

   Irene  Lebovics  currently  serves as Senior Vice  President,  Marketing  and
Communications,  and President of NCT Headsets,  a division of the Company.  She
joined the Company as Vice President of NCT and President of NCT Medical Systems
(NCTM) in July 1989. In March 1990 NCTM became part of NCT Personal Quieting and
Ms. Lebovics served as President.  In January 1993 she was appointed Senior Vice
President of the Company. In November 1994, Ms. Lebovics became President of NCT
Headsets.  From August 1, 1995, to May 1, 1996,  she also served as Secretary of
the Company.  Ms. Lebovics has held various  positions in product marketing with
Bristol-Myers,  a consumer products  company,  and in advertising with McCaffrey
and McCall.

   Cy E. Hammond  currently  serves as Senior Vice  President,  Chief  Financial
Officer of the Company.  He joined the Company as Controller in January 1990 and
was  appointed a Vice  President in February  1994.  Mr.  Hammond also serves as
Treasurer  of NCT Audio  Products,  Inc.,  a position to which he was elected on
September 4, 1997.  During 1989,  he was  Treasurer  and Director of Finance for
Alcolac,  Inc., a multinational  specialty chemical producer.  Prior to 1989 and
from  1973,  Mr.  Hammond  served in several  senior  finance  positions  at the
Research Division of W.R. Grace & Co., the last of which included  management of
the division's worldwide financial operations.

   John B. Horton,  Esq.,  currently  serves as Senior Vice  President,  General
Counsel  and  Secretary.  He joined the  Company as Vice  President  and General
Counsel in September  1991,  assumed the office of Secretary in October 1991 and
was appointed a Senior Vice President in January 1993. Mr. Horton also serves as
Secretary  of NCT Audio  Products,  Inc.,  a position to which he was elected on
September 4, 1997.  From November 1, 1994 to May 1 1996,  Mr. Horton  engaged in
the private practice of law and served as a legal consultant to the Company.  On
May 1, 1996, he rejoined the Company as Senior Vice  President,  General Counsel
and  Secretary.  Between  1988  and  1991,  he was a Vice  President/Partner  at
Korn/Ferry  International,  a worldwide executive search firm. From 1986 through
1988, Mr. Horton was Vice President and General Counsel at Montchanin Management
Corporation,  a private investment banking firm. Prior thereto and from 1963, he
was engaged in the private  practice of law,  first as an  associate  and then a
partner at Satterlee, Warfield & Stephens in New York City and subsequently as a
partner  at Hall,  McNicol,  Hamilton  & Clark in New  York  City and  Stamford,
Connecticut.  At both law firms, Mr. Horton was a member of the firm's corporate
practice group.

   Michael A. Hayes,  Ph.D.,  currently  serves as Senior Vice President,  Chief
Technical  Officer after  joining the Company in 1996.  During 1995 and 1994 Dr.
Hayes served as Deputy Project Director,  Research Support for Antarctic Support
Associates,  with operations in Chile, New Zealand,  Australia,  and Antarctica.
From 1991 to 1994 he served as Deputy Program  Manager,  Special  Payloads,  for
Martin Marietta  Government  Services  (formerly a division of General Electric)
while  directly   managing   critical   spacecraft   sub-system  and  instrument
development for Goddard Space Flight Center. Prior to 1991 Dr. Hayes served as a
research  faculty  member at Georgia  Institute of  Technology,  and as a Senior
Process Engineer at Texas Instruments.

   John J. McCloy II currently serves as a Director of the Company. He served as
Chief Executive  Officer of the Company from September 1987 to November 1994 and
as its Chairman of the Board from September 1986 to November 1994.  Additionally
he served as Chief Financial  Officer from November 1990 to February 1993 and as
its  Secretary-Treasurer  from October 1986 to September  1987.  Mr.  McCloy was
appointed a Director of the Company's subsidiary,  NCT Audio Products,  Inc., on
November 14, 1997, and currently  serves as a Director.  Since 1981, he has also
been a private  investor  concentrating  on  venture  capital  and  early  stage
investment projects in a variety of industries. Mr. McCloy is also a director of
American  University  in Cairo,  the Sound Shore Fund,  Inc.,  and the  Atlantic
Council.

   Sam Oolie  currently  serves as a Director  of the  Company.  Mr.  Oolie also
serves as a Director of the Company's  subsidiary,  NCT Audio Products,  Inc., a
position to which he was  appointed  on  September  4, 1997.  He is Chairman and
Chief  Executive  Officer of NoFire  Technologies,  Inc., a manufacturer of high
performance  fire  retardant  products,  and has held that position since August
1995. He is also Chairman of Oolie Enterprises,  an investment company,  and has
held that position since July 1985. Mr. Oolie currently  serves as a director of
Avesis,  Inc. and Comverse  Technology,  Inc. He has also been a director of CFC
Associates, a venture capital partnership, since January 1984.

   Stephan  Carlquist was elected as a Director of the Company on July 14, 1997,
and currently serves as a Director of the Company. Mr. Carlquist also has served
as a Director of NCT Audio Products,  Inc. since November 14, 1997 and continues
to serve  as a  Director  of that  company.  He is  President  of ABB  Financial
Services,  Inc.  (USA),  one of four business  segments in the ABB Group and has
held that  position  since May 1993.  Mr.  Carlquist  is also  President  of ABB
Treasury  Center (USA),  Inc. and has held that position since June,  1990. From
April,  1988 to 1990 he was the Executive  Vice  President of ABB World Treasury
Center,  Zurich, and from April, 1986 to April, 1988 he was the President of the
Geneva  branch of Asea  Capital  Corporation.  Mr.  Carlquist  joined Asea AB in
September,  1983 as Manager,  International  Cash  Management and served in that
capacity until April,  1986. From February,  1981 to April, 1983 he was employed
as a Foreign  Exchange/Cash Manager at Atlas Copco AB. Mr. Carlquist serves as a
member of the following  Boards:  ABB  Financial  Services,  Inc.,  ABB Treasury
Center USA, Inc., ABB Treasury Center  (Canada),  ABB Treasury Center  (Brazil),
ABB Project & Trade Finance,  Inc., ABB Investment Management  Corporation,  ABB
Credit, Inc., Sirius Americas Corporation,  ABB Industrial Systems,  Inc., SUSA,
Inc., and Swedish-American Chamber of Commerce, New York.

   Morton Salkind currently serves as a Director of the Company. Mr. Salkind was
elected as a Director of the Company's subsidiary,  NCT Audio Products, Inc., on
September 4, 1997 and  currently  also serves as a Director of that  subsidiary.
Formerly he served as a New Jersey State  Lottery  Commissioner  for five years.
This followed previous elective and appointive offices at the state,  county and
municipal levels. Mr. Salkind is currently retired.

     Section  16(a) of the  Securities  Exchange  Act of 1934,  as amended  (the
"Exchange Act"), requires the Company's officers and directors,  and persons who
own more than 10% of a registered class of the Company's equity  securities,  to
file  reports of  ownership  and changes in ownership  with the  Securities  and
Exchange Commission.  Officers,  directors and greater than 10% stockholders are
required by regulations of the Securities and Exchange Commission to furnish the
Company  with  copies of all such  reports.  Based  solely on its  review of the
copies of such reports received by it, or written  representations  from certain
reporting  persons that no reports were required for those persons,  the Company
believes that, during the period from January 1, 1997, to December 31, 1997, all
filing requirements applicable to its officers,  directors, and greater than 10%
stockholders  were  complied  with,  except  that  Morton  Salkind  and  Stephan
Carlquist  each filed a Form 3 late and Sam Oolie and Jay Haft each filed a Form
5 late.


ITEM 11.    EXECUTIVE COMPENSATION

   Information  required  under this item is  contained  in a  definitive  proxy
statement which the Registrant anticipates will be filed by April 30, 1998, and
is incorporated herein by reference.


ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
            AND MANAGEMENT

   Information  required  under this item is  contained  in a  definitive  proxy
statement which the Registrant anticipates will be filed by April 30, 1998, and
is incorporated herein by reference.


ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   In October 1990, the Company's Board of Directors  authorized the issuance of
warrants to acquire  420,000  shares of common stock to each of Messrs.  McCloy,
Parrella and Oolie and Ms. Lebovics,  exercisable through September 30, 1994, at
$.375 per share,  being the market  price of the  Company's  common stock on the
date of such  authorization,  based upon each such person's commitment to extend
his or her personal  guarantee  on a joint and several  basis with the others in
support  of  the  Company's  attempt  to  secure  bank  or  other  institutional
financing,  the amount of which to be covered by the guarantee  would not exceed
$350,000.  No firm  commitment  for any such  financing  has been secured by the
Company and at present no such financing is being sought.  However, each of such
persons'  commitment  to  furnish  said  guarantee  continues  in full force and
effect.

   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, Co-Chairman, and Chief
Executive Officer of the Company,  shares investment  control over an additional
24% of the outstanding  capital of ERI. The Company believes that the respective
terms  of  both  the  establishment  of the  joint  venture  with  ERI  and  its
termination  were comparable to those that could have been negotiated with other
persons or entities. During the fiscal year ended December 31, 1996, the Company
was not required to make any such payments to ERI under these agreements.

   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,  1994,  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.  During the
fiscal year ended  December  31,  1996,  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, 1996, the Company made
no payments to QSI for project management services.

   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 include
NCT's  failure to develop the products or the failure of the parties to agree on
ertain  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.

   The Company believes that the terms of its agreements with QSI are comparable
to those that it could have negotiated with other persons or entities.




<PAGE>


                                          PART IV


ITEM 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K

(a) The following documents are filed as part of this Report:

(1)   Financial Statements.

Independent Auditors Report

Consolidated Balance Sheets, as of December 31, 1996, and 1997.

Consolidated  Statements of  Operations,  for the years ended December 31, 1995,
1996 and 1997.

Consolidated  Statements of Stockholders'  Equity,  for the years ended December
31, 1995, 1996 and 1997.

Consolidated  Statements of Cash Flows,  for the years ended  December 31, 1995,
1996 and 1997.

Notes to the Consolidated Financial Statements.

(2)   Financial Statement Schedules.

Report of Independent Auditors with Respect to Schedule.

Schedule:

II.      Valuation and Qualifying Accounts.

Other financial statement schedules are omitted because the conditions requiring
their filing do not exist or the information required thereby is included in the
financial statements filed, including the notes thereto.

(3)   Exhibits.

      Exhibit
      Number      Description of Exhibit

       3(a)       Restated  Certificate of Incorporation of the Company filed in
                  the Office of the  Secretary of State of the State of Delaware
                  on  September  23, 1996,  incorporated  herein by reference to
                  Exhibit 3(a) to the  Company's  Quarterly  Report on Form 10-Q
                  for the quarter ended September 30, 1996.

       3(b)       Certificate  of  Amendment  of  the  Restated  Certificate  of
                  Incorporation  of  the  Company  filed  in the  Office  of the
                  Secretary  of State of the State of Delaware on June 20, 1997,
                  incorporated  by reference  to Exhibit  3(a) to the  Company's
                  Quarterly  Report on Form 10-Q for the quarter  ended June 30,
                  1997.

*      3(c)       Certificate  of   Designations,    Preferences  and  Rights of
                  Series C Convertible  Preferred  Stock of the Company filed in
                  the Office of the  Secretary of State of the State of Delaware
                  on October 29, 1997.

*      3(d)       Certificate   of  Increase  in  the  Number  of  Shares in the
                  Series C Convertible  Preferred  Stock of the Company filed in
                  the Office of the  Secretary of State of the State of Delaware
                  on November 14, 1997.

       3(e)       By-laws of the  Company,  incorporated  herein by reference to
                  Exhibit 3(b) to Amendment No. 1 to the Company's Annual Report
                  on Form 10-K for the fiscal year ended December 31, 1991.

       4(a)       Warrant  to  purchase  125,000  shares of Common  Stock of the
                  Company at a purchase  price of $.20 per share  issued to John
                  J. McCloy II, incorporated herein by reference to Exhibit 4(a)
                  to Amendment No. 1 to the Company's Annual Report on Form 10-K
                  for the fiscal year ended December 31, 1991.

       4(b)       Warrant #BW-1-R to purchase  862,500 shares of Common Stock of
                  the  Company at a purchase  price of $.75 per share  issued to
                  John J. McCloy II, incorporated herein by reference to Exhibit
                  4(b) to the  Company's  Annual  Report  on Form  10-K  for the
                  fiscal year ended December 31, 1996.

       4(c)       Warrant #BW-2-R to purchase  862,500 shares of Common Stock of
                  the  Company at a purchase  price of $.75 per share  issued to
                  Michael  J.  Parrella,  incorporated  herein by  reference  to
                  Exhibit 4(c) to the  Company's  Annual Report on Form 10-K for
                  the fiscal year ended December 31, 1996.

       4(d)       Warrant #BW-4-R to purchase  201,250 shares of Common Stock of
                  the  Company at a purchase  price of $.75 per share  issued to
                  Irene  Lebovics,  incorporated  herein by reference to Exhibit
                  4(d) to the  Company's  Annual  Report  on Form  10-K  for the
                  fiscal year ended December 31, 1996.

       4(e)       Warrant  #BW-9-R and  #BW-46-R to purchase  218,500  shares of
                  Common  Stock of the  Company at a purchase  price of $.75 per
                  share issued to Jay M. Haft,  incorporated herein by reference
                  to Exhibit 4(e) to the  Company's  Annual  Report on Form 10-K
                  for the fiscal year ended December 31, 1996.

*      4(f)       Secretary's Certificate dated March 20, 1998, as to a two
                  (2) year  extension  of the  expiration  dates of the Warrants
                  described in 4(b), (c), (d) and (e) above.

       4(g)       Warrant  Agreement,  dated as of January 20, 1988, between the
                  Company and American Stock Transfer Company, as Warrant Agent,
                  relating to certain  warrants to purchase  Common Stock of the
                  Company  at a price of $.40 per  share  issued  to Sam  Oolie,
                  Oolie Enterprises, John J. McCloy II, and Michael J. Parrella,
                  incorporated herein by reference to Exhibit 4(gg) to Amendment
                  No. 1 to the  Company's  Annual  Report  on Form  10-K for the
                  fiscal year ended December 31, 1991.

**    10(a)       1987 Incentive Stock Option Plan,  incorporated  herein by 
                  reference to Exhibit  10(b) to  Amendment  No. 1 on Form  S-1
                  to the  Company's  Registration Statement on Form S-18 
                  (Registration No. 33-19926).

**    10(b)       Stock Option  Agreement,  dated as of February 26, 1987,
                  between the Company and John J. McCloy II, incorporated herein
                  by  reference  to  Exhibit  10(b)  to  Amendment  No. 1 to the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1991.

**    10(c)       Stock Option  Agreement,  dated as of February 26, 1987,
                  between  the Company  and  Michael J.  Parrella,  incorporated
                  herein by reference to Exhibit 10(c) to Amendment No. 1 to the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1991.

**    10(d)       Stock Option  Agreement,  dated as of February 26, 1987,
                  between  the  Company  and Sam Oolie,  incorporated  herein by
                  reference to Exhibit 10(d) to Amendment No. 1 to the Company's
                  Annual Report on Form 10-K for the fiscal year ended  December
                  31, 1991.

**    10(e)       Stock  Option  Agreement,  dated as of June  17,  1987,
                  between the Company and John J. McCloy II, incorporated herein
                  by  reference  to  Exhibit  10(f)  to  Amendment  No. 1 to the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1991.

**    10(f)       Stock  Option  Agreement,  dated as of March 29,  1990,
                  between the Company  and Jay M. Haft,  incorporated  herein by
                  reference to Exhibit 10(m) to Amendment No. 1 to the Company's
                  Annual Report on Form 10-K for the fiscal year ended  December
                  31, 1991.

      10(g)       Lease,  dated  December  20,  1991,  between West Nursery Land
                  Holding Limited  Partnership ("West Nursery") and the Company,
                  as amended by a letter  amendment,  dated  December  20, 1991,
                  between West Nursery and the Company,  incorporated  herein by
                  reference to Exhibit 10(u) to Amendment No. 1 to the Company's
                  Annual Report on Form 10-K for the fiscal year ended  December
                  31, 1991.

      10(h)       Lease,  dated February 26, 1991,  between West Nursery and the
                  Company, as amended by a letter amendment,  dated February 26,
                  1991,  between  West  Nursery  and the  Company,  incorporated
                  herein by reference to Exhibit 10(v) to Amendment No. 1 to the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1991.

     10(i)        Lease  (undated),  between West  Nursery and the  Company,  as
                  amended by a letter amendment,  dated April 23, 1990,  between
                  West Nursery and the Company, incorporated herein by reference
                  to Exhibit 10(w) to Amendment  No. 1 to the  Company's  Annual
                  Report on Form 10-K for the  fiscal  year ended  December  31,
                  1991;

      10(j)       Agreement,  dated March 4, 1991,  between West Nursery and the
                  Company as amended by the First Amendment of Agreement,  dated
                  December  20,  1991,  between  West  Nursery and the  Company,
                  incorporated herein by reference to Exhibit 10(x) to Amendment
                  No. 1 to the  Company's  Annual  Report  on Form  10-K for the
                  fiscal year ended December 31, 1991.

      10(k)       Patent Assignment Agreement,  dated as of June 21, 1989, among
                  George B.B. Chaplin,  Sound Alternators  Limited, the Company,
                  Active  Noise and  Vibration  Technologies,  Inc.  and Chaplin
                  Patents Holding Co., Inc., incorporated herein by reference to
                  Exhibit 10(aa) to Amendment No. 2 on Form S-1 to the Company's
                  Registration   Statement  on  Form  S-18   (Registration   No.
                  33-19926).

      10(l)       Joint Venture and Partnership Agreement,  dated as of November
                  8, 1989, among the Company,  Walker  Manufacturing  Company, a
                  division of Tenneco,  Walker Electronic Mufflers, Inc. and NCT
                  Muffler,  Inc.,  incorporated  herein by  reference to Exhibit
                  (c)(1) to the  Company's  Current  Report  on Form 8-K,  dated
                  November  8, 1989,  as amended  on Form 8, dated  January  24,
                  1990.

      10(l)(1)    Letter  Agreement  between Tenneco  Automotive,  a division of
                  Tennessee Gas Pipeline Company, and the Company dated November
                  22, 1993, incorporated herein by reference to Exhibit 10(a) to
                  the Company's  Current  Report on Form 8-K dated  November 22,
                  1993.

      10(l)(2)    Stock  Purchase  Agreement  between  Tenneco   Automotive,   a
                  division of Tennessee  Gas Pipeline  Company,  and the Company
                  dated December 14, 1993,  incorporated  herein by reference to
                  Exhibit  10(b) to the  Company's  Current  Report  on Form 8-K
                  dated November 24, 1993.

      10(l)(3)    Transfer  Agreement  among  Walker  Manufacturing   Company  a
                  division of Tennessee Gas Pipeline Company,  Walker Electronic
                  Mufflers,  Inc.,  the  Company,  NCT  Muffler,  Inc.,  Chaplin
                  Patents  Holding  Co.,  Inc.  and  Walker  Noise  Cancellation
                  Technologies dated November 15, 1995,  incorporated  herein by
                  reference to Exhibit  10(l)(3) to the Company's  Annual Report
                  on Form 10-K for the fiscal year ended December 31, 1995. ***

      10(l)(4)    License  Agreement  between  Chaplin  Patents Holding Co.,
                  Inc. and Walker Electronic  Mufflers,  Inc. dated
                  November 15, 1995,  incorporated  herein by reference to 
                  Exhibit  10(l)(4) to the  Company's  Annual Report on Form
                  10-K for the fiscal year ended December 31, 1995. ***

      10(l)(5)    License  Agreement  between the Company and Walker  Electronic
                  Mufflers, Inc. dated November 15, 1995, incorporated herein by
                  reference to Exhibit  10(l)(5) to the Company's  Annual Report
                  on Form 10-K for the fiscal year ended December 31, 1995. ***

      10(l)(6)    Support,  Research  and  Development  Agreement  among  Walker
                  Electronic Mufflers,  Inc.,  the  Company,  NCT  Muffler,  
                  Inc.  and Chaplin  Patents Holding  Co.,  Inc.  dated  
                  November  15,  1995,  incorporated  herein  by reference to
                  Exhibit  10(l)(6) to the Company's Annual Report on Form 10-K
                  for the fiscal year ended December 31, 1995. ***

      10(l)(7)    Mutual Limited Release by (i) the Company,  NCT Muffler,  Inc.
                  and Chaplin Patent  Holding Co.,  Inc.  and (ii)  Tennessee  
                  Gas Pipeline  Company and Walker  Electronic  Mufflers,  Inc. 
                  dated November 15, 1995,  incorporated herein by reference to 
                  Exhibit  10(l)(7) to the Company's Annual Report on
                  Form 10-K for the fiscal year ended December 31, 1995. ***

      10(m)       Technical  Assistance and License  Agreement,  dated March 25,
                  1991,  among  the  Company,  Foster  Electric  Co.,  Ltd.  and
                  Foster/NCT Headsets International Ltd., incorporated herein by
                  reference  to  Exhibit  10(nn)  to  Amendment  No.  1  to  the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1991.***

      10(m)(1)    Amendment,  dated April 16, 1991, to Technical  Assistance and
                  License  Agreement,  dated March 25, 1991,  among the Company,
                  Foster   Electric   Co.,   Ltd.   and   Foster/NCT    Headsets
                  International  Ltd.,   incorporated  herein  by  reference  to
                  Exhibit  10(nn)(1) to Amendment No. 5 to the Company's  Annual
                  Report on Form 10-K for the  fiscal  year ended  December  31,
                  1991.

      10(m)(2)    Letter  Agreement  between  Foster  Electric Co., Ltd. and the
                  Company  dated  November  22,  1993,  incorporated  herein  by
                  reference to Exhibit 10(b) to the Company's  Current Report on
                  Form 8-K dated November 22,1993.

      10(m)(3)    Letter  agreement among Foster Electric Co., Ltd.,  Foster NCT
                  Headsets  International,  Ltd. and the Company  dated July 28,
                  1995, incorporated herein by reference to Exhibit 10(a) of the
                  Company's  Quarterly Report on Form 10-Q for the quarter ended
                  June 30, 1995.

      10(n)       Joint Development Cooperation Agreement,  dated June 28, 1991,
                  between AB Electrolux and the Company,  incorporated herein by
                  reference  to  Exhibit  10(oo)  to  Amendment  No.  3  to  the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1991.***

      10(n)(1)    Amendments  to the Joint  Development  Cooperation  Agreement,
                  dated June 28, 1991,  between AB Electrolux and the Company as
                  set  forth  in  the  First  Amendment  to  Joint   Development
                  Cooperation  Agreement,  dated  September 1, 1993,  between AB
                  Electrolux and the Company,  incorporated  herein by reference
                  to Exhibit  10(z)(1) to the  Company's  Annual  Report on Form
                  10-K for the fiscal year ended December 31, 1994.***

      10(n)(2)    Second Amendment to Joint Development  Cooperation  Agreement,
                  dated  January,  1994 between AB  Electrolux  and the Company,
                  incorporated  herein by reference  to the Exhibit  10(z)(2) to
                  the  Company's  Annual Report on Form 10-K for the fiscal year
                  ended December 31, 1994.

      10(o)       Letter  Agreement,  dated  March  19,  1992,  between  Siemens
                  Medical  Systems,   Inc.  and  NCT  Medical   Systems,   Inc.,
                  incorporated   herein  by  reference  to  Exhibit   10(pp)  to
                  Amendment  No. 1 to the  Company's  Annual Report on Form 10-K
                  for the fiscal year ended December 31, 1991.

      10(o)(1)    OEM  Agreement  between  the  Company  and  Siemens  AG  dated
                  November 24, 1993, incorporated herein by reference to Exhibit
                  10(a)  to the  Company's  Current  Report  on Form  8-K  dated
                  November 24, 1993.

**    10(p)       Noise  Cancellation  Technologies,  Inc. Stock  Incentive 
                  Plan (as adopted April 14, 1993, and amended through August 
                  16, 1996),  incorporated herein by reference to Exhibit 4 to 
                  the Company's  Registration Statement on Form S-8 filed with 
                  the  Securities  & Exchange  Commission  on August 30, 1996
                  (Reg. No. 333-11213).

      10(q)       Master Agreement between Noise Cancellation  Technologies,  
                  Inc. and Quiet Power  Systems,  Inc.  dated  March  27,  1995,
                  incorporated  herein  by reference to Exhibit  10(a) of the  
                  Company's  Current  Report on Form 8-K filed with the 
                  Securities and Exchange commission on August 4, 1995.

      10(q)(1)    Letter Agreement between Noise Cancellation Technologies, Inc.
                  and   QuietPower   Systems,   Inc.   dated  April  21,   1995,
                  incorporated  herein  by  reference  to  Exhibit  10(b) of the
                  Company's Current Report on Form 8-K filed August 4, 1995.

      10(q)(2)    Letter Agreement between Noise Cancellation Technologies, Inc.
                  and QuietPower Systems, Inc. dated May 21, 1996,  incorporated
                  herein by  reference  to  Exhibit  10(q)(2)  of the  Company's
                  Annual Report on Form 10-K for the fiscal year ended  December
                  31, 1996.

      10(q)(3)    Letter Agreement between Noise Cancellation Technologies, Inc.
                  and QuietPower Systems, Inc. dated April 9, 1997, incorporated
                  herein by  reference  to  Exhibit  10(q)(3)  of the  Company's
                  Annual Report on Form 10-K for the fiscal year ended  December
                  31, 1996.

      10(r)       Asset Purchase  Agreement,  dated September 16, 1994,  between
                  Active Noise and Vibration Technologies, Inc. and the Company,
                  incorporated herein by reference to Exhibit 2 to the Company's
                  Current Report on Form 8-K filed September 19, 1994.

**    10(s)       Noise Cancellation Technologies,  Inc. Option Plan for Certain
                  Directors (as  adopted  November 15, 1994  and amended through
                  August 16, 1996), incorporated  herein by reference to Exhibit
                  4 to the Company's Registration  Statement on  Form S-8  filed
                  with the Securities and Exchange Commission on August 30, 1996
                  (Reg. No. 333-11209).

      10(t)       Variation  of Teaming  Agreement  between  Noise  Cancellation
                  Technologies,  Inc. and Ultra Electronics  Limited dated April
                  6, 1995,  incorporated herein by reference to Exhibit 10(c) of
                  the  Company's  Current  Report  on Form 8-K  filed  August 4,
                  1995.)

      10(t)(1)    Agreement  for Sale and  Purchase of Part of the  Business and
                  Certain Assets among Noise  Cancellation  Technologies,  Inc.,
                  Noise   Cancellation   Technologies  (UK)  Limited  and  Ultra
                  Electronics  Limited dated April 6, 1995,  incorporated herein
                  by reference to Exhibit 10(d) of the Company's  Current Report
                  on Form 8-K filed August 4, 1995.

      10(t)(2)    Patent   License    Agreement    among   Noise    Cancellation
                  Technologies,   Inc.,  Noise  Cancellation  Technologies  (UK)
                  Limited  and Ultra  Electronics  Limited  dated April 6, 1995,
                  incorporated  herein  by  reference  to  Exhibit  10(e) of the
                  Company's Current Report on Form 8-K filed August 4, 1995)

      10(t)(3)    License  Agreement  between  Chaplin Patents Holding Co., Inc.
                  and  Ultra   Electronics   Limited   dated   April  6,   1995,
                  incorporated  herein  by  reference  to  Exhibit  10(f) of the
                  Company's Current Report on Form 8-K filed August 4, 1995.

      10(t)(4)    Patent   Sub-License   Agreement   among  Noise   Cancellation
                  Technologies,   Inc.,  Noise  Cancellation  Technologies  (UK)
                  Limited  and Ultra  Electronics  Limited  dated May 15,  1995,
                  incorporated  herein  by  reference  to  Exhibit  10(g) of the
                  Company's Current Report on Form 8-K filed August 4, 1995.

**    10(u)       Agreement among Noise Cancellation Technologies,  Inc., Noise 
                  Cancellation Technologies  (UK)  Limited,  Dr.  Andrew John  
                  Langley,  Dr.  Graham Paul Eatwell  and Dr.  Colin  Fraser
                  Ross dated  April 6,  1995,  incorporated herein by reference
                  to Exhibit  10(h) of the Company's  Current  Report on
                  Form 8-K filed August 4, 1995.

      10(v)       Securities  Purchase  Agreement  dated  April 8, 1996,  by and
                  among  the  Company  and  Kingdon  Associates,  L.P.,  Kingdon
                  Partners,  L.P. and M.  Kingdon  Offshore  NV,  together  with
                  Exhibit  A-1  thereto,  Form of Secured  Convertible  Note and
                  Exhibit   A-2   thereto,    Registration   Rights   Agreement,
                  incorporated  herein  by  reference  to  Exhibit  10(a) of the
                  Company's  Quarterly Report on Form 10-Q for the quarter ended
                  June 30, 1996.

      10(v)(1)    Security  Agreement dated April 10, 1996,  between the Company
                  and Kingdon  Associates,  L.P., Kingdon Partners,  L.P. and M.
                  Kingdon  Offshore  NV,  dated  August 13,  1996,  incorporated
                  herein  by  reference  to  Exhibit   10(b)  of  the  Company's
                  Quarterly  Report on Form 10-Q for the quarter  ended June 30,
                  1996.

      10(v)(2)    Notices of  Exercise of Options to  Purchase  Common  Stock by
                  Kingdon  Associates,  L.P.,  Kingdon  Partners,  L.P.,  and M.
                  Kingdon  Offshore,NV,  dated August 13, 1996,  incorporated by
                  reference to Exhibit 10(c) to the Company's  Quarterly  Report
                  on Form 10-Q for the quarter ended June 30, 1996.

      10(v)(3)    Notices of Conversion of Secured  Convertible Notes by Kingdon
                  Associates,  L.P.,  Kingdon  Partners,  L.P.  and  M.  Kingdon
                  Offshore NV, dated  August 13,  1996,  incorporated  herein by
                  reference to Exhibit 10(d) to the Company's  Quarterly  Report
                  on Form 10-Q for the quarter ended June 30, 1996.

      10(w)(1)    Cross  License  Agreement  dated April 15, 1997,  among Verity
                  Group plc,  New  Transducers  Limited  and Noise  Cancellation
                  Technologies, Inc., incorporated by reference to Exhibit 10(a)
                  to the Company's Quarterly Report on Form 10-Q for the quarter
                  ended June 30, 1997.***

      10(w)(2)    Security  Deed dated April 14, 1997,  from Noise  Cancellation
                  Technologies,  Inc.  to  Verity  Group  plc,  incorporated  by
                  reference to Exhibit 10(b) to the Company's  Quarterly  Report
                  on Form 10-Q for the quarter ended June 30, 1997.

      10(w)(3)    Common Stock Purchase  Option dated April 15, 1997, from Noise
                  Cancellation   Technologies,   Inc.   to  Verity   Group  plc,
                  incorporated  by reference to Exhibit  10(c) to the  Company's
                  Quarterly  Report on Form 10-Q for the quarter  ended June 30,
                  1997.

      10(w)(4)    Letter Agreement dated April 17, 1997, from Noise Cancellation
                  Technologies,  Inc.  to  Verity  Group  plc,  incorporated  by
                  reference to Exhibit 10(d) to the Company's  Quarterly  Report
                  on Form 10-Q for the quarter ended June 30, 1997.

      10(x)(1)    New Cross License  Agreement dated  September 27, 1997,  among
                  Verity Group plc, New Transducers Limited,  Noise Cancellation
                  Technologies,  Inc. and NCT Audio Products, Inc., incorporated
                  by  reference  to  Exhibit  10(a) to the  Company's  Quarterly
                  Report on Form 10-Q for the quarter ended September 30, 1997.

      10(x)(2)    Master License Agreement dated September 27, 1997, between New
                  Transducers Limited and NCT Audio Products, Inc., incorporated
                  by  reference  to  Exhibit  10(b) to the  Company's  Quarterly
                  Report on Form 10-Q for the quarter ended September 30, 1997.

      10(x)(3)    Letter   Agreement   dated  September  27,  1997,  from  Noise
                  Cancellation   Technologies,   Inc.   to  Verity   Group  plc,
                  incorporated  by reference to Exhibit  10(c) to the  Company's
                  Quarterly  Report on Form 10-Q for the quarter ended September
                  30, 1997.

      10(x)(4)    License  Agreement  dated  September  4, 1997,  between  Noise
                  Cancellation Technologies,  Inc. and NCT Audio Products, Inc.,
                  incorporated  by reference to Exhibit  10(d) to the  Company's
                  Quarterly  Report on Form 10-Q for the quarter ended September
                  30, 1997.

*     21          Subsidiaries

*     23(a)       Consent of Richard A. Eisner & Company, L.L.P.

*     27          Financial Data Schedule.

*     99(a)       Letter  from  Peters Elworthy & Moore, Chartered  Accountants,
                  to   Noise Cancellation Technologies, Inc.  regarding  audited
                  financial statements of  the Company's U.K.  subsidiaries  and
                  reports of Peters  Elworthy  &  Moore, Chartered  Accountants,
                  on their audits of such  financial  statements  as at December
                  31, 1997 and for the year ended December 31, 1997.

*     99(b)       Letter  from  Peters Elworthy & Moore, Chartered  Accountants,
                  to   Noise Cancellation Technologies, Inc.  regarding  audited
                  financial statements of  the Company's U.K.  subsidiaries  and
                  reports of Peters  Elworthy  &  Moore, Chartered  Accountants,
                  on their audits of such  financial  statements  as at December
                  31, 1996 and for the year ended December 31, 1996.

*     99(c)       Letter  from  Peters Elworthy & Moore, Chartered  Accountants,
                  to   Noise Cancellation Technologies, Inc.  regarding  audited
                  financial statements of  the Company's U.K.  subsidiaries  and
                  reports of Peters  Elworthy  &  Moore, Chartered  Accountants,
                  on their audits of such  financial  statements  as at December
                  31, 1995 and for the year ended December 31, 1995.

*     99(d)       Letter  from  Peters Elworthy & Moore, Chartered  Accountants,
                  to Noise Cancellation  Technologies, Inc. regarding  confirma-
                  tion that the accounts for the year end December 31, 1997 were
                  audited under auditing standards substantially similar to U.S.
                  General Accepted Auditing Standards.

*     99(e)       Letter  from  Peters Elworthy & Moore, Chartered  Accountants,
                  to Noise Cancellation  Technologies, Inc. regarding  confirma-
                  tion that the accounts for the year end December 31, 1996 were
                  audited under auditing standards substantially similar to U.S.
                  General Accepted Auditing Standards.

*     99(f)       Letter  from  Peters Elworthy & Moore, Chartered  Accountants,
                  to Noise Cancellation  Technologies, Inc. regarding  confirma-
                  tion that the accounts for the year end December 31, 1995 were
                  audited under auditing standards substantially similar to U.S.
                  General Accepted Auditing Standards.


-----------------------

   *  Filed herewith.

   ** Pertains to a management contract or compensation plan or arrangement.

   ***Confidential  treatment  requested  for  portions of this  document.  Such
      portions have been omitted from the document and  identified by asterisks.
      Such portions also have been filed separately with the Commission pursuant
      to the Company's application for confidential treatment.


(b) The  following  report on Form 8-K was filed  during the last quarter of the
period covered by this Report:

      A report on Form 8-K was filed on November 14, 1997, reporting the receipt
      and  acceptance  by the Company of Series C  Convertible  Preferred  Stock
      subscription  agreements  and the  consideration  received  by the Company
      thereunder  as of November 13, 1997,  and  including  unaudited  condensed
      consolidated balance sheets of the Company and its subsidiaries reflecting
      the reported transactions.
<PAGE>
F-1


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

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
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
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 and 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, LLP
New York, New York
February 27, 1998

<PAGE>
NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars except share and per share amounts)
F-2                                          
                                                           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)                                      $       -  $ 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>
NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
F-3
<CAPTION> 
                                                     (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>
NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
F-4
(In thousands of dollars and shares)
<CAPTION>
                                                                                     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>

<PAGE>
F-42
<TABLE>
NOISE CANCELLATION TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
                                                                   (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, options 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 feature on
       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 a
       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
                                                              =========        ========    ========

See Notes  6 and 11 with  respect  to  settlement  of  certain  obligation  by
issuance of  securities.  

See notes to consolidated financial statements.
</TABLE>


<PAGE>

                             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  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.

<PAGE>
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:

Products 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 or upon  completion of any  performance
criteria specified within the agreement. See Note 3, with respect to the license
fee 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  the  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.


<PAGE>

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
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                   $3,994          $90          $61
Technologies
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:

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.

<PAGE>

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                                 (2,873)      (3,447)
  depreciation
                                              ------------ ------------
       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 fourt 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 $(.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.

   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
                       -------   -------- -------- --------- -------- --------
Outstanding at         
 beginning of year     1,790,472  $0.58  1,540,000   $0.56  1,500,000    $0.54
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
 at year-end           1,540,000  $0.56  1,500,000   $0.54  1,350,000    $0.51
                       =========        ==========         ==========


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

   Information  with respect to non-plan stock option  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
                       ------  --------  -------  -------- ------     --------
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
                       ========          =======           =========

   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 and certain directors.



<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
                       --------   --------  -------- --------  ------   --------
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
                       =========           =========          =========

   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.

   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
                      ------     --------  ------    -------- ------   --------
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
                        =======            =======           ========

     As of December  31,  1997,  there were 75,000  options for the  purchase of
shares available for future grants under the Directors Plan.

     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
     Plan       Range of         Out-       (In        Exercise Exer-   Exercise
  Plan          Exercise Price   standing   Years)     Price    cisable   Price
--------------  --------------   ---------  ---------  -------  -------  -------
1987 Plan       $0.50 to $0.63   1,350,000   1.18      $0.51   1,350,000   $0.51
               
Non-Plan        $0.27 to $5.09   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
              


Warrants:

   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.

   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
                       ------- -------- -------  --------  -------     --------
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
                     =========         =========           =========


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   NumberPrice  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
 


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 include
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.

Other Parties

   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.

   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.


   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:


<PAGE>



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

NOISE CANCELLATION TECHNOLOGIES, INC.

By:   /s/ MICHAEL J. PARRELLA                              Date: March 31, 1998
      -----------------------
      President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  Registrant and
in the capacities and on the dates indicated.

           Signature                  Capacity          Date
  ------------------------------------------------------------------------


  /s/ MICHAEL J. PARRELLA      President and Director      March 31, 1998
  ---------------------------- (Principal Executive 
      Michael J. Parrella            Officer)        
                                


  /s/ CY E. HAMMOND           Senior Vice President and    March 31, 1998
  ---------------------------- Chief Financial Officer
      Cy E. Hammond           (Principal Financial and
                                 Accounting Officer)  
                              


  /s/ JAY M. HAFT               Chairman of the Board
  ----------------------------  of Directors and Director  March 31, 1998 
      Jay M. Haft               


  /s/ JOHN J. McCLOY II               Director             March 31, 1998
  ----------------------------
      John J. McCloy II


  /s/ SAMUEL A. OOLIE                 Director             March 31, 1998
  ----------------------------
      Samuel A. Oolie


  /s/ MORTON SALKIND                  Director             March 31, 1998
  ----------------------------
      Morton Salkind


  /s/ STEPHAN CARLQUIST               Director             March 31, 1998
  ----------------------------
      Stephan Carlquist

<PAGE>



                        (Richard A. Eisner & Company, LLP Letterhead)

INDEPENDENT AUDITORS' REPORT ON SCHEDULE II

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

     Our  audits  were  conducted  for the  purpose of forming an opinion on the
basic  consolidated  financial  statements  taken  as a whole.  The  information
included on Schedule II is presented for purposes of additional  analysis and is
not a  required  part  of the  basic  consolidated  financial  statements  as at
December  31, 1996 and 1997 and for each of the years in the  three-year  period
ended December 31, 1997 taken as a whole.  The information  included on Schedule
II is presented for purposes of  additional  analysis and is not a required part
of the  basic  consolidated  financial  statements.  Such  information  has been
subjected  to the  auditing  procedures  applied  in  the  audits  of the  basic
consolidated  financial  statements and, in our opinion, is fairly stated in all
material  respects in relation to the basic  consolidated  financial  statements
taken as a whole.  Also, such schedule presents fairly the information set forth
therein  in  compliance  with  the  applicable  accounting  regulations  of  the
Securities and Exchange Commission.




/s/ RICHARD A. EISNER & COMPANY, LLP

New York, New York
February 27, 1998

<PAGE>


                                   SCHEDULE II
NOISE CANCELLATION TECHNOLOGIES, INC. AND
SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(In thousands of dollars)
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
Column A                                           Column B       Column C         Column D        Column E       Column F
---------------------------------------------------------------------------------------------------------------------------
                                                                  Additions
                                                   Balance at     charged to                                      Balance
                                                   beginning      costs and        Decuctions      Deductions     at end
       Description                                 of Period      expenses         describe        describe       of period 
---------------------------                        ----------     ----------       ----------      ----------     ---------
<S>                                                <C>            <C>              <C>             <C>            <C> 
Year ended December 31, 1995:
  Allowance for doubtful accounts                  $      901     $      552       $    1,334(2)   $        -     $     119
                                                   ==========     ==========       ==========      ==========     =========

Year ended December 31, 1996:
  Allowance for doubtful accounts                  $      119     $      192       $      188(2)   $        -     $     123
                                                   ==========     ==========       ==========      ==========     =========

Year ended December 31, 1997:
  Allowance for doubtful accounts                  $      123     $      130       $       65(2)   $      150(3)  $      38
                                                   ==========     ==========       ==========      ==========     =========

Year ended December 31, 1995:
  Allowance for inventory obsolence                $    2,025     $      452       $    2,122(1)   $        -     $     355
                                                   ==========     ==========       ==========      ==========     =========

Year ended December 31, 1996:
  Allowance for inventory obsolence                $      355     $        -       $       93(1)   $        -     $     262
                                                   ==========     ==========       ==========      ==========     =========

Year ended December 31, 1997:
  Allowance for inventory obsolence                $      262     $      210       $        -      $        -     $     472
                                                   ==========     ==========       ==========      ==========     =========

Attention is directed to the foregoing accountants' reports and to the accompanying notes to the consolidated financial statements.
(1) To write off reserves  applied to December 31, 1994 and December 31, 1995
    inventory.  
(2) To write off fully reserved accounts receivable deemed uncollectible. 
(3) To reduce reserve for accounts collected.
</TABLE>